Enhancing the economic growth of Africa: Does banking sector efficiency matter?

Abstract

Purpose - The purpose of this paper is to examine the relationship between banking sector efficiency and economic growth in Africa. Methodology/approach - The paper used the stochastic frontier approach stating the banking sector cost function as a Fourier flexible to estimate bank efficiency. We then used the Arellano-Bond GMM estimator to investigate the relationship between banking sector efficiency and economic growth. Annual data for banking sector financial statements were used in estimating efficiency scores. Findings - The study found banking sector efficiency in the sample to be 69%. We also found a positive relationship between banking sector efficiency and economic growth, confirming the critical role banks play in the economy. Practical implications - Banking sector efficiency score of 69% implies banks in Africa could save up to 31% of their total cost if they were to operate efficiently. Policy direction should therefore focus on policies and incentives that will improve the efficiency of the banking sector and hence economic growth. The study brings to the fore the importance of the qualitative aspect of the banking sector in allocating financial resources in the real economy. Focus in the real economy should not be only on the size of the banking system but also on the quality with which resources are allocated. Originality/value of paper - This study is among the first dedicated solely to African countries. It does set the pace for future research in the area and also confirms in Africa the Schumpeterian hypothesis that the banking sector is key in allocating resources in the real economy. Copyright © 2012 by Emerald Group Publishing Limited.