Sources and impact of excess liquidity on monetary policy in Nigeria

Abstract

This paper examined the sources and effects of excess liquidity in the Nigerian banking system. The Deposit Money Banks (DMBs) in Nigeria do not hold voluntary reserve over and above the required reserve for precautionary reasons depending on their risk appetite. The practice over the years has been that DMBs constrained themselves by holding involuntary reserve which is a major concerns to the monetary authorities. The ideal situation is that banks should deploy excess reserves as loans to the public and invest in government securities, but on the contrary this is not done based on the profit maximisation tendencies of the DMBs. The Ordinary Least Squares (OLS) estimation result using monthly data from 2002 – 2012 showed that banks foreign assets and government deposits were important contributors to observed excess liquidity in the system. Government deposit featured as a key determinant of the demand for excess reserves. The paper also found a positive relationship between excess reserves and inflation.