Financial Sector Reforms, Competition and Banking System Stability in Sub-Saharan Africa

Abstract

Financial sector reform is generally considered good for the economy as it engenders financial innovation and promotes efficiency in the financial system, potentially leading to higher economic growth. However, recent global evidence has shown that deregulation of the banking industry can sometimes have the unintended effect of destabilizing the financial system, contributing to macroeconomic instability and, in some cases, reversal of the economic growth. A salient feature of structural financial sector reforms is enhanced competition in the banking industry, with the attendant stability-fragility trade-off. Compared to other economies, Sub-Sahara Africa (SSA) financial system is broadly bank-based and weakly contestable, therefore, any systemic bank failures would have serious contagious repercussions in these economies. Combining both micro and macro factors, we implement a duration bank distress prediction model on a sample of SSA countries to identify the main internal and external risk drivers of fragility (insolvency) to the banking industry in the aftermath of financial sector reforms. The results indicate that bank-specific, macroeconomic and institutional factors are important in predicting episodes of bank distress. JEL Classification: G21, G28, O23, O55