Shadow Banking, Financial Stability, and Regulatory Arbitrage in Nigeria: An Original Theoretical and Policy Framework

Shadow banking in Nigeria, encompassing unregulated credit intermediation by fintech lenders, cooperative societies, informal money lenders, and unregistered investment schemes, poses systemic financial stability risks that are inadequately theorised and poorly regulated. This study develops an original theoretical framework for understanding the growth, interconnectedness, and financial stability implications of shadow banking activities in the Nigerian financial system, and derives empirically-grounded regulatory design principles. The theoretical framework integrates regulatory arbitrage theory, systemic risk amplification models, and the credit cycle theory to explain shadow banking growth as a supply-side response to prudential regulation-induced credit gaps and a demand-side response to financial exclusion. An original Nigerian Shadow Banking Activity Index is constructed using data from the National Bureau of Statistics, the Securities and Exchange Commission, and primary data from 120 financial industry specialists, covering informal credit volume, unregistered investment scheme activity, and cooperative society financial intermediation. Structural equation modelling and qualitative comparative analysis were employed. Results confirm that shadow banking growth accelerates during periods of bank credit tightening, with a lag of two to three quarters, consistent with regulatory arbitrage dynamics. Shadow banking interconnectedness with the formal banking system through shared funding sources and borrower overlap amplifies systemic risk. An original tiered regulatory framework, calibrated to shadow banking activity type and systemic interconnectedness, is proposed as the primary policy contribution of the study.

Keywords: shadow banking, financial stability, regulatory arbitrage, systemic risk, Nigeria