Why Do African Banks Lend So Little?
| Date | 01 June 2015 |
| Published date | 01 June 2015 |
| Author | Svetlana Andrianova,Badi Baltagi,David Fielding,Panicos Demetriades |
| DOI | http://doi.org/10.1111/obes.12067 |
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©2014 The Department of Economics, University of Oxford and JohnWiley & Sons Ltd.
OXFORD BULLETIN OF ECONOMICSAND STATISTICS, 77, 3 (2015) 0305–9049
doi: 10.1111/obes.12067
Why DoAfrican Banks Lend So Little?*
Svetlana Andrianova,†Badi Baltagi,‡Panicos Demetriades§
and David Fielding¶
†Department of Economics, Leicester University, University Road, Leicester LE17 6EE, UK
(e-mail: sa153@le.ac.uk)
‡Department of Economics and Center for Policy Research, Syracuse University, Syracuse,
NY 13244, USA (e-mail: bbaltagi@maxwell.syr.edu)
§Department of Economics, Leicester University, University Road, Leicester LE17 6EE, UK
(e-mail: pd28@le.ac.uk)
¶Department of Economics, University of Otago, PO Box 56, Dunedin, 9054, New Zealand
(e-mail: david.fielding@otago.ac.nz)
Abstract
Weput forward a plausible explanation of African banking sector under-developmentin the
form of a bad credit market equilibrium. Using an appropriately modified Industrial Orga-
nization model of banking, we show that the root of the problem could be unchecked
moral hazard (strategic loan defaults) or adverse selection (a lack of good projects).
Applying a dynamic panel estimator to a large sample of African banks, we show that
loan defaults are a major factor inhibiting bank lending when institutional quality is low.
We also find that once a threshold level of institutional quality has been reached, improve-
ments in the default rate or institutional quality do not matter. This provides support for
our theoretical predictions.
I. Introduction
Africa remains one of the most financially under-developed parts of the world. Financial
under-development is frequentlyassociated with a countr y’sinability to mobilize sufficient
amounts of saving to satisfy the demand for credit. However, a recent study by the World
Bank has shown that African banking systems, while lacking in depth compared to other
parts the world, are also excessively liquid and channel a large proportion of savings into
foreign assets (Honohan and Beck, 2007).1That is to say, savings mobilization does not
appear to represent a binding constraint on African banks’ability to lend. Instead, African
banks complain of a lack of creditworthy borrowerswhile at the same time households and
firms complain about lack of credit. The same study showsthat the least developed banking
*we acknowledge the support of ESRC grant number RES-000-22-2774 and ESRC-DFID grant number
ES/J009067/1.
JEL Classification numbers: G21, O16.
1This study reports that only 30% of the assets of Sub-SaharanAfrican banks are in the for m of loans to the private
sector, while in every other region the figure is 60%–70%.The report notes that 35% of Sub-Saharan bank assets are
loans to the public sector, 15% are liquid assets and 20% are foreign assets.
340 Bulletin
systems inAfrica are also the most liquid, which implies that resolving the paradox of excess
liquidity may hold the key to understanding African banking sector under-development.
To do so requires focussing on the structure and mechanics of African credit markets.
In this article, we delve further into some of the issues raised by Honohan and Beck
(2007). Our main contribution is to put forward a plausible explanation ofAfrican banking
sector under-development in the form of a bad credit market equilibrium generated either
by a moral hazard problem (taking the form of strategic loan defaults) or possibly by an
adverse selection problem (emanating from a lack of viable investment projects).
The first part of the article is theoretical. It modifies a standard Industrial Organization
model of banking to analyze the market for bank credit. The model encapsulates vari-
ous stylized characteristics of African credit markets, including high loan default rates. In
the model, sub-optimal equilibria arise when there are severe informational imperfections
(moral hazard or possibly adverse selection) and institutions intended to contain these
imperfections are weak. In these sub-optimal equilibria there is a high loan default rate (an
endogenous variable in the model) and this deters the expansion of bank credit. When we
use the model to explore the impact of improvements in institutions designed to mitigate
informational imperfections, we find important nonlinearities in the response of the bank-
ing system. For example, improvements in the quality of institutions which limit the risks
banks face from bad loans can reduce the impact of loan default on lending, but only when
quality is low to begin with. Once quality has reached a certain level,fur ther improvements
will have no impact on banks’ behaviour. These results appear in both the moral hazard
and adverse selection versions of the model and are consistent with the threshold effects
implicit in other macroeconomic studies.
The second part of the article is empirical. It is aimed at testing specific predictions of
the theory utilizing panel data for over a hundred African banks over a ten-year period.
Specifically, it explores the relationship between the amount thatAfrican banks are willing
to lend, loan default rates and the institutional environment, allowingfor threshold effects.2
The model is fitted using a GMM dynamic panel estimator (Arellano and Bond, 1991;
Blundell and Bond, 1998). Our empirical results provide strong support for the predictions
of our theoretical model and we are able to identify a threshold effect in the level of
institutional quality.
The article is structured as follows. Section II provides a brief institutional overview
of banking in Africa. Section II sets out the theoretical model and describes various credit
market equilibria under moral hazard and adverse selection. Section IV outlines the empir-
ical model, describes the data set and explains the estimation method. Section V presents
the empirical results and section VI concludes.
II. Banking in Africa
As noted by Allen, Otchere and Senbet (2011), the diversity of financial institutions across
Africa is as great as the economic and cultural diversity.In par ts of NorthAfrica and in the
Republic of South Africa, the banking sector is relatively well developed, with an active
stock market and a modern banking system. In other parts of Africa, the stock market
2Unlike the bulk of the literature on African financial systems that is mainly macroeconomic, our study uses
microeconomic data, allowing us to search for threshold effects more directly.
©2014 The Department of Economics, University of Oxford and JohnWiley & Sons Ltd
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