Financial freedom, market power and bank margins in sub-Saharan Africa

Author:Emmanuel Sarpong-Kumankoma, Joshua Abor, Anthony Quame Q. Aboagye, Mohammed Amidu
Position:Department of Finance, Business School, University of Ghana, Accra, Ghana
Pages:283-299
SUMMARY

Purpose This paper examines the effect of financial (banking) freedom and market power on bank net interest margins (NIM). Design/methodology/approach The study uses data from 11 sub-Saharan African countries over the period, 2006-2012, and the system generalized method of moments to assess how financial freedom affects the relationship between market power and bank NIM. Findings... (see full summary)

 
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Financial freedom, market
power and bank margins in
sub-Saharan Africa
Emmanuel Sarpong-Kumankoma,Joshua Abor and
Anthony Quame Q. Aboagye
Department of Finance, Business School, University of Ghana, Accra, Ghana, and
Mohammed Amidu
Department of Accounting, Business School, University of Ghana, Accra, Ghana
Abstract
Purpose This paper examines the effect of nancial (banking) freedom and market power on bank net
interestmargins (NIM).
Design/methodology/approach The study uses data from 11 sub-Saharan Africancountries over the
period, 2006-2012,and the system generalized method of momentsto assess how nancial freedom affects the
relationshipbetween market power and bank NIM.
Findings The authors nd that both nancial freedom and market power have positive relationships
with bank NIM. However, there is some indication that the impact of market power on bank margins is
sensitive to the level of nancial freedom prevailing in an economy. It appears that as competition
intensies, margins of banks in freer countries are likely to reduce faster than those in areas with more
restrictions.
Practical implications Competition policies could be guidedby the insight on how nancial freedom
moderatesthe effect of market power on bank margins.
Originality/value This study provides new empirical evidence on how the level of nancial freedom
affectsbank margins and the market power-bank margins relationship.
Keywords Competition, Market power, Banks, Financial freedom, Lerner, Net interest margins
Paper type Research paper
1. Introduction
Empirical research on the impact of market power or market structure on bank net interest
margins (NIM) has produced conicting results. Studies that have found a positive
(negative) relationship between market power (competition) and NIM include Almarzoqi
and Naceur (2015),Hawtrey and Liang (2008),Poghosyan (2013),Aboagye et al. (2008) and
Chirwa and Mlachila (2004). In contrast,Maudos and de Guevara (2004) show that the fall of
margins in the European bankingsystem is compatible with a relaxation of the competitive
conditions (increasein market power and concentration), as this effect has been counteracted
by a reduction of interest rate risk, credit risk and operatingcosts. On the other hand, while
Kasman et al. (2010) found marketpower to be a vital determinant of bank interest margin in
both new and old EU member countries, the effect was opposite for the two groups.
Beck and Hesse (2009) also found little evidencefor market structure explaining variation in
spreads or margins overtime for Uganda.
JEL classication D42, E43, G21
Bank margins
in sub-Saharan
Africa
283
Received29 May 2019
Revised28 October 2019
Accepted31 October 2019
Journalof Financial Regulation
andCompliance
Vol.28 No. 2, 2020
pp. 283-299
© Emerald Publishing Limited
1358-1988
DOI 10.1108/JFRC-05-2019-0066
The current issue and full text archive of this journal is available on Emerald Insight at:
https://www.emerald.com/insight/1358-1988.htm
The lack of consensus in the literature suggests the need to identify channels through
which market power affects bank interest margins. One potential channel is the freedom
with which banks are allowed to operate. In an ideal banking and nancing environment
where a minimum level of government interference exists, independent central bank
supervision and regulation of nancial institutions are limited to enforcing contractual
obligations and preventing fraud. Credit is allocated on market terms, and the government
does not own nancial institutions. Financialinstitutions provide various types of nancial
services to individuals and companies, and banks are free to extend credit, accept deposits
and conduct operations in foreign currencies. Foreign nancial institutions operate freely
and are treated the same as domestic institutions (Heritage Foundation, 2015). In such an
environment, banks may feel compelled to operate more efciently and reduce
intermediationcost.
Even so, an examination of the linksbetween economic freedom and bank performance is
very scanty in the literature. This is surprising given the importance of bank lending in
promoting economic developmentand the impact that economic freedom is likely to have on
the banking sector (Suan and Habibullah, 2010). Suan and Habibullah (2010) provide
empirical evidence on the positive impact of economic freedom on banksperformance in
Malaysia. Chortareas et al. (2013), also suggest that the higher the degree of an economys
nancial freedom, the higher the benets for banks in terms of cost efciency. Financial
freedom is a measure of the degree of restrictionsand controls in the nancial sector. When
nancial institutionsoperate in a less restricted environment, they are more likelyto engage
in competitive policies,resulting in higher levels of efciencies.
Given the difculty in understanding the channels between market power and bank
interest margins, this study seeks to assess the potential effect of nancial freedom on the
market powerNIMrelationship.
Beck et al. (2011) report that African banking is very expensive as reectedbyhighinterest
spreads and margins. Decompositions of interest rate spreads and margins point to high
overhead costs as the main driver. For instance, Beck and Cull (2013) report that net interest
margins in the median African country stood at 5.9 per cent in 2011, while they stood at 4.7 per
cent outside Africa. Similarly, the interest rate spread between lending and deposit rate was
10.3 per cent in Africa and 8.2 per cent outside. According to Honohan and Beck (2007), the high
spread between deposit and lending interest rates provides disincentives for both savings and
lending and is driven mainly by the absence of scale economies and very high risks because of
weak and underdeveloped contractual frameworks and economic and political volatility.
Indeed, as noted by Senbet and Otchere (2006), savings mobilization and credit allocation have
generally not improved by as much as expected, after years of reforms.
Further, banking marketsin this region are less competitive compared to other regions of
the world. African banks are also well-capitalized, quite liquid, more protable and fairly
stable (Beck and Cull, 2013;Honohan and Beck, 2007;Beck etal.,2011). But as competitive
conditions continue to improve with the gradual relaxation of remaining restrictions on
banking activities as reected inthe index of nancial freedom (Heritage Foundation, 2015),
how will bank efciency be affected? Will the comparatively high net interest margins
decline or increase? Our study contributes to the literature by addressing these issues and
other related matters.
The results reveal that both nancial freedom and market power have positive
relationships with bank net interest margins. However, there is some indication that the
impact of market power on bank margins is sensitive to the level of nancial freedom
prevailing in an economy. It appears that as competition intensies, margins of banks in
freer countries arelikely to reduce faster than those in areas with more restrictions.
JFRC
28,2
284

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