Bank Portfolio Allocation: Evidence from Sierra Leone

Abstract

Bank portfolio allocation is an important determinant of the efficacy of monetary policy through the bank lending channel of monetary policy transmission mechanism. This study generally investigates the factors that influence banks‟ portfolio allocation in Sierra Leone. Specifically, the study looks into the effects of risk premium, leverage ratio, and credit risk on banks‟ earning asset portfolio allocation in Sierra Leone between 2002 and 2011. Using annual bank level data on an unbalanced panel of thirteen commercial banks for the study period, and employing time and bank specific fixed effects model for estimation, it is confirmed that risk premium, the share of non-performing loans in the banks‟ loan portfolio, tier 1 capital ratio (leverage ratio), and local currency deposit levels positively and significantly affect the share of loan supply to the private sector in banks‟ earning assets. On the other hand the loan-deposit ratios (or advance-deposit ratio) and bank size has significant negative effects on the share of loans in banks‟ earning assets. The study also finds bank type (state, private domestic, and foreign) and the growth rate of real Gross Domestic Product - a control variable for economic activities and hence, loan demand - to be important determinants of the share of loans in banks‟ earning assets. Based on these results, the study makes a number of recommendations including the following:

Action should be taken to increase risk premium to banks, for example, through exercising stronger fiscal discipline so as to bring down the yield on government securities.

The Central Bank of Sierra Leone should play a parental role in strengthening the depth of the Interbank Market operations as a secondary market. This will have the effect of increasing access of banks to short term liquidity The availability of more funding sources other than client deposits reduces the risk of adverse deposits shocks.

Banks should be encouraged to have capital in excess of the minimum paid up capital (Capital buffers) so as have more room to absorb the inherent risk in the business of banking.