Some
research effort has been devoted to examining the linkages between financial
instability and down turns in industrial growth. One major observation is that
money market booms and busts have preceded banking crises not only in developed
countries Davis
(1999) and Renaud (1999).
Based
on the above hypotheses of financial sector cycles, there are at least three
dimensions of INTERACTION BETWEEN INDUSTRIAL GROWTH AND COMMERCIAL BANK CREDIT.
First, bank interest rates may affect the
volume of bank credit for various
reasons. From the borrowers’ point of view, changes in the interest rates of
banks will have a large effect on their perceived wealth and borrowing
capacity, inducing them to change their borrowing plans and credit demand
(given positive costs of bankruptcy when net worth becomes negative). The low
liquidity and interest rate volatility of various bank services/products should
induce caution among borrowers in taking full account of loans for credit
rises. However, from the banks’ point of view, banks have been involved in
financial markets not only directly by owning investment loans, but also by
providing credit that are collateralized by assets. Giving credit to property
and construction companies along is one of the most procyclical and volatile
elements of banks’ provisioning.
Davis,
1993, accordingly adding these mechanisms together, changes in property prices
will have major impacts on banks’ asset quality and the value of bank capital,
and therefore affect banks’ credit capacity. Banks are willing to provide more
investment credits and property prices are higher, generating a propagation
mechanism through which credit cycles are strongly linked with each other. Such
a cycle may be exacerbated by capital inflows intermediated by domestic banks,
as in East Asia in the mid 1990s, as well as
poor regulation (Collyns and Senhadji, 2002).
A
further complementary effect may operate via the above mentioned financial
accelerator mechanism, whereby credit givers become less concerned about moral
hazard and adverse selection when net worth is high, as borrowers have more to
lose from default. This implies that changes in asset prices over the cycle
gives rise to procyclical feedback effects of agency costs on the cost of
external finance and hence on real corporate expenditures. This channel might
be more powerful if banks tend to underestimate the default risk of investment
related loans in a business boom and the moral hazard to which borrowers
financing business investments are subject. In practice, this tendency can be
the result of various factors, including poor risk management practice,
inadequate data or pervasive incentives of banks, including moral hazard linked
to the safety net (Herring and Wacher, 2002).
Second,
bank credit may affect industrial development via various liquidity effects.
Changes in credit availability and credit attitudes have a sizable impact on
the demand for real investment decisions, which will ultimately lead to changes
in economic prices. Zhu, (2002), it has been widely documented that floods of
capital seeking investment opportunities and the industrial competition among
financial institutions after financial deregulation helped to stimulate the
building frenzy phenomenon in a number of countries in the 1980s and 1990s,
Davis (1995) and Demirgue-Kunt and Detragiache (1998).
Hargraves
et al (1993) note in addition that financial liberalization tends to derive the
higher quality corporate borrowers to
the bond market and depositors to money funds, thus leading banks to take
excessive risks to re-establish margins. Finally, credit cycles can be driven
by common economic factors. Its behaviour is largely determined by economic
conditions and prospects (notably GDP and interest rates). On the other hand,
the state of economic activity also exerts important forces on the money
market. Changes in the business environment will cause demand and supply
imbalances in commercial property and generate variations in investments and
prises. These external shocks can arise from the demand side, such as changes
in income. Interest rates and demographic factors; or they can arise from the
supply side such as input costs as well as changes in restrictions enhancing
the availability of credit or land for development (Dokko et al 1999), Chen and
Patel (1998).
Financial
disclosure and business information transparency is a critical element in
ensuring more stable capital flows. Effective debtor-creditor and insolvency
regimes are critical to absorbing business failure and releasing assets for
productivity use, hence bank credit are essential ingredients in overcoming
industrial sector crises, IMF (2004).
Commercial
bank provides resources for social sector programmes to reduce the impact of
poor infrastructure on industrial crises. In the Republic of Korea,
banks helped the government create a financial supervisory commission and a
financial supervisory service combining four regulatory agencies. Banks are
helping the government support numerous small no medium enterprises, which are
under stress from the financial crises, in restructuring liabilities and
increasing their demand for credit. In Thailand, banks helped recapitalise
other financial intermediaries, strengthen the legal and regulatory framework
for the financial sector, and stress to specialized financial institutions
capacity to increase credit in order to ease credit contraction. Outside East Asia, banks have provided credit or non-credits
services with some degree of financial sector vulnerability, including
financial sector assessment policy reviews and intensive dialogue with
government authorities.
There are many reasons why formula
provision of financial services may be limited in Nigeria and other developing
countries, even after liberalization. High levels of government debt have often
constrained access to credit for private firms and individuals, and high
inflation has discouraged saving. Poor physical and institutional
infrastructure (e.g intermittent electricity supplies, inadequate
telecommunications services, weak institutions for contract enforcement etc)
raise the cost of provision, particularly to poor and rural areas. At the same
time, poorer people have no collateral or credit record and many countries lack
credit bureau, all of which serve to deter credit giving. Regulatory
requirements that guard against money laundering can also make it difficult for
poor people to open a bank account, as they may not have the necessary
documentation. Thus widening access to financial services may simply be
unprofitable in many cases. Indeed, given the many types of market failures
present in financial services, the market is likely to under-provide. It is
also the case that weak competition policy in some countries has results in
quite a concentrated financial sector even after liberalization, allowing high
spread to persist, which blunts incentives to expand access to unfamiliar and
risky market segments, even where they may be potentially profitable. And a
lack of detailed information about the characteristics of these market segments
has made it difficult for financial institutions to correctly assess the costs
and risk associated with expanding access to credit.
According to the theories of corporate
credit or finance, there are three main categories of sources to finance the
investment: first the internal finance, which depends on the retained earnings
of the firm, the only cost of this kind is the shareholders return and the
opportunity cost of this fund. Second, debt finance, this kind may be secured
debt or unsecured debt, which include loans, bonds, this cost of these kinds
represent in the interest payable plus any premium on repayment. Third equity
finance, share issues, ordinary and preference, the cost of these kinds are
earning price per share (EPS) and fixed dividend company should not only alter
its capital structure to take advantage of changes in the explicit and implicit
cost of various source of finance, but also to maximize control and capital
gearing for the company. External factors represented by the degree of the
development of the financial system and the changes in its structure affect the
investment decision Modighani and Miller (1958).
According to the theory of investment,
in the absence of financial restriction, firm investment depends on the (q
ratio) or the q value of the firm, which equal to the market value of the firm
to its replacement value, Jorgensem (1971).
When
the firm faces constraints on external finance its internal resources will determine
its investment. The degree of leverage of the firm (debt to capital ratio) also
depends on the development of the financial sector and its structure. When the
firm faces imperfect financial market this ratio decline and deter the
availability of external finance, even after controlling the q value,
Francisco, Norman, Loyza (2008).
Therefore,
we assume that the firms face better function of financial system when
investment is more responsive to q Tobin. Investment is less determined by the
firm cash flow. Investment is less negative affected by the firm liability
composition. There are a lot of applied literature investigated on this issue,
due to financial liberalization and the substantial change in the structure of
the financial market they concentrate on the effect of such change on the
growth and investment at the firm level.
The most recent literatures are the
study of Marten Comelmen: describe the developments that have transpired in Mexico’s
financial structure over the last two decades. Then he analyzed how the
increase in credit to the private sector brought about by these macroeconomic
and financial developments affected output and investment in different sectors
and therefore, growth in the Mexican economy. He argued that an increase in the
availability of credit has a relatively large effect on the output of those
sectors such as manufactures, durables, construction, and investment in the
construction sector.
The
financial sector limits, prices, pools and trades all the risks involved in a transaction
and provide incentives for savers to invest by matching potential earnings with
those risks. In contrast, distorted financial markets with high macroeconomic
instability, direct government involvement and weak regulations can have
extremely adverse effects on industrial sector and on economic growth in
general. As a result, the focus of much recent work on the financial sector has
been on deepening and broadening financial markets in developing countries and
on improving financial sector regulation, supervision and governance. The
increasing participation of commercial banks has been one of the most striking
structural changes experienced by banking systems in developing countries over
the past decade.
In
Nigeria
the number of banks stands at 24 due to the recent consolidation exercise.
Common argument against bank credit is that banks might tend to “cheery pick”
the most profitable customers, reducing financial risks and thus, affecting the
overall distribution of credit. In particular, the main area of concern is the
availability of credit to private investors and small firms. In many developing
countries, small firms account for a very significant share of total value
added and generate a large fraction of the total jobs in the economy.
Commercial
banks are perceived as having a comparative advantage over other credit
institutions in small business credit. This role is likely to be more important
in less developed countries that are generally more heavily dependent on bank
financing. In Argentina
for example, 79 percent of small industrial firms have bank debt (Lorens, Van
der Host, and Isusi, 1999).
Moreover,
small firms tend to have exclusive dealings with a single bank with which they
have a strong relationship, given the paucity of information on the risk
characteristics of individual investors or small firms. Therefore, access to
credit by private investors and small firms would be reduced if banks were to
neglect small firms and/or drive domestic micro-finance banks from the market,
destroying the information generated through bank-borrower relationship. It have been argued that commercial banks
seems to improve banking systems efficiency in the provision of credit to
investors and contribute to overall banking stability in developing countries
(See Dermirgue-Kunt, Levine, and Min (1998), Levine (1999), Barajas et al
(2000). On the other hand, the effect of bank credit on industrial sector in
developing countries especially in Nigeria remains largely unexplored.
While large banks are unlikely to replicate the credit methods of small
domestic micro finances banks technological innovation could offer them an
avenue for increasing small firm’s credit.
Mester
(1997) argues that advances in credit scoring methodologies, together with
enhanced computer power and increased data availability, are likely to change
the nature of small business credit. This suggests that there could be a
non-linear and in particular U-shaped relation between bank size and credit to
small firms. The literature for the US also suggests that the type of
bank may affect credit patterns. For example, the evidence from the U.S. indicates
that de novo entrants seem to devote larger shares of their assets to small
firms than other banks (Goldberg and White, 1998. Deyoung et al, 1999 and
Jenkins (2000).
Commercial
bank entry through merger and acquisition might have different effects on small
firm credit. Some studies find that, merger and acquisitions among small banks
led to increased propensity to give credit to small firms following their
consolidation (Peek and Rosengren, 1998), Walraven, 1997), Strahan and Weston
(1998), Berger et al (1998).
Using
the Kaminsky and Reinhard (1999) framework, Pugh and Dehesh (2001) argued that
financial liberalization has contributed to a closer interdependence between
property and industrial sector developments in a number of countries since the
1980s. In addition, some recent studies have looked into the real effects of
house price fluctuations.
Hendershott
and kane (1992) noted that the early 1990s credit crunch in the United states
could be partly attributed to capital rebuilding by financial institutions that
had made large real estate loses. Moreover, on the demand side, the recession
itself may have linked to a collapse in investment reflecting excessive capital
formation in terms of real estate. Ludwig and Slok (2002) suggested that, in
market-based economies, housing prices tend to have a significant effect on
consumption, similar is provided by Boone et al (2001) and Barrell and Davis (2004).
Laporta,
lopez-de Silanes, Shleifer and Vishny, (1999), Modigliani and Perotti (1998),
argued that the legal system in a country is a primary determination of the
effectiveness of its financial market based and bank based. Financial systems
may not be of primary importance for policy in the absence of a strong legal
system that can protect the rights of external investors, which financial
transactions are intermediated through.