Roles of Financial Markets in Economic Growth
In this article, Henry I. Osazuwa notes that financial markets play a pivotal role in economic development
Financial Market comprises securities exchange, commodities trading, and trade in their respective derivatives. Banking is a financial institution but distinguishable from a financial market based on their roles which are however complementary where corresponding growth exists, and both serve as props for economic sustenance. A lopsided growth in favour of banking practice creates a usurpation of functions, confusion of roles, and reduction of the other’s economic importance into a minuscule.
While banking practice and financial market are important predicates to the economy, the financial market is the cornerstone, because it creates wealth from which savings accrue and form revenue sources for the banks, which banking institutions utilise as redistributable assets on collateralised principles. Where savings is almost nonexistent as in Nigeria, the financial market is unorganised, and also not viable; the economy is shallow, meaning the people spend more on living than they earn. That economic environment has no incentive for creativity, and business enterprise suffers from lack of system support. Consequently, the viability of the banking institutions will either be in jeopardy or banking funds will generate from sources other than savings. The incessant banking reforms and recapitalisations in Nigeria is a classic example of how funding derive from extraneous sources.
Nigeria banking Institutions have gone wholesale into financial products to justify existence and augment revenue sources whereas banking in economies with healthy investment base continue to find savings a lucrative source of capital, using value additions to create niches and competitions. Although the strategy in Nigeria has increased banking assets tremendously, but because it is an economic aberration, it has never been able to give the economy any sustainable lift.
Empirically, investment reliance on collateralised funding, systems have been found to be ineffective to boost economic sufficiency as a result all such systems have presented a shallow economy. Researchers have repeatedly demonstrated this by developing a catalogue with countries operating banking products source of investment, and another for countries operating financial market as source of investment financing. The result was always incontrovertible! Countries deriving financing source from the financial market are mostly developed countries, meaning they have a deepened economy, while countries reliant on banking for investment are mostly third world countries, and all have shallow economies.
In Nigeria, because savings is scanty or non-existent, banking funds constitute the major source of investment, and the economy is thus shallow. The low purchasing power of the naira attests to the shallowness of the economy, and it will be simplistic to attribute the recession just to oil pricing challenges without reflecting on the impact of low productivity in non-oil sectors of the economy.
Infusion of dollar into the economy does not address the purchasing power problem of the naira, although it may give impetus by way of subsidy to import, it will not address the issues of living standard and unemployment. President Muhammad Buhari’s initial reluctance to deregulate the FX rate was a sure palliative, if it was matched with local productive stimulation.
The stimulation of local productivity will require more than random policy thrust; it will require structure, law, concertedness, and organisation. Nigeria lacks all of these, and could not have achieved the stimulation of local productivity on random policy thrust as a result the President’s initial reluctance to deregulation was overwhelmed by demand forces. Economic result responds to economic principles, Nigeria cannot be investing in consumer culture, when its problem is productivity and hope to achieve result.
The enabling environment for productivity can still be achieved with the President’s political will to resuscitate the Nigerian economy, by reforming the financial market with the primary objective to grow wealth. Wealth creation is the bye product of a viable financial market which Nigeria does not currently have, but could have through the strumming of the above factors.
There are a number of financial and intermediary institutions trading financial products in the country without the requisite market organisation due to absence of structure, and law as a result the objective of wealth creation is lost. Wealth creating function of the financial market is sustained through enabling structure, and effective regulation. To randomly apply market instrument or loosely assign Institutions to market operations undermines market confidence, and prevents participation which thus impairs wealth creation.
To understand the importance of regulation, structure, and control, it is important to look at the meaning of security transaction and commodity trading: Security transaction in its simplest sense is investment into a business venture at the control and management of another person who promises a profit in return for the investment, and the promise is the motivation for the investment. Security transaction is therefore more than stocks and bonds.
While this article is not to look at types of security items, regulation is crucial in ensuring that(i) a venture thus exist or that there is a meaningful intention for one to exist;(ii) the promise of profit is honoured; (iii) that savers are encouraged to invest. Regulation and structure is used to protect the public against exploitation, and to provide financing source for bona fide business growth. Although transactional exemptions from regulation can be created, law must enforce public protection against any form of investment exploitations, and Ponzi schemes.
Absence of regulation or ineffective regulation impairs growth because of the absence of market confidence. Regulation by itself will be tested and strained if the requisite structure is absent for monitoring, control, and enforcement. To guarantee investment, the regulation and control mechanism must be robust and proactive not only for protection but also for market creativity.
Commodity trading traditionally is the exchange of desiderata between parties, but corresponding with societal growth, satisfaction in trading started to assume complexities and trading started to evolve different platforms to achieve the most proximate satisfaction. As a result trading types evolved from the traditional and oldest exchange form known as cash market or spot delivery. Subsequently Forward Contract and Futures Contract evolved in sequence. Contingencies in trading also impacted the conditions of trade and so commodities could be bought OTC, on the exchange, or purchase may be on option basis.
Today satisfaction is still the key in trading and consequently trading objective is to manage the cost of risk, as a result there are mechanisms in commodities trading for risk redistribution like hedging. Hedging is just about managing risk, and could generate different sides of interests beside those of the buyer and seller of an underlining commodity; and those interest creates added value to the benefit of all, as well as distribute risk in the process. For a single commodity on trade, there could be different sides which operate as speculators, arbitrageurs, and hedgers. Commodity trading is now very complex, thus if Nigeria expects to participate in global trade on equal term, we should expect the other or counterparty to seek maximise satisfaction which we don’t seem ready to offer as yet. Spot delivery is how Nigeria currently trade, and does not only make us unprepared for global trade, it deprives the country of legitimate earnings and employment opportunities.
Financial market’s objective is wealth creation and the liquidity generated from its activities help not only to support savings, but the proliferation of capital sources in the market, for investment needed to stimulate innovativeness and enterprise. Enterprise, liquidity flow, volatility control, and market close proximities are all interdependent and inures from a principled legal and structural support which allows inherent mechanisms to play, and guarantee investment fungibility. Investors look for this environment, and foreign governments welcome their citizens’ entry into such market. Nigeria has more to gain if we evolve a viable financial market.
Financial market is pivotal to the resurgence in other sectors, and will kick start the Nigeria economy. As a viable Investment environment, Nigeria will be attractive to meaningful foreign investments and local participation. Unemployment, corruption, and other ails, which actually are symptoms of ineffectiveness in current status quo, will at worst become an exception to the rule.
Financial market is pivotal to the resurgence in other sectors, and will kick start the Nigeria economy. As a viable Investment environment, Nigeria will be attractive to meaningful foreign investments and local participation. Unemployment, corruption, and other ails, which actually are symptoms of ineffectiveness in current status quo, will at worst become an exception to the rule