Economic freedom, competition and bank stability in Sub Saharan Africa

Abstract

Purpose – This study aims to analyze the potential implications of economic freedom and competition for bank stability. Design/methodology/approach – Using system generalized method of moments and data from 139 banks across 11 Sub-Saharan African (SSA) countries during the period 2006–2012, this study considers whether the degree of economic freedom affects the relationship between competition and bank stability. Findings – The results show evidence of the competition-fragility hypothesis in SSA banking but suggest that beyond a setting threshold, market power increases may also damage bank stability. Financial freedom hurts bank stability, implying that banks operating in environments with greater financial freedom generally tend to be less stable or more risky. The authors also find evidence of a conditional effect of economic freedom on the competition–stability relationship, implying that bank failure is more likely to occur in countries with greater economic freedom but low competition in the banking sector. Practical implications – The results suggest to policymakers that a moderate level of competition and economic freedom may be the appropriate policy to ensure the stability of banks. Originality/value – The study provides insight into the competition–bank stability relationship, by providing new empirical evidence on the effect of economic freedom, which has not been previously considered.