A key lesson from the global financial crisis of 2007-2009 and the ensuing widespread economic dislocations is the reminder of the nexus between financial system stability and resilience, and macroeconomic stability. Also, emerging research efforts at exploring financial system stability, resilience and economic welfare have underscored the importance of diversity in the financial system. This study assessed Nigeria’s financial system stability and diversity. Specifically, the study sought to develop an Aggregate Financial Stability Index that is reflective of the intrinsic structure of the Nigerian financial services sector; develop an Aggregate Financial Diversity Index for the Nigerian financial services sector; investigate the determinants of aggregate financial stability index; and also investigate the relationship between the aggregate financial stability index and aggregate financial diversity index. Using annual and quarterly banking sector data for the period 2006-2015 and employing Principal Component Analysis, Hirschman-Herfindahl (HH) Index, Simpson Index, Simple Regression and Granger Causality, the study establishes that the Nigerian financial system shows a cyclical movement, and yet to achieve diversity. The study also found that, financial diversity positively influences financial stability and that there exists a bidirectional causal relationship between financial diversity and financial stability running from diversity to stability and vice versa. The study recommends that regulatory and supervisory authorities in Nigeria should include the diversity of financial services in their policy design as this will enhance, not only the stability of financial system, but also the economy as a whole. The Central Bank of Nigeria can also regularly monitor banks’ funding models to ensure that banks set up diverse funding plans to preempt a systemic crisis.
