Cross-Border Banking and Depositor Market Discipline in Africa

Abstract

This thesis focuses on the effect of cross-border banks on bank risk and market discipline in the presence of explicit deposit insurance and depositor market discipline incentives using a dataset that covers many countries in Africa. Based on different estimation techniques, this thesis provides the following robust results. First, cross-border banks have better: asset quality, liquidity, and diversification mean scores than their domestic counterparts. Simultaneously, cross-border banks also experience higher overhead expenses, higher volatility in earnings, lower capital levels, higher market risk, and lower stability than domestic banks. These findings lend credence to both the diversification hypothesis and market risk hypothesis. Second, cross-border banks operating in countries with explicit deposit insurance arrangements have higher loan loss provision (lower asset quality), a higher standard deviation of return on assets (higher variation in earnings), higher market risk (lower Sharpe ratio), and lower stability (lower Z-score). This study, therefore, reveals a benign form of regulatory arbitrage hypothesis within cross-border banks in Africa. Third, depositor market discipline via the priced based mechanism and the quantity-based mechanism exist in Africa. This evidence supports a complete test for depositor market discipline. This finding is based on robust evidence from the capital adequacy ratio and the ratio of corporate loans to total loans of cross-border banks. Fourth, the study finds that the capital level of cross-border banks serves as an incentive for depositors to monitor the risk of cross-border banks. Fifth, the study finds that when depositors monitor and discipline banks for excessive risk-taking, it is strong enough to influence banks to reduce their risk-taking levels among Good Banks. This last evidence supports a true form of test for depositor market discipline in Africa. This study makes the following contributions to the literature: First, to gain new insights into the effect cross-border banking has on bank risk, it makes use of unexamined samples. The evidence the study provides on depositor market discipline within the cross-border banking context is also new in the literature. Lastly, the finding that the capital level of cross-border banks serves as an incentive for depositors to monitor cross-border bank risk, is also new in the literature. This study has revealed the important role depositors can play in the monitoring and policing of cross-border bank risk. The Basel Committee on Banking Supervision and bank regulators should, therefore, take note and put in place structures that will enable depositors to have access to cross-border bank information such as capital level and corporate loan concentration level constantly.