EFFECT OF FOREIGN DIRECT INVESTMENT ON FINANCIAL STABILITY IN NIGERIA

Abstract

The relationship between Foreign Direct Investment (FDI) and financial stability is of increasing concern among economies. The volume and structure of FDI can affect the stability of the financial system. This study examines the effect of foreign direct investment on financial stability in Nigeria between the first quarter of 2003 and the last quarter of 2019. An ex-post facto research design was adopted in this study and data were obtained from secondary sources. The data were subjected to a stationarity test using the Augumented Dickey-Fuller test, and the test result shows that all variables were integrated in the order of 1. The Johansen cointegration test result showed a long-run relationship between all the dependent and independent variables. The hypotheses were tested using the Error Correction Mechanism (ECM). It was found that the short runs deviations will adjust to their long-run equilibrium by 17.3% quarterly. The findings show that FDI as a percentage of GDP positively affects Nigeria’s financial stability. In contrast, FDI as a percentage of fixed investment and net FDI have a significant negative effect on Nigeria’s financial stability. The study, therefore, concluded that inflows of FDI play a significant role in Nigeria’s financial stability. Based on the findings, the study recommends that authorities such as Ministry responsible for trade, commerce, and investment create an enabling investment environment such as regulations for protecting investors’ interests to attract FDI into the system.
Keywords: Net FDI, FDI as a percentage of GDP, FDI as a percentage of fixed investment financial stability

Introduction
Financial stability refers to the smooth operation of the financial system’s critical components (financial markets, institutions, participants, instruments, and services). A stable financial system can efficiently allocate resources, manage financial risk, maintain employment levels, and eliminate volatile movements of financial assets that may affect its stability. Financial institutions such as commercial banks are reluctant to finance viable projects in the absence of financial stability, leading to a fall in assets’ intrinsic values. Consequently, affecting confidence in the financial system, leading to bank runs, rising inflation rates, or stock market crashes (World Bank Group, 2020).
Capital flows such as Foreign Direct Investment (FDI) play a significant role in a country’s financial stability. The volume and unexpected changes in FDI could disrupt financial stability. The inability of the financial system to absorb these shocks and, in turn, prevent disruptive tendencies could lead to crises. Data obtained from the National Bureau of Statistics has shown that FDI flows to Nigeria have been unpredictable from the 1980s to date.