An Analysis of Credit Risk Associated with Banking Sector Deregulation in West Africa

Abstract

The study uses data spanning from the period 1996-2017 with random effect model to investigate the impact of credit risk on banking sector deregulation in West Africa. Two main objectives were addressed. First, the determinants of credit risk. Second the effect of credit risk on banking sector deregulation. The key determinants of the credit risk include return on equity of banks, financial system deposit to GDP ratio and bank assets to GDP ratio. The findings show that return on equity positively and significantly increases credit risk of banks in West Africa. However, we find that financial system deposit and bank assets to GDP negatively and significantly reduce credit risk in West Africa. We did not find any significant impact of macroeconomic indicators such as gross domestic product and inflation in our model. With respect to the impact of credit risk on deregulation, the study finds positive and significant effect of credit risk on deregulation in West Africa. This means that higher credit risk could necessitate deregulation of the financial sector in West Africa. Other bank specific variables we found to relate positively and significantly with deregulation include liquid liabilities to GDP, net interest margin and bank z-score. Similarly, the inclusion of the macroeconomic variables into the model improves on the performance of the model. The liquid liabilities as a percentage of GDP became positive and significant as well. The study makes some useful recommendation for policy and future research direction.