Investigating the asymmetric effect of exchange rate on domestic credit volumes: evidence from Nigeria

Abstract

Increasing domestic credit is crucial for economic growth, particularly in developing countries like Nigeria, where it enables firms to mitigate exchange rate risks during periods of financial instability. This study employs the first-generation speculative attack model as its theoretical framework to examine the long-run asymmetric impact of exchange rate fluctuations on domestic credit in Nigeria from 1973 to 2022. The Non-linear Autoregressive Distributed Lag (NARDL) model is utilised to capture potential asymmetries. Notably, the findings indicate that currency appreciation shocks have stronger and more persistent effects on domestic credit compared to depreciations. Additionally, foreign interest rates and gross domestic product are identified as key drivers of credit expansion, while the domestic interest rate proves ineffective, underscoring structural vulnerabilities in monetary policy transmission. In light of these findings, policymakers should consider implementing asymmetric capital buffers and dynamic loan-to-value ratios to address the disproportionate impact of currency appreciation on credit expansion. Furthermore, adopting a managed float exchange rate system with strategic interventions is recommended to mitigate disruptive foreign exchange volatility.