Unmasking the Impacts of Monetary Policy Rate, Reserve Requirements, Open Market Operations, and Liquidity Ratio on Financial Stability in the Nigerian Banking Sector

This study examines the dynamic relationship between monetary policy instruments and financial stability in the Nigerian banking sector over the period 1992–2024. Specifically, it investigates the relationships between the monetary policy rate (MPR), cash reserve ratio (CRR), open market operations (OMO), and liquidity ratio (LRA), using the banking-sector Z-score as a proxy for financial stability and controlling for money supply relative to gross domestic product (M2/GDP) and the exchange rate (EXR). The study employs the autoregressive distributed lag (ARDL) framework to examine short-run dynamics and long-run relationships. The reported unit-root test results indicate a mixture of I(0) and I(1) variables, supporting the suitability of the ARDL approach, provided that no variable is integrated of order two. The bounds-test results indicate a long-run relationship across the four model specifications, with F-statistics of 5.873 for MPR, 4.925 for CRR, 4.381 for OMO, and 5.104 for LRA, all exceeding the reported 5% upper critical bound of 4.35. The reported long-run estimates show positive and statistically significant associations for MPR and OMO, whereas CRR is statistically insignificant and LRA has a negative and statistically significant coefficient. Money supply relative to GDP is positive and significant in the CRR and OMO specifications, while the exchange rate has negative and statistically significant coefficients in the MPR and LRA specifications. In the short run, changes in MPR and OMO are positively associated with financial stability, while changes in LRA and the exchange rate exhibit negative associations in their respective models; CRR is statistically insignificant. The error-correction coefficients are negative and statistically significant across all four specifications, indicating adjustment towards the estimated long-run relationships. Preliminary diagnostic tests do not identify significant residual normality, serial-correlation, functional-form or heteroscedasticity problems at the 5% level. However, the CUSUMSQ results for the OMO model indicate unusual residual behaviour around 2001 that warrants further investigation. The findings suggest that the estimated relationships between monetary policy instruments and banking-sector stability differ across specifications. Nevertheless, the absence of the original estimation dataset and workfile means that these results require reconstruction and independent verification before definitive empirical conclusions and policy recommendations can be established.