THE IMPACT OF FOREIGN DIRECT INVESTMENT ON THE NIGERIAN BANKING SECTOR

BANKING AND FINANCE PROJECT TOPICS AND MATERIALS

 

1.0 CHAPTER ONE

INTRODUCTION

  • BACKGROUND TO THE STUDY

Foreign direct investment is viewed as a major stimulus to economic growth in developing countries. Its ability to deal with two major obstacles, namely, shortages of financial resources and technology and skills, has made it the centre of attention for policy-makers in low-income countries in particular. Only a few of these countries have been successful in attracting significant FDI flows however. From the early 1970’s net resource flows to developing countries have followed an uneven path, but have risen rapidly since 1986 to an unprecedented U.S $285 billion in 1996(World Bank,1996).The fluctuating nature of private capital flows has played a key role in this. Whereas official flows have continued broadly unchanged after a peak in 1989-91 private capital flows have experienced two waves of explosive growth, the first from 1975 to 1981,dominated by bank lending involving a high proportion of recycled petrol-dollars, the second since 1990,dominated by foreign direct investment.

In the 1970s FDI made up only 12% of all financial flows to developing countries (World Bank, 1996). Between 1981 and 1984 there was a sharp fall in private lending as international banks lost confidence in borrowing countries financial stability following the debt crisis of 1982. Since the mid 1980’s the growing integration of markets and financial institutions, increased economic liberalization, and rapid innovation in financial instruments and technologies, especially in terms of computing and telecommunications have contributed to a near doubling of private flows. Most significant has been the steady progression of FDI to a 35% share in 1990- 1996(World Bank, 1996). An examination of net private capital flows by income group reveals the fluctuating nature of those to middle-income countries which were severely affected by the debt crisis of 1982 and to a lesser extent by the 1994 Mexican crisis. Low income countries, on the other hand have seen a smoother rise in inflows of private capital. Most of them were less affected by the debt crisis, because of their low level of commercial bank loans, due, in part, to their previously closed economies and their lack of suitable financial markets. It was only towards the end of the 1970s that those in Asia in particular began to open their doors wider for foreign capital.

According to the World Bank, Nigeria is the second largest foreign direct investment recipient in Africa (World Bank, 1996). Traditionally FDI had been concentrated in the extractive industries, but there has been a recent diversification into the manufacturing, services (banking sector) and other sectors respectively. The regulatory frame-work for the promotion of foreign direct investment received a boost in Nigeria with the enactment of the Nigerian Investment Promotion Commission Act and the Foreign Exchange (Monitoring and Miscellaneous Provisions) Act all in 1995. A look at the trend of FDI in Nigeria since 1961 has shown that the economy has lagged in FDI inflows.Sectoral composition of FDI inflows into Nigeria lacks production oriented investment that could help integrate the economy into international production chains. On the aggregate, at N10371.5 and N2555.9million the naira equivalent of FDI inflows and outflows respectively was the highest for 40years (see table 6). It is equally interesting to know that the overvaluation of naira equally accounted for the seemingly heaviest net inflows of FDI into Nigeria in 1982 when the exchange rate was U.S$1.49 to N1 and the consequent FDI activities resulted in $2,414.8million. That is, with only N1, 624.9million, the recorded net flow in dollar terms was $ 2,414.8million.The huge net inflow was due to substantial unmerited profit from United Kingdom (UK) companies operating in Nigeria as well as due to other foreign liabilities which TNC’s affiliates operating in Nigeria from UK and USA were to pay as overseas commitments, but inadequate foreign exchange made such accrued payment impossible. A further analysis of the flows revealed that for two consecutive years (i.e. 1989 and 1990 activities of foreign investors, on the whole, resulted in Nigeria becoming a net exporter of capital resources (i.e. making more outflows than inflows) to the tune of $59.4 and $57.8 million respectively. Regional analysis of the flows has shown that American foreign investors were the most inconsistent in Nigerian economy. During the 40 years, they recorded 15 years of net outflow of net capital flows beginning from 1975. Both UK and Western European foreign investors recorded 4 years of net outflow of FDI each. Investors from other unspecified countries appeared most consistent as their inflow of capital always exceeded their outflows (except for three years i.e. civil war year of 1967, 1985 and the 1993).

The unprecedented explosion in the Nigerian banking industry during the late 1980s attested to how the performance of the operators in a sector can attract foreign investors. The launch of the Structural Adjustment Programme (SAP) in July 1986 opened the flood gate of applications for banking licenses both by foreign and domestic investors. There was a phenomenal increase in the number of registered banks in operation due to perceived high level of illegal arbitrage profits made from trading in foreign exchange. Between 1985 and 1992, for instance, the number of licensed commercial and merchant banks in the country increased from 40 to 120 (Uche/Osho, 1997). There was therefore massive influx of foreign investors into the banking sector during this period. The Nigerian banking sector propelled by the 2005 consolidation, is today steadily positioning itself as the key driver for the Nigerian economy. Though the challenges brought about by the global economic recession have created a lot of setback for the sector, it has remained consistent in growth. Recently, the financial times described it as the fastest growing sector of the Nigerian economy. Operating at the short term end, the sector was rated by Fitch Corporate (Fitch) as recording the highest credit growth among countries covered by Fitch during 2007/2008. For the banking sector to fully maximize its potential of driving Nigeria’s economic resurgence, and ultimately becoming a regional financial centre, experts say that there necessarily has to be an infusion of foreign players and capital from across borders. The entrance of foreign investors will benefit the country by providing deeper liquidity to the market with the resultant reduction in the cost of capital. This would in turn impact on production, employment and living standards. Given the competition amongst countries for foreign direct investment, Nigeria (especially the Nigerian banking sector) has the challenge of persuading astute investors to impact capital in Nigeria.  The recent global economic meltdown has however raised a lot of concern to economic analysts and development experts. Following the unprecedented level of capital flight that occurred during the last credit crunch, the challenge is whether foreign direct investment is a worthwhile activity at all.

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