The Effect of Interest Rate on Savings in Nigeria



This study examined the effect of interest rates on savings in Nigeria Using multiple regression analysis. The study also carried out some diagnostic tests like heteroskedasticity, serial correlation test and stability test. This work made use of secondary data sourced from the central bank of Nigeria statistical bulletin from 1981 to 2014. The result of this regression analysis showed that the coefficient of interest rate was positive and the level of significance, 0.05 was less than the p-value so interest rate has a positive but insignificant relationship with savings in Nigeria. The control variable used (GDP and government expenditure) also showed positive but insignificant relationship with savings. This simply means that interest rate has no significant effect on savings in Nigeria. Rather, savings are affected by low income. Since the result shows a positive relationship between interest rates and saving, it was recommended that the central bank should adopt a policy of interest rates that will not only boost savings in Nigeria but also improve the level of investment which will in the long run increase the income of individuals and thereby increasing their level of savings and therefore that of the economy as a whole. Also the government should spend more on viable projects as it increases investment, income, savings and finally economic growth. The government should also provide enabling environment to thrive as this will increase income thereby increasing total savings of the country.














  • Background of the Study

Interest rate and savings are inseparably linked. They are among the economic variables that are of great importance to a large number of people, the government, business firms, entrepreneurs, foreign investors, the financial sector and the household. They are so important that they determine to a large extent the level of investment and the economic growth in an economy (Udude, 2015). Interest rate is an important economic price. This is because whether seen from the point of view of cost of capital or from the perspective of opportunity cost of funds, interest rate has fundamental implications for the economy either impacting on the cost of capital or influencing the availability of credit, by increasing savings (Acha and Acha 2011).

Interest rate is the opportunity cost of borrowing money from a lender to finance investment project. It is the price paid for the use of money. Interest rates play important role in controlling major macroeconomic variables. The primary role of interest rate is to help in the mobilization of financial resources and to ensure efficient utilization of resources for the promotion of economic growth and development (CBN 1970). Savings is defined as that portion of income after tax, which is not spent on consumption goods. Savings can also be seen as that part of income, which is not devoted to the purchase of household items and firm (McKinnon, 1973). Saving has been represented frequently as elastic with respect to interest so that an increase in interest rate would cause a relatively large increase in the volume of saving (Tucker, 1943). To effectively mobilize savings in an economy, the deposit rate must be relatively high and inflation rate stabilized to ensure a high positive real interest rate which motivates investors to save from their disposable income. However, there are various states of interest rates in the financial system. They are generally classified into two categories: Deposit and lending rates. Deposits rate are paid to savings and time deposits of different maturities, while lending rates are interest rates charged on loans to customers and they vary according to cost of loanable funds and lending margins.

A number of factors influence the behavior of interest rates in an economy. Prominent among these are the volume of savings, inflation, investment, government spending, monetary policy and taxation constitute the major source (supply) of credit while investment represents the major demand for credit. Therefore, the level of savings partly determines the level of interest rates. For instance, a decrease in the accumulation of loanable funds (savings) is bound to exert an upward pressure on interest rates, just as the reverse situation would tend to have a moderating effect.

Oresotu (1992) explains that the basic functions of interest rates in an economy in which individual economic agents take decisions as to whether they should borrow, invest, save and/or consume, are summarized by International Monetary Fund (IMF) under three aspect; namely:

  • Interest rates as return on financial assets serve as incentive to savers, making them defer present consumption to a future date.
  • Interest rates being a component of cost of capital affect the demand for and allocation of loanable funds; and
  • The domestic interest rate in conjunction with the rate of return on foreign financial assets and goods are hedged against inflation.

Interest rate therefore plays a crucial role in the efficient allocation of resources aimed at facilitating savings, investment, growth and development of an economy and its variation over time affects saving decisions. The need to promote an interest rate that will ensure increase in savings which increases investment and consequently enhance economic growth cannot be over emphasized. Deposit rates, lending rates, Treasury bill rate, interbank rate and Minimum Rediscount rate are all examples of interest rates. High saving rate encourages savings which means more lendable funds for investments.

Banks as financial intermediaries move fund and largely have the primary responsibility of financial intermediation in order to make fund available for economic agents. They move fund from surplus sectors/units to deficit sectors/units by accepting deposits and lending them out. The extent to which this could be done depend upon the rate of interest and level of development of financial sector as well as the saving and investment habit of the people. Hence, the availability of investible fund is therefore necessary for all investment in the economy which eventually translates to economic growth and development (Uremadu, 2006).

Consequently, the Nigerian Economy has been highly prone to interest rate volatility and fragility (CBN, 2000). Interest rates of all instruments have experienced very volatile movements. Inconsistencies have been the order of the day (Adewunmi, 1997). The problem of mobilizing savings and deposits has always been the bane of economic growth and development. The level of funds mobilization by banks is quite low due to a number of reasons, ranging from low savings deposit rates to the poor banking habits or culture of the people (Nnanna, Englama and Odoko, 2004). Also, another disincentive to funds mobilization according to these authors is the attitude of banks towards small savers. That is most banks target corporate customers and government deposits and pay little or no attention to the small savers. Admittedly, the services rendered to the small savers are more tasking on the banks, but there is need to encourage them to save. As a matter of fact, the funds from household savings are relatively cheaper and more stable than government deposits that are very volatile and expensive (Olayemi, 2013).

Prior to 1986, interest rates were fixed by the central bank of Nigeria (CBN) on the basis of policy decisions. The major objectives during this period were: to obtain socially optimum resources allocation to promote orderly growth in the financial market and facilitate flow of credit to the preferred sectors-agriculture, manufacturing etc. (Soludo, 2008). During the era of fixed interest rates, real interest rates were generally negative. The negative real interest rate had catastrophic consequences on the economy. It led to financial disintermediation, leading to low level of saving. Also leads to Low level of investment and low level of growth (Nwachukwu and Odigie, 2009).

Banks were allowed to determine deposit and lending rates according to market forces through negotiations with their customers


Fig.1 savings deposit ratio from 1970-2008



The situation in Nigeria is such that the saving ratio is so low.

This situation has affected productivity growth in Nigeria. Corroborating this, Iyoha (1998) maintained that the negative growth in real GDP in the mid-1980s could be attributed to a host of factors of which decline in investment and savings are a major factor. Nnanna (2003) also maintained that savings and investment culture in Nigeria is very poor relative to most economies of the world. Nnanna indicated that the domestic savings which averaged 15.7 percent of GDP during the period 1986-1989 declined significantly to 6.0 per cent between 1990-1994 while in 1996 and 1999, this ratio stood at 13.2 per cent and 14.5 percent respectively. Also in recent years, savings deposit rate (sdr) has been low as depicted by CBN (2009), in 2004, sdr was 4.4%,it came down to 3.8% in 2005, declined further to 3.1% in 2006, and rose to 3.5% in 2007 but fell to 2.8% and 2.9% respectively in 2008 and 2009. In a similar vein, the total savings as a ratio of gross domestic product has not been encouraging. CBN (2012) shows the total saving as a ratio of GDP in millions thus: in 2008, it stood at 16.95, rose to 23.25 in 2009, fell to 17.52 and 17.46 in 2010 and 2011 respectively; it rose slightly to 19.89 in 2012.

Since the introduction of SAP in 1986, Nigeria has experimented several monetary management policies, operating what the CBN termed “control deregulation, regulation and complete deregulation” at different periods. Interest rate rose following the deregulation of the financial sector (Soludo, 2008), what is unclear; however, is whether savings has increased with increasing interest rate. The directional flow of interest rate has a linkage to savings in an economy. This relationship calls for the need to examine the impact of interest rate on investment and savings in Nigeria, hence the need for this research work.

1.2 Statement of the Problem

Prior to the structural adjustment program (SAP) in 1986, the financial system of Nigeria was under stress which was as a result of the interest rates being fixed by the CBN. This period was called a period of financial repression of government regulations, laws, and other non-market restrictions preventing financial intermediaries from functioning at full capacity) as explained by Mckinnon& Shaw (1973). Real interest rates were generally negative as a result of the repressed regime and the consequences were financial disintermediation, leading to low savings, low investment and low growth. The low and sometimes negative real interest rates which discouraged savings increased the demand for loanable funds. The demand for credit soon exceeded the supply of funds while essential sectors of the economy were starved of funds (Obute, Asor and Idoko(2012). This led to inadequate availability of investible funds which is regarded as the necessary start for all investment in an economy. The economic shocks of the 1980s and the financial repression reduced the real growth rate and retarded the development process. Nigerian economy witnessed the introduction of Structural Adjustment Program (SAP) which shifted emphasis from public sector to private sector. The goal was to, among other things, encourage private domestic savings, private domestic investment and capital formation in order to enhance economic growth. By encouraging savings, resources were diverted from current consumption and invested in capital enterprises. Unfortunately things have not worked out as expected. Even after the SAP, Nigeria has very low savings rate as depicted by CBN (2009). In 2004, sdr was 4.4%,it came down to 3.8% in 2005, declined further to 3.1% in 2006, and rose to 3.5% in 2007 but fell to 2.8% and 2.9% respectively in 2008 and 2009. The use of interest rates as stimulants in savings mobilization has not been very effective in Nigeria. The argument put forwards as the cause is that financial sector is weak. For this reason, people prefer their money outside the banking system, which many believe is shallow and prone to distress. The reason why saving is not responsive to interest rates as highlighted by Acha (2011) are; lack of confidence in the banking system; low income and preference for cash.

In view of the above stated challenges, the questions are: to what extent does interest rate affect savings in Nigeria and how can Nigeria mobilize savings through interest rates. Hence, the need for this research work.

1.3 Objective of the Study

The main objective of this research work is:

To determine the effect of interest rate on savings in Nigeria over time.

1.4 Statement of Hypotheses

The following hypotheses have been formulated based on the objectives of study and the research questions;

: There is no significant impact of interest rate on savings in Nigeria.

: There is a significant impact of interest rate on savings in Nigeria

1.5 Significance of the study

The need for undertaking this study stems from the important role the rate of interest plays in determining the growth of savings and therefore investment and economic growth in Nigeria. This shall be of immense benefit to commercial banks in general, the general economy and to future researchers in the field of interest rate.

1.6 Scope and limitation of the Study

In order to carry out a comprehensive and meaningful research work on the critical effect of interest rate as a determining factor in the growth of savings in Nigeria, the study focuses on the effect of interest rate on savings in Nigeria starting from 1981-2014 using annual time series data.

The major constraint in this research work was getting access to the data used for the regression and some relevant materials needed to carry out the research work.