Freedom, competition and bank profitability in Sub-Saharan Africa

Author:Emmanuel Sarpong-Kumankoma, Joshua Abor, Anthony Quame Q. Aboagye, Mohammed Amidu
Position:University of Ghana Business School, Accra, Ghana
Pages:462-481
SUMMARY

Purpose This paper aims to examine the effects of financial freedom and competition on bank profitability. Design/methodology/approach The study uses system generalized method of moments and data from 139 banks across 11 Sub-Saharan African countries during the period 2006-2012. Findings The results of the study show that higher market power (less competition) is... (see full summary)

 
FREE EXCERPT
Freedom, competition and
bank protability in
Sub-Saharan Africa
Emmanuel Sarpong-Kumankoma,Joshua Abor,
Anthony Quame Q. Aboagye and Mohammed Amidu
University of Ghana Business School, Accra, Ghana
Abstract
Purpose This paper aims to examine the effects of nancial freedom and competition on bank
protability.
Design/methodology/approach The study uses system generalized method of moments and
data from 139 banks across 11 Sub-Saharan African countries during the period 2006-2012.
Findings The results of the studyshow that higher market power (less competition) is positively relatedto
bank protability, but operating efciency is a more important determinant of protability than market
power. Also, both nancial freedom and economic freedom show a positive impact on bank prots. The
authors nd evidence that bankswith higher market power operating in countries with higherfreedom for
banking activities are more protable than their counterparts in countries with greater restrictions on
banking activities.
Practical implications The results have shown that allowing banks greaterfreedom to operate would
enhance their performance,without necessarily damaging the economy, as operatingefciency appears to be
a more importantreason for the observed protability than market power.
Originality/value This study provides insight on the ambiguousrelationship between competition and
bank protability by consideringthe moderating effect of nancial freedom which has not been taken into
accountin previousstudies.
Keywords Lerner index, Competition, Bank protability, Market power, Financial freedom
Paper type Research paper
1. Introduction
A sound and protable banking sector is better able to withstand negative shocks and
contribute to the stability of the nancial system. Therefore, the determinants of bank
protability have attracted the interest of academic research as well as of bank
management, nancial markets and bank supervisors (Athanasoglou et al., 2008).
Also, as suggested by the European Central Bank (2010), the question of what is an
acceptable level of bank protability is likely to play a pivotal role in the post-crisis
debate among banking executives, investors and regulators, considering the
enormous losses in the nancial crisis and the huge government intervention
required.
Indeed, bank protability is an intricate issue. Higher protability may raise
concerns about potential abuse of market power and risk-taking by banks. For instance,
while market power and regulations can avert arbitrage and keep returns high, standard
asset pricing models also suggest that arbitrage will ensure that riskier assets are
JEL classication G21, G28, L11
JFRC
26,4
462
Journalof Financial Regulation
andCompliance
Vol.26 No. 4, 2018
pp. 462-481
© Emerald Publishing Limited
1358-1988
DOI 10.1108/JFRC-12-2017-0107
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1358-1988.htm
compensated with higher returns (Flamini et al., 2009). And if higher protability is the
result of market power, then consumers could be disadvantaged through higher loan
rates, lower deposit rates, credit rationing and poor quality of nancial services
(Chortareas et al., 2011). Thus, high bank protability may call for policy interventions
to reduce bank entry barriers and other obstacles to competition, and to lower risk.
However, bank prots may be reinvested, which should produce safer banks and
promote nancial stability (Flamini et al., 2009). On the other hand, low protability in
the banking sector may suggest intense competition or inefciency in operations, either
of which requires appropriate policy responses on competition, quality of human capital
and cost of doing business.
Most recent studies on the relationship between bank competition and protability
test the structure-conduct-performance (SCP) and/or the efciency structure (ES)
hypotheses. Generally, the results have been mixed. While some have found support for
the SCP, other studies nd no evidence of market structure or market power having an
effect on bank protability. Instead, some have found that the level of bank protability
isexplainedbyefciency. Of course, even when market structure or market power is
found to affect protability, the outcome is not always the same. In some cases
protability is positively affected by market structure, while the effect is negative in
other situations. Support for the market power (MP) hypothesis has been found by
Tregenna (2009),Jeon and Miller (2002),Mirzaei et al. (2013) and Fu and Heffernan
(2009). In contrast, some studies report that the MP argument is not held in the banking
industry. Examples are Seelanatha (2010) and Chortareas et al. (2011). Instead, these
studies suggest that efciency seems to be the main driving force of increased bank
protability.
However, conspicuously absent in the banking literature is an examination of the links
between economic freedom and bank performance. The limited research in this area is
somewhat surprising given the importance of bank lending in promoting economic
development and the impact that economic freedom is likely to have on the banking sector
(Suan and Habibullah, 2010). Indeed, as noted by Hafer (2013), a number of studies have
found that nancial developmentand higher levels of economic freedom are associated with
(or cause) economic growth. The unanswered question, however, is whether the nancial
development-economic growth nexus reects inuences of economic freedom operating
through the nancial system (Hafer, 2013). Suan and Habibullah (2010) provide new
empirical evidence on the positive impact of economic freedom on banksperformance in
Malaysia. Chortareas et al. (2013), possibly the rst to directly investigate the dynamics
between the nancial freedom counterparts of the economic freedom index drawn from
the Heritage Foundation database and bank efciency levels, suggest that the higher the
degree of an economysnancial freedom, the higher the benets for banks in terms of
cost efciency. Financial freedom is a measure of the degree of restrictions and controls
in the nancial sector. When nancial institutions operate in a less restricted
environment they are more likely to engage in competitive policies, resulting in higher
levels of efciencies. Related studies include Smimou and Karabegovic (2010) who show
that changes in economic freedom have a positive impact on equity market returns, and
Hafer (2013) nds that countries with higher levels of initial economic freedom, on
average, exhibit greater levels of nancial intermediary development in subsequent
years.
Chortareas et al. (2013) have noted that studies that consider the effects of economic
freedom on bank performance typically treat the freedom index as one of the control
variables, and also focus on the aggregate (economic) freedom index and not on the
Sub-Saharan
Africa
463

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