General - all subjectsPrivate sector development and banking
The determinants of commercial bank profitability in sub-saharan Africa (SSA)
The determinants of high profits and the relationship between profits and equity in SSA banks
Authors:
V. Flamini
Publisher:
International Monetary Fund Working Papers, 2009
The analysis of a sample of 389 banks, operating in 41 countries, from 1998 through 2006, shows that the bank profits are high in SSA compared to other regions. This picture holds true whether profitability is measured as returns on assets, returns on equity, or net interest margins.
Standard asset pricing models imply that arbitrage should ensure that riskier assets are remunerated with higher returns. Bank profitability should then reflect bank-specific risk, as well as risks associated with the macroeconomic environment (non-diversifiable, systemic risk). Banks in most SSA countries operate in risky financial environments, which include weak legal institutions and loose enforcement of creditor rights. Hence, risk appears a good explanation for high returns.
Bank specific and macroeconomic risk factors are the most important explanations for banks’ high returns. The main source of bank-specific risk in SSA is credit risk. Poor enforcement of creditor rights, weak legal environment, and insufficient information on borrowers expose banks to high credit risk. At the macroeconomic level, weak economic growth adds to risk as it promotes the deterioration of credit quality, and increases the probability of loan defaults.
The coefficient of equity is positive and highly significant, meaning that well-capitalized banks experience higher returns.
If high returns are the consequence of market power, this would imply some degree of inefficiency in the provision of financial services. So, policymakers have to introduce measures to lower risk, remove bank entry barriers if they exist as well as other obstacles to competition, and lower regulatory costs.
Bank profits are also an important source of equity. If bank profits are reinvested, this should lead to safer banks and could promote financial stability.
Since privately owned banks earn higher returns compared to publicly owned ones, privatisation could be encouraged, but only to the extent that reinvestment of the profits can be effectively encouraged.
Macroeconomic policies are important. Fiscal and monetary policies that are designed to promote output stability and sustainable growth are good for financial intermediation.
