Bank regulation and risk-taking in sub-Sahara Africa
| DOI | https://doi.org/10.1108/JFRC-12-2021-0104 |
| Published date | 20 June 2022 |
| Date | 20 June 2022 |
| Pages | 149-169 |
| Subject Matter | Accounting & finance,Financial risk/company failure,Financial compliance/regulation |
| Author | Sopani Gondwe,Tendai Gwatidzo,Nyasha Mahonye |
Bank regulation and risk-taking in
sub-Sahara Africa
Sopani Gondwe
School of Economics and Finance, Faculty of Commerce Law and Management,
University of the Witwatersrand, Johannesburg, South Africa and Financial Sector
Regulation Department, Reserve Bank of Malawi, Blantyre, Malawi, and
Tendai Gwatidzo and Nyasha Mahonye
School of Economics and Finance, Faculty of Commerce Law and Management,
University of the Witwatersrand, Johannesburg, South Africa
Abstract
Purpose –In a bid to enhance the stability of banks, supervisory authorities in sub-Sahara Africa
(SSA) have also adopted international bank regulatory standards based on the Basel core principles.
This paper aims to investigate the effectiveness of these regulations in mitigating Bank risk
(instability) in SSA. The focus of empirical analysis is on examining the implications of four
regulations (capital, activity restrictions, supervisory power and market discipline) on risk-taking
behaviour of banks.
Design/methodology/approach –This paper uses two dimensions of financialstability in relation to
two different sources of bank risk: solvency risk and liquidity risk. This paper uses information from the
World Bank RegulatorySurvey database to construct regulation indices on activity restrictionsand the three
regulationspertaining to the three pillars of Basel II, i.e. capital, supervisorypower and market discipline. The
paper then uses a two-step system generalisedmethod of moments estimator to estimate the impact of each
regulationon solvency and liquidity risk.
Findings –The overall results show that:regulations pertaining to capital (Pillar 1) and market discipline
(Pillar 3) areeffective in reducing solvency risk; and regulationspertaining to supervisory power (Pillar 2) and
activityrestrictions increase liquidity risk (i.e. reduce bank stability).
Research limitations/implications –Given some evidencefrom other studies which show that market
power (competition) tends to condition the effect of regulations on bank stability,it would have been more
informative to examine whether this is really the case in SSA, given the low levels of competition in some
countries.This study is limited in this regard.
Practical implications –The key policy implications from the study findings are three-fold: bank
supervisory agencies in SSA should prioritise the adoption of Pillars 1 and 3 of the Basel II framewor k
as an effective policy response to enhance the stability of the banking system; a universal banking
model is more stability enhancing; and there is a trade-off between strong er supervisory power and
liquidity stability that needs to be properly managed every time regulatory agencies increase their
supervisory mandate.
Originality/value –This paper provides new evidence on which Pillars of the Basel II regulatory
framework are more effectivein reducing bank risk in SSA. This paper also shows that theway regulations
affect solvency risk is different from that of liquidity risk –an approachthat allows for case specific policy
© Sopani Gondwe, Tendai Gwatidzo and Nyasha Mahonye. Published by Emerald Publishing
Limited. This article is published under the Creative Commons Attribution (CC BY 4.0) licence.
Anyone may reproduce, distribute, translate and create derivative works of this article (for both
commercial and non-commercial purposes), subject to full attribution to the original publication and
authors. The full terms of this licence may be seen at http://creativecommons.org/licences/by/4.0/
legalcode
Bank
regulation and
risk-taking
149
Received3 December 2021
Revised8 April 2022
16May 2022
23May 2022
Accepted27 May 2022
Journalof Financial Regulation
andCompliance
Vol.31 No. 2, 2023
pp. 149-169
EmeraldPublishing Limited
1358-1988
DOI 10.1108/JFRC-12-2021-0104
The current issue and full text archive of this journal is available on Emerald Insight at:
https://www.emerald.com/insight/1358-1988.htm
interventions based on the type of bank risk under consideration. Ignoring this dual dimension of bank
stabilitycan thus lead to erroneous policy inferences.
Keywords Bank regulation, Basel II, Solvency risk, Liquidity risk, Market discipline, Bank stability
Paper type Research paper
1. Introduction
A sound and stable banking system underpins economic growth and development and is crucial
in alleviating poverty and shared prosperity (World Bank, 2019). Some empirical studies also
find evidence in support of the bank stability and economic growth relationship (Jayakumar
et al.,2018;Lin and Huang, 2012;Pradhan et al., 2017;Levine, 2004). Banks, however, do not
always function in a beneficial manner to support this growth objective in the economy. For this
reason and to shield safe banks from risky ones, regulators have adopted prudential regulation
which is aimed at mitigating excessive risk-taking behaviour by banks, thereby reducing the
overall risk exposure in the financial system (Thakor, 2014). However, following the global
financial crisis (GFC), there have been divergent views, both in the public policy arena and
academic circles about the effectiveness of prudential regulation in mitigating bank risk (see, for
example, World Bank Global Financial Development Report, 2013;Organisation of Economic
Cooperation (OECD), 2009, 2011;Ayadi et al., 2016;Schaeck and Cihak, 2013).Itis,therefore,not
surprising that the interaction between bank risk and prudential regulations has become one of
the commonly researched areas in banking after the GFC (Barth et al.,2013;Saif-Alyousfiet al.,
2020;Danisman and Demirel, 2019;Pasiouras et al., 2009;Delis and Staikouras, 2011;Klomp and
de Haan, 2015). However, research that specifically investigates the impact of regulations on
bank risk in banking sectors of developing countries has received relatively less attention –yet
most of these countries have adopted international regulatory standards as prescribed by the
Basel Committee on Banking Supervision (BCBS).
In this paper, we examine the implications of prudential regulations on bank risk (stability)
in sub-Sahara Africa (SSA). The focus on the SSA banking sector is relevant for two reasons:
First, the banking sector in SSA is critical in serving as a source of investment finance as
capital markets are relatively undeveloped in many countries. Its effectiveness in achieving this
role can however be undermined by the type of regulatory policies implemented by supervisory
authorities (Triki et al., 2017)[1]. Beck and Cull, (2015) suggest that banks can only make a
meaningful contribution towards the growth of African economies if regulatory gaps and
governance issues are addressed. Second, most countries in SSA have weak supervisory
capacity and institutional governance frameworks (Beck and Maimbo, 2013). Because banks
behave differently under different institutional environments (Haselmann and Wachtel, 2007),
it implies that the way regulations shape risk-taking behaviour in banks, may be different
across the different global regions. In fact, questions have been raised (Beck and Maimbo, 2013)
as to whether developing countries in SSA need to adopt international bank regulatory
standards wholesale –and whether the benefits arising from the adoption of such policies or
standards outweigh the costs. On the other hand, correspondent banks in developed countries
still require banks operating in SSA to ascribe to and maintain the same international
regulatory standards –failure which risks isolating these countries from global trade. The SSA
region thus presents a good ground to empirically examine the relevance of international
regulatory standards in developing countries.
We examine the regulation-risk relationship by focusingon two dimensions of bank risk:
solvency risk and liquidity risk; and four prudential regulations: capital, activity
restrictions, supervisory power and private monitoring as in (Barth et al.,2013). We derive
the regulatory indices on activity restrictions and the three pillars of Basel II i.e. capital
JFRC
31,2
150
To continue reading
Request your trial