Bank Efficiency and Financial Development in Africa: An Empirical Study

Abstract

This thesis investigates the link between banking sector efficiency and financial development. The study also examines the relationship between financial development and economic growth from the banking efficiency perspective. The thesis discussed extensively the theoretical and the empirical literature on each topic. The study uses the semi-non parametric Fourier flexible functional approach to estimates bank cost efficiency. This method has been found in literature to envelope banking data better than other methods used in estimating banking sector efficiency. To establish the relationship between banking sector efficiency and financial development, the study made use of the Instrumental Variables (IV) 2SLS estimator to test whether bi-causality exist between the two variables. The study also uses the dynamic generalized methods of moments (GMM) technique which is able to address potential endogeneity issues to examine further the link between financial development and economic growth. The study made very important findings and contributions to literature. Firstly, the study concluded that the efficiency level of banks included in the sample averaged 76% over the period, 1999-2008. This means that there is about 24% inefficiency in terms of cost. Thus banks in Africa could actually save up to almost a quarter of their cost if they were to operate efficiently. It also finds that causality runs positively in both directions between bank cost efficiency and financial development. This means that as banks become more cost efficient, financial sector develops further and credit allocation gets more distributed in the real economy. Similarly, it is important that policy makers know that financial sector policies that deepen the financial system also result in cost efficiency in the banking sector by challenging the banking sector to be innovative and efficient in their bit to increase shareholder value. Among the other control variables, inflation is found to destabilize the financial development. Excessive government spending in the financial sector appears to destabilize banking sector efficiency. Also, a good legal environment improves financial development. Other historical variables that impact cross-country variations in financial development are settler mortality and percentage of rural population. These have negatively affected the development of the financial sector. Finally, the evidence of the findings from the study supports the notion that the quality of the financial intermediation measured as banking sector cost efficiency scores significantly affects economic growth positively. The thesis did not find a statistically significant effect of the traditional volume measures of financial sector development and economic growth. Further, the share of domestic savings to GDP is found to be positive and statistically significant reflecting the crucial role private savings play in economic growth. Moreover, concentration of the banking sector is found to be negatively related to economic growth. Lastly, annual rate of population growth is found to be significant and negatively related to economic growth. These results suggest that developing policies to boost the efficiency of the banking sector is a step in the right direction. This is because; it will positively impact on financial development and growth on the continent.