Monetary Policy, Exchange Rate And Bank Risk-Taking In Sub-Sahara Africa

Abstract

In the years preceding the global financial crisis which begun in the US in 2008, it was revealed that the US and several European countries had prolonged periods of low interest rates. Since the crisis, extant literature has established a strong causal relationship between monetary policy and risk-taking mainly in the countries that were most affected. We cannot discount the effect of exchange rate when examining monetary policy. This is because during the period many of the countries that were affected had strong currencies. In the recent decade (2007 to 2017) however, it has been observed that African countries are exhibiting some of these characteristics, that is, falling policy rates and currency appreciation. On the basis of this observation, it is important to establish the causal relationship between the two macroeconomic variables and bank risk-taking in the context of Africa. We study an unbalanced panel of 534 banks from 37 countries in sub-Sahara Africa from 2001 to 2015.We examined five types of risks: default, credit, asset, liquidity and capital risks. The LSDV and PCSE techniques were implemented. The results suggest that low policy rate increases default risk, asset risk and capital risk and reduces credit and liquidity risk. Currency appreciation on the other hand increases all four risk types but decreases credit risk. These results are significant both economically and statistically. We find that the risks of big banks were amplified by monetary policy changes except for credit risk where monetary policy diminished the risks of big bank. Monetary policy also amplified the risks of more profitable banks except for capital risk where the impact was reduced for more profitable banks. We recommend that, based on our results monetary authorities should be modest in reducing interest rates to enhance the stability of the financial system in Africa.