Freedom, competition and bank profitability in Sub-Saharan Africa
| DOI | https://doi.org/10.1108/JFRC-12-2017-0107 |
| Pages | 462-481 |
| Date | 13 November 2018 |
| Published date | 13 November 2018 |
| Author | Emmanuel Sarpong-Kumankoma,Joshua Abor,Anthony Quame Q. Aboagye,Mohammed Amidu |
| Subject Matter | Financial compliance/regulation,Accounting & Finance |
Freedom, competition and
bank profitability 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 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 studyshow that higher market power (less competition) is positively relatedto
bank profitability, but operating efficiency is a more important determinant of profitability than market
power. Also, both financial freedom and economic freedom show a positive impact on bank profits. The
authors find evidence that bankswith higher market power operating in countries with higherfreedom for
banking activities are more profitable 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 operatingefficiency appears to be
a more importantreason for the observed profitability than market power.
Originality/value –This study provides insight on the ambiguousrelationship between competition and
bank profitability by consideringthe moderating effect of financial freedom which has not been taken into
accountin previousstudies.
Keywords Lerner index, Competition, Bank profitability, Market power, Financial freedom
Paper type Research paper
1. Introduction
A sound and profitable banking sector is better able to withstand negative shocks and
contribute to the stability of the financial system. Therefore, the determinants of bank
profitability have attracted the interest of academic research as well as of bank
management, financial 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 profitability is likely to play a pivotal role in the post-crisis
debate among banking executives, investors and regulators, considering the
enormous losses in the financial crisis and the huge government intervention
required.
Indeed, bank profitability is an intricate issue. Higher profitability 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 classification –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 profitability is the
result of market power, then consumers could be disadvantaged through higher loan
rates, lower deposit rates, credit rationing and poor quality of financial services
(Chortareas et al., 2011). Thus, high bank profitability may call for policy interventions
to reduce bank entry barriers and other obstacles to competition, and to lower risk.
However, bank profits may be reinvested, which should produce safer banks and
promote financial stability (Flamini et al., 2009). On the other hand, low profitability in
the banking sector may suggest intense competition or inefficiency 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 profitability
test the structure-conduct-performance (SCP) and/or the efficiency structure (ES)
hypotheses. Generally, the results have been mixed. While some have found support for
the SCP, other studies find no evidence of market structure or market power having an
effect on bank profitability. Instead, some have found that the level of bank profitability
isexplainedbyefficiency. Of course, even when market structure or market power is
found to affect profitability, the outcome is not always the same. In some cases
profitability 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 efficiency seems to be the main driving force of increased bank
profitability.
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
(Sufian and Habibullah, 2010). Indeed, as noted by Hafer (2013), a number of studies have
found that financial developmentand higher levels of economic freedom are associated with
(or cause) economic growth. The unanswered question, however, is whether the financial
development-economic growth nexus reflects influences of economic freedom operating
through the financial system (Hafer, 2013). Sufian and Habibullah (2010) provide new
empirical evidence on the positive impact of economic freedom on banks’performance in
Malaysia. Chortareas et al. (2013), possibly the first to directly investigate the dynamics
between the financial freedom counterparts of the economic freedom index drawn from
the Heritage Foundation database and bank efficiency levels, suggest that the higher the
degree of an economy’sfinancial freedom, the higher the benefits for banks in terms of
cost efficiency. Financial freedom is a measure of the degree of restrictions and controls
in the financial sector. When financial institutions operate in a less restricted
environment they are more likely to engage in competitive policies, resulting in higher
levels of efficiencies. 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) finds that countries with higher levels of initial economic freedom, on
average, exhibit greater levels of financial 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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