Institutional Quality, Monetary Policy and Banking System Stability in Nigeria

Abstract

The study used a Generalized Method of Moments to examine the effect of six IQ indices (voice and accountability, rule of law, regulatory quality, government effectiveness, corruption control and political stability and absence of violence) and MP tools (monetary policy rate, loan-deposit ratio, lending rate, logarithm of broad money supply and banking system liquidity ratio) on the Z-Score, a proxy for banking system stability. The study found that, among the six MP indices, only corruption control index has a positive and significant effect on bank stability (coefficient = 0.245124, p = 0.0042). Also, out of five MP variables, only the loan-deposit ratio has a significantly positive effect on bank stability (coefficient = 0.0070482, p = 0.0072). The effect of the other IQ and MP indicators are not significant enough for inference purposes. We conclude that IQ affects banking system stability positively and significantly. We also found that MP affects the stability of the banking system positively and significantly. We recommend, among others, that authorities should continue to pursue zero corruption in institutions and that banks should be mandated to improve on the existing anti-corruption measures. Also the Central Bank of Nigeria should continue to maintain the range of loan-deposit ratio that has existed for many years. There is the need to re-appraise other IQ and MP variables with no significant positive effect on banking system stability in Nigeria.