One of the major components of the overall Nigerian economy is the informal sector. Transactions in this sector are conducted mainly in cash to avoid official detection, and this is capable of starving the banking system of the deposits needed to improve its liquidity. This is the first study that empirically examined the impact of informality on the liquidity of the banking system in Nigeria. The results indicate that informality impacts negatively on the liquidity of deposit money banks in Nigeria. Specifically, we found that a unit increase in the size of the informal sector results in 7.44% deterioration in the liquidity of deposit money banks. Based on these findings, the study recommends that deposit money banks in Nigeria should pursue policies and products that will assist them to capture the huge economic activities taking place in the informal sector, while the government (through the Central Bank of Nigeria, CBN) should also reconsider its policies that are capable of driving economic units underground. The study concludes that deposit money banks in Nigeria must work together with the CBN to achieve an all inclusive banking system, thereby reducing the negative impact of informality on the liquidity of deposit money banks in Nigeria.
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