Effect of Inward Capital Flows on Financial Stability in Nigeria

Abstract

Capital inflows could thwart monetary policies by stimulating reckless lending and asset bubbles, resulting in financial instability. This study examines the effect of inward capital flows on financial stability in Nigeria, spanning over 2003 to 2019. The hypotheses were tested using Error Correction Mechanism (ECM). The findings indicate that the short runs deviations will adjust to their long-run equilibrium by 10.9% quarterly. The findings show that inward FDI and inward portfolio investment have a positive effect on Nigeria’s financial stability, while other capital flows do not have a significant effect on Nigeria’s financial stability. Also, the analysis shows that controlling for macroeconomic factors such as GDP and inflation rate significantly affects Nigeria’s financial stability. Based on the findings, the study recommends that monetary authorities need to adopt and promote economic policies to increase FDI and entice portfolio investment with rewards such as better economic freedom and lower taxation to boost the country’s economy.