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UNIVERSITY OF GHANA  

COLLEGE OF HUMANITIES 

 

 

FINANCIAL FREEDOM, COMPETITION AND BANK PERFORMANCE 

IN SUB-SAHARAN AFRICA 

 

 

                                   BY 

 

 

EMMANUEL A. SARPONG-KUMANKOMA 

(ID. 10016633) 

 

 

 

 

 

 

A THESIS SUBMITTED TO THE SCHOOL OF GRADUATE 

STUDIES IN PARTIAL FULFILLMENT OF THE REQUIREMENT FOR 

THE AWARD OF DEGREE OF DOCTOR OF PHILOSOPHY IN FINANCE 

 

 

 

 

 

 

 

DEPARTMENT OF FINANCE 

 

JUNE 2016 

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DECLARATION 

I hereby declare that this thesis is my own work produced from research I carried out under 

supervision. This thesis has not been presented by anyone for any academic award, in this or any 

other institution. All references made to work done by other people have been duly acknowledged. 

I am solely responsible for any shortcomings in this work. 

 

 

……………………………………     …………………………………… 

Emmanuel A. Sarpong-Kumankoma      Date 

(Candidate) 

         

 

        

 

 

 

 

 

 

 

 

 

 

 

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CERTIFICATION 

We hereby certify that this thesis was supervised in accordance with procedures laid down by the 

University. 

  

        

……………………………………     …………………………………… 

Professor Joshua Yindenaba Abor       Date 

(Principal Supervisor) 

  

 

…………………………………….    ……………………………………  

Professor A. Q. Q. Aboagye        Date 

(Co-Supervisor) 

 

 

…………………………………….     …………………………………… 

Dr. Mohammed Amidu        Date 

(Co-Supervisor) 

 

 

 

 

 

 

 

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ACKNOWLEDGEMENTS 

I would like to express my appreciation for the financial support provided by the University of 

Ghana and the Business School to enable me undertake this study. 

 

Many people have also played important roles in the development of this thesis. Special mention 

should be made of my supervisors, Professor Joshua Yindenaba Abor, Professor A. Q. Q. Aboagye 

and Dr. Mohammed Amidu, who provided much guidance, encouragement and support throughout 

the preparation of the thesis. I would forever be grateful for your wonderful show of magnanimity. 

May the Almighty God, Jehovah reward the way you act. 

  

My colleagues in the Department of Finance have also shown good comradeship during the course 

of the study. My current Head of Department, Prof. Godfred Bokpin, in particular has shown much 

interest in getting this work completed, and so have Professor Kofi A. Osei, Dr. Simon K. Harvey, 

Dr. Charles Andoh and Dr. Vera Fiador. Considerable support have also been received from Dr. 

Kwaku Ohene-Asare, Dr. Patrick Asuming, Dr. Lord Mensah, Dr. Elikplimi Agbloyor, Mr. Frank 

Ametefe, Dr. Ibrahim Bedi, Dr. Agyapomaa Gyeke-Dako, Dr. Saint Kuttu, Miss. Esther Laryea, 

Miss. Sandra Ayiku and Mrs. Josephine Ofosu-Mensah Ababio, for which I am truly grateful.  

 

I am also grateful to Dr. Ebow Turkson and Mr. Solomon Aboagye from the Department of 

Economics, who provided much needed assistance with the data analysis. 

 

And finally, I very much appreciate the love and understanding shown by my wonderful wife, 

Beatrice, and my children, Nana Ama Sarpomaa, Maame Akosua and Kwabena Akosa. 

 

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ABSTRACT 

The inferences of competition for bank stability, profitability and efficiency have been the subject 

of much debate, yet they remain controversial and inconclusive. Identifying channels through 

which competition affects bank performance may improve our understanding of the inconsistent 

findings in the literature. Hence, this thesis analyses the implications of competition and financial 

freedom for bank performance. The study also examines the determinants of bank profit 

persistence. Using data from 139 banks in 11 Sub-Saharan African countries over the period, 2006-

2012, and the financial (or banking) freedom index from the Heritage Foundation, this study 

considers whether the degree of freedom in the banking sector affects the relationship between 

competition and bank performance. The results show a positive relationship between market power 

and bank stability, profitability and cost efficiency, suggesting that higher market power (or less 

competition) may improve bank profitability, efficiency, and stability. However, the relationship 

between market power and bank stability is found to be quadratic, implying that beyond a certain 

threshold, further increases in market power may damage bank stability. The evidence from this 

study shows that, the positive effect of market power is stronger on bank profitability, and weaker 

on bank efficiency with higher levels of financial freedom. We do not find evidence suggesting 

that financial freedom influences the relationship between competition and bank stability. On the 

determinants of bank profit persistence, the results of the study show differences across countries. 

The results of this study suggest that policies that allow banks to maintain some level of market 

power may be necessary to ensure banking system efficiency and overall stability. Also, while 

higher financial freedom improves bank profitability, it may be harmful for cost efficiency, 

especially for banks with higher market power. Thus, policies that ensure some restrictions on 

banking freedom may still be required to enhance bank efficiency.  

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TABLE OF CONTENTS 

CONTENT                                                                                                                             PAGE 

DECLARATION ............................................................................................................................ ii 

CERTIFICATION ......................................................................................................................... iii 

ACKNOWLEDGEMENTS ........................................................................................................... iv 

ABSTRACT .................................................................................................................................... v 

TABLE OF CONTENTS ............................................................................................................... vi 

LIST OF TABLES .......................................................................................................................... x 

CHAPTER ONE ............................................................................................................................. 1 

INTRODUCTION .......................................................................................................................... 1 

1.1 Background of the Study .................................................................................................. 1 

1.2 Statement of the Research Problem ................................................................................. 7 

1.3 Research Questions ........................................................................................................ 12 

1.4 Research Hypotheses...................................................................................................... 13 

1.5 Objectives of the Study .................................................................................................. 16 

1.6 Significance of the Study ............................................................................................... 16 

1.7 Scope of the Study.......................................................................................................... 18 

1.8 Structure of the Thesis.................................................................................................... 19 

CHAPTER TWO .......................................................................................................................... 20 

LITERATURE REVIEW ............................................................................................................. 20 

2.1 Introduction ......................................................................................................................... 20 

2.2 Theoretical Framework and Determinants of Bank Competition ....................................... 21 

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2.3 Bank Stability ...................................................................................................................... 27 

2.3.1 Theoretical Review of Bank Competition-Stability Relationship ................................... 27 

2.3.2 Empirical Evidence on Competition-Stability Relationship ............................................. 29 

2.3.3 Is There a Transmission Mechanism Between Competition and Stability? ................... 31 

2.4 Bank Profitability ................................................................................................................ 34 

2.4.1 Theoretical Review of Determinants of Bank Profitability .............................................. 34 

2.4.2 Empirical Evidence on Determinants of Bank Net Interest Margins .............................. 38 

2.4.3 Empirical Evidence on Determinants of Bank Profitability ............................................. 42 

2.5 Bank Competition and Efficiency ....................................................................................... 47 

2.5.1 Theoretical Review of Bank Competition-Efficiency Relationship ................................ 47 

2.5.2 Empirical Evidence on Competition-Efficiency Relationship ......................................... 50 

2.6 Bank Profit Persistence ....................................................................................................... 54 

2.6.1 Theoretical Background on Profit Persistence ................................................................... 54 

2.6.2 Empirical Evidence on Determinants of Bank Profit Persistence .................................... 55 

2.7 Economic Freedom and Bank Performance ........................................................................ 58 

2.8 Overview of the Banking Sector in Africa .......................................................................... 68 

2.8.1 Banking Systems in Africa .................................................................................................... 68 

2.8.2 African Banking Market Structure and Performance ........................................................ 71 

2.9 Chapter Summary and Gaps in the Literature ..................................................................... 76 

CHAPTER THREE ...................................................................................................................... 79 

METHODOLOGY ....................................................................................................................... 79 

3.1 Introduction ......................................................................................................................... 79 

3.2 Research Design .................................................................................................................. 79 

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3.3 Population of Study ............................................................................................................. 81 

3.4 Sampling Technique and Sample Size ................................................................................ 81 

3.5 Measuring Bank Competition ............................................................................................. 82 

3.6 Measurement of Bank Performance .................................................................................... 86 

3.6.1 Measurement of Bank Stability ............................................................................................ 87 

3.6.2 Measurement of Bank Profitability ...................................................................................... 88 

3.6.3 Measurement of Bank Efficiency ......................................................................................... 88 

3.7 The Economic Freedom Index ............................................................................................ 91 

3.8 Estimating Effect of Competition and Financial Freedom on Bank Stability ..................... 93 

3.9 Modelling Competition, Financial Freedom and Bank Profitability ................................... 95 

3.10 Modelling Effect of Financial Freedom on Bank Competition ....................................... 100 

3.11 Estimating Effect of Competition and Financial Freedom on Bank Efficiency.............. 102 

3.12 Estimating the Determinants of Bank Profit Persistence ................................................ 105 

3.13 Method of Data Analysis ................................................................................................. 107 

3.14 Chapter Summary ............................................................................................................ 111 

CHAPTER FOUR ....................................................................................................................... 116 

RESULTS AND DISCUSSION ................................................................................................. 116 

4.1 Introduction ....................................................................................................................... 116 

4.2 Descriptive Statistics ......................................................................................................... 116 

4.3 Competition, Economic Freedom and Bank Risk ............................................................. 120 

4.3.1 Competition, Freedom and Bank Stability ........................................................................ 120 

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4.3.2 Competition, Freedom and Bank Asset Quality ............................................................... 126 

4.4 Competition, Economic Freedom and Bank Profitability ................................................. 130 

4.4.1 Competition, Freedom and Bank Net Interest Margins .................................................. 133 

4.4.2 Competition, Freedom and Bank Return on Assets ......................................................... 136 

4.5 Competition, Economic Freedom and Bank Efficiency .................................................... 141 

4.5.1 Sources of Bank Market Power in Sub-Saharan Africa .................................................. 141 

4.5.2 Competition, Freedom and Bank Efficiency .................................................................... 144 

4.6 Bank Profit Persistence in Sub-Saharan Africa ................................................................. 153 

4.7 Chapter Summary .............................................................................................................. 155 

CHAPTER FIVE ........................................................................................................................ 166 

SUMMARY, CONCLUSIONS AND RECOMMENDATIONS............................................... 166 

5.1 Introduction ....................................................................................................................... 166 

5.2 Summary of Findings ........................................................................................................ 166 

5.3 Contributions of the Study ................................................................................................ 172 

5.4 Conclusions ....................................................................................................................... 174 

5.5 Policy Recommendations .................................................................................................. 175 

5.6 Limitations and Suggestions for Further Research ........................................................... 176 

REFERENCES ........................................................................................................................... 177 

 

 

 

 

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LIST OF TABLES 

 

Table 3.1: Number of Banks for Each Country ............................................................................ 81 

Table 4.1: Summary Descriptive Statistics ................................................................................. 117 

Table 4.2: Effects of Competition and Freedom on Bank Stability (Conventional Lerner) ....... 121 

Table 4.3: Effects of Competition and Freedom on Bank Stability (Adjusted Lerner) .............. 122 

Table 4.4: Effects of Competition and Freedom on Asset Quality (Conventional Lerner) ........ 127 

Table 4.5: Effects of Competition and Freedom on Asset Quality (Adjusted Lerner) ............... 128 

Table 4.6: Effects of Competition and Freedom on Bank NIM (Conventional Lerner)............. 131 

Table 4.7: Effects of Competition and Freedom on Bank NIM (Adjusted Lerner) .................... 132 

Table 4.8: Effects of Competition and Freedom on Bank ROAA (Conventional Lerner) ......... 137 

Table 4.9: Effects of Competition and Freedom on Bank ROAA (Adjusted Lerner) ................ 138 

Table 4.10: Sources of Bank Market Power ............................................................................... 142 

Table 4.11: Bank Cost Efficiency Estimates .............................................................................. 145 

Table 4.12: Effects of Competition and Freedom on Cost Efficiency (Conventional Lerner)....146 

Table 4.13: Effects of Competition and Freedom on Cost Efficiency (Adjusted Lerner) .......... 147 

Table 4.14: Effects of Competition and Freedom on Cost Efficiency (IV with Conv. Lerner) . 148 

Table 4.15: Effects of Competition and Freedom on Cost Efficiency (IV with Adj. Lerner)….149  

Table 4.16: Determinants of Bank Profit Persistence…………………………………………..154 

 

 

 

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 CHAPTER ONE 

INTRODUCTION 

 

1.1 Background of the Study 

 

The banking sector plays a critical role in every economy. Much of the work of transferring surplus 

funds to deficit units is carried out through the intermediation function of financial institutions, 

with banks as the dominant entity across many jurisdictions. A well-functioning banking system 

is widely recognized as essential to economic growth and development. Even so, reforms, 

globalization and technological advancement have changed the nature of the banking business over 

the last few decades. In addition, the 2007-2008 financial crisis that originated mainly in the U.S 

and spread to other developed countries and some emerging markets, and the recent banking crisis 

in Europe have re-ignited debate about regulation of the banking sector, and the level of freedom 

required to encourage innovation and efficiency and also ensure the stability of the financial 

system. 

 

Indeed, recent decades have witnessed a considerable increase in the number of financial reforms 

across the globe, in both developed and developing countries. This development has resulted in 

the liberalization of banking sectors in many countries with higher-income countries being more 

liberalized than lower-income countries. A major reason for these reforms was to make the 

financial markets in general, and the banking sector in particular, more competitive (Delis, 2012). 

A widely accepted view is that competition in the banking sector will engender efficiency in 

operations, and also enhance general performance of financial institutions. Yet, research has shown 

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that the relationship between competition and bank performance is very complex, and that the view 

that competition is unambiguously good may be more naive in banking than in other industries 

(Claessens & Laeven, 2004). Strong competition may not be best for performance in the financial 

sector. It is no wonder then, that several years after some of these reforms were initiated, 

fundamental questions are still being asked about the implications of competition for the 

performance of the banking sector. For instance, is competition good for the overall stability of 

the banking sector? Has the opening up of the banking sector to greater competition 

unambiguously led to greater efficiency in banking operations? Is the high profitability observed 

in many banking markets driven by improved efficiency, or by exploitation of market power by 

banks? What factors influence the effects of competition on bank performance? 

 

Finding answers to these questions remain relevant, because despite numerous research on the 

repercussions of competition for banking sector performance, there is no consensus on the effect 

of competition on bank stability, profitability or efficiency. A related issue that continues to puzzle 

researchers is the persistence of bank profits. While economic theory suggests that freedom of 

entry and exit in competitive markets should whittle away excess profits, this is not observed in 

the real world of banking. Bank profits continue to persist (Gschwandtner, 2005). So what drives 

the persistence of bank profits? Are there variations in these influencing factors across different 

countries?  

 

Nevertheless, profitability in the banking sector is important and could partly explain the stability 

observed in some banking markets. Highly profitable banks should be able to increase their capital 

reserve to absorb potential losses and remain resilient to shocks. And as suggested by the European 

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Central Bank (2010), the question of what is an acceptable level of bank profitability is likely to 

play a pivotal role in the post-crisis debate among banking executives, investors and regulators, 

considering the enormous losses in the financial crisis, and the huge government intervention 

required. Even so, recent events have shown that the most common measure for a bank’s 

performance, which is profitability, may be only part of the story, and that a more comprehensive 

assessment of bank performance may be warranted (European Central Bank, 2010). Another issue 

of concern, however, is the fact that higher bank profitability may be achieved at the expense of 

the rest of the economy, resulting in welfare losses and inefficient allocation of resources. 

 

Also, the need for a stable banking system cannot be overemphasized. Instability in the banking 

sector is likely to result in the malfunctioning of other sectors of the economy, which depend on 

the payment system and intermediation functions provided by the banking sector, besides other 

services. Indeed, frequent bank failures was one of the major reasons for the reforms carried out 

in the banking sectors in many countries. And since the implementation of the reforms, we have 

not seen as many bank failures as was witnessed in the 1980s and 1990s. Yet concerns remain 

about the possibility of bank failures, considering the continued integration of banking systems, 

and the uncertainty about the effects of policy reforms such as competition on bank stability. 

 

Efficiency in banking operations also has implications for the larger economy. For instance, the 

ability of banks to reduce costs through the use of modern technology should be beneficial to both 

their customers and shareholders, in terms of lower prices (and hence greater access to finance), 

and higher wealth creation.  

 

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The theoretical and empirical literature on the relationship between competition and bank 

performance (efficiency, profitability and stability) is quite extensive, yet it is obvious that more 

work needs to be done in view of the contrasting and even inconclusive results obtained in several 

studies. Generally, both the theoretical and empirical literature present ambiguous positions on the 

competition-stability, competition-profitability and competition-efficiency relationships. 

 

For instance, the theoretical literature on the relationship between competition and bank stability 

presents no consensus.  Two opposing views are theorized in the literature. One view, called the 

competition–fragility or competition-instability view, and pioneered by the influential work of 

Keeley (1990), asserts that competition in banking reduces market power (or the ability of banks 

to price their products/services above marginal cost), decreases profit margins, and results in 

reduced franchise value that encourages banks to take on greater risks. This position is supported 

by Hellmann, Murdock and Stiglitz (2000), Besanko and Thakor (1993), Allen and Gale (2000), 

and Allen and Gale (2004). In contrast, the competition–stability view came out strongly from the 

work of Boyd and de Nicoló (2005), who argued that competition leads to greater bank stability. 

They assert that as banking markets become more concentrated (and less competitive), banks tend 

to show market power by charging higher interest rates to borrowers. This worsens moral hazard 

incentives and makes it more difficult for borrowers to repay, as they also take on greater risks in 

search of more profits, and the result is an increase in the possibility of loan default and therefore 

the risk of bank portfolios. On the other hand, a reduction in interest rates on loans as a result of 

greater competition would encourage borrowers to seek safer investments, thus minimizing the 

risk of default and bank portfolio risk. This is also supported by Caminal and Matutes (2002) and 

Beck, Demirguc-Kunt and Maksimovic (2004), among others. 

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Also, two competing theories emerged from the industrial organization literature to explain the 

relationship between market structure and bank profitability. These are the Market Power (MP) 

and Efficiency Structure (ES) paradigms. These approaches provide different suggestions for the 

direction of causality between market structure and profitability.  

 

The literature on competition and bank efficiency is related to the hypotheses that explain the 

relationship between market structure and performance. A special case of the MP hypothesis, the 

Quiet Life hypothesis, is the focus of this study. The ‘Quiet Life’ hypothesis (QLH), originally 

proposed by Hicks (1935) suggests that the higher the market power enjoyed by a firm, the lower 

the effort put forth by managers to improve efficiency, resulting in a negative relationship between 

market power and efficiency (Berger & Hannan, 1998). As an alternative, the efficient structure 

hypothesis developed by Demsetz (1973), submits that more efficient banks are better armed to 

survive competitive pressures and gain market share at the expense of the less efficient ones. 

Schaeck and Cihak (2008) categorize these hypotheses as ‘competition-efficiency’ and 

competition-inefficiency hypotheses. Similar to the competition-stability, and competition-

profitability relationships, the empirical evidence on competition-efficiency relationship has been 

inconclusive. And only some recent studies have tried to test the quiet life hypothesis in banking 

(Coccorese & Pellecchia, 2010).  

 

Noticeably absent in the banking literature is an examination of the links between economic 

freedom and bank performance. The limited research in this area is somewhat surprising given the 

importance of bank lending in promoting economic development and the impact that economic 

freedom is likely to have on the banking sector (Sufian & Habibullah, 2010). Indeed, as noted by 

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Hafer (2013), a number of studies have found that financial development and higher levels of 

economic freedom are associated with (or cause) economic growth. The unanswered question, 

however, is whether the financial development-economic growth nexus reflects influences of 

economic freedom operating through the financial system (Hafer, 2013). Sufian and Habibullah 

(2010) provide new empirical evidence on the positive impact of economic freedom on banks’ 

performance in Malaysia. Chortareas, Girardone, and Ventouri (2013), possibly the first to directly 

investigate the dynamics between the financial freedom counterparts of the economic freedom 

index drawn from the Heritage Foundation database and bank efficiency levels, suggest that the 

higher the degree of an economy’s financial freedom, the higher the benefits for banks in terms of 

cost efficiency. Financial freedom is a measure of the degree of restrictions and controls in the 

financial sector. When financial institutions operate in a less restricted environment they are more 

likely to engage in competitive policies, resulting in higher levels of efficiencies. Related studies 

include Smimou and Karabegovic (2010) who show that changes in economic freedom have a 

positive impact on equity market returns, and Hafer (2013) who finds that countries with higher 

levels of initial economic freedom, on average, exhibit greater levels of financial intermediary 

development in subsequent years.  

 

Chortareas et al. (2013) has noted that studies that consider the effects of economic freedom on 

bank performance typically treat the freedom index as one of the control variables, and also focus 

on the aggregate (economic) freedom index and not on the specific financial freedom counterparts, 

which gives rise to the possibility of misspecification bias. Indeed, since it became available some 

twenty years ago, several studies have used the financial freedom index (sometimes called banking 

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freedom) either as control variable or instrumental variable, but hardly is there any focus on its 

effect on bank performance.  

 

Given the difficulty in understanding the channels between competition and bank stability, our 

study seeks to assess the effect of financial freedom on the competition-stability relationship. We 

also seek to provide additional insight into the ambiguous relationship between competition and 

bank profitability by considering the conditioning effect of financial freedom on this relationship. 

Further, this study seeks to test the quiet life hypothesis in the developing country context, which 

is largely ignored in the literature, and also provide new empirical evidence on the impact of 

financial freedom on the competition-efficiency relationship. In addition, we consider the 

determinants of bank profit persistence, and differences in determinants of profit persistence 

among countries. And though yet to be tested in the literature, there is some concern that excessive 

financial freedom may contribute to financial institutions’ propensity to take on greater risks, 

which in turn may have contributed to the recent global and European crises (Chortareas et al., 

2013).  

 

1.2 Statement of the Research Problem 

Recent studies that provide evidence for the competition–fragility hypothesis include Diallo 

(2015), Fungacova and Weill (2013), Berger, Klapper and Turk-Ariss (2009) and Beck, Demirguc-

Kunt and Levine (2006). They obtain similar findings, suggesting that increased competition may 

undermine bank stability. On the other hand, gains in market power will increase the stability and 

reduce the risk for the banking system. In contrast, a number of studies have found support for the 

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hypothesis that competition enhances bank stability. For example, Boyd and de Nicoló (2005), 

Uhde and Heimeshoff (2009), Schaeck and Cihak (2014) and Schaeck, Cihak and Wolfe (2009).  

 

However, recently, Martinez-Miera and Repullo (2010) questioned the theoretical predictions of 

Boyd and de Nicoló (2005) by arguing that lower loan rates resulting from greater bank 

competition also reduces the interest payments from performing loans (which provide a buffer 

against loan losses) because of imperfect correlation of loan defaults. They conclude that a U-

shaped relationship between competition and the risk of bank failure generally obtains. Studies 

supporting this position are Forssbæck and Shehzad (2014), Beck, de Jonghe, and Schepens 

(2013), Liu, Molyneux and Wilson (2013), and Jimenez, Lopez, and Saurina (2013). 

 

Empirical research on the impact of competition or market structure on bank interest margins have 

also produced conflicting results. Studies that have found a positive relationship between market 

power and net interest margins or a negative relationship between competition and net interest 

margins include Almarzoqi and Naceur (2015), Hawtrey and Liang (2008), Van Leuvensteijn, 

Sorensen, Bikker and Rixtel (2013), and Poghosyan (2013). Similarly, for Africa, while Aboagye, 

Akoena, Antwi-Asare, and Gockel (2008a) found that increases in bank market power (or 

concentration) significantly increase net interest margin in Ghana, Chirwa and Mlachila (2004) 

suggest that the observed high spreads in Malawi can be attributed to high monopoly power. 

 

In contrast, Maudos and de Guavara (2004) show that the fall of margins in the European banking 

system is compatible with a relaxation of the competitive conditions (increase in market power 

and concentration), as this effect has been counteracted by a reduction of interest rate risk, credit 

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risk, and operating costs. On the other hand, while Kasman, Tunc, Vardar and Okan (2010) found 

market power to be a vital determinant of bank interest margin in both new and old EU member 

countries, the effect was opposite for the two groups. Beck and Hesse (2009) also found little 

evidence for market structure explaining variation in spreads or margins over time for Uganda. 

 

Generally, the empirical evidence on the market structure and bank profitability relationship have 

been mixed. While some have found support for the Market Power (MP) hypothesis, other studies 

find no evidence of market structure or market power having an effect on bank profitability. 

Instead, some have found that the level of bank profitability is explained by efficiency, thus 

supporting the Efficiency Structure (ES) paradigm. Support for the MP hypothesis has been found 

by Tregenna (2009), Jeon and Miller (2002), Mirzaei, Moore and Liu (2013) and Fu and Heffernan 

(2009). In contrast, some studies report that the MP argument is not held in the banking industry. 

Examples are Seelanatha (2010) and Chortareas, Garza-Garcia and Girardone (2011). Instead, 

these studies suggest that efficiency seems to be the main driving force of increased bank 

profitability.  

 

Similar to the competition-stability, and competition-profitability relationships, the empirical 

evidence on competition-efficiency relationship has been inconsistent. Surprisingly, the quiet life 

hypothesis (QLH) in particular, has received relatively little attention in the empirical literature, 

and only some recent studies have tried to test the QLH in banking (Coccorese & Pellecchia, 2010). 

Moreover, the few studies in this area have largely centered on developed economies. However, 

given the differences in levels of efficiency and institutional arrangements between developed 

markets and developing markets (Eldomiaty, 2007), we cannot assume that the results obtained 

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will necessarily apply to developing economies.  Hence, studies in developing countries should 

enhance our understanding of this important issue in banking. Those reporting evidence of the 

quiet life hypothesis include Berger and Hannan (1998), Delis and Tsionas (2009), and Coccorese 

and Pellecchia (2010). In contrast, Weill (2004), Koetter, Kolari and Spierdijk (2012), Casu and 

Girardone (2006), Maudos and de Guavara (2007), Casu and Girardone (2009), and Williams 

(2012) provide support for a negative relationship between competition and efficiency in banking 

(a rejection of the QLH).  

 

Even so, Williams (2012) has noted that the contrast in the empirical evidence may be attributable 

to the simultaneous relationship between competition (market power) and bank efficiency, which 

is usually ignored in empirical investigations. The interdependence between competition and bank 

efficiency implies the possibility of reverse causality. The efficient structure hypothesis, for 

instance, suggests that efficiency may be driving market power (Turk-Ariss, 2010). The problem 

is demonstrated further by the empirical evidence that shows that the quiet life hypothesis is 

usually accepted in studies that do not control for simultaneity (Berger & Hannan, 1998), whilst it 

is rejected in studies that account for the problem (Maudos & de Guevara, 2007; Koetter et al., 

2012). As noted by Koetter et al. (2012), with the exception of Maudos and de Guevara (2007), 

Koetter and Poghosyan (2009), and Delis and Tsionas (2009), virtually all studies on market power 

and efficiency ignore the simultaneous relation between them. This points to a potential gap in the 

literature, which our study seeks to fill, given the seeming dependence of the outcome on whether 

or not simultaneity is taken into consideration.  

 

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Contestable markets theory and the new industrial organization literature also highlight the 

influence of potential and actual competition on profitability. The Persistence of Profit (POP) 

theory proposed by Mueller (1977), asserts that entry into and exit from an industry are sufficiently 

free to abolish any abnormal profit quickly, and that the profit rates of all the firms in an industry 

tend to converge towards the same long-run average value. However, this theory does not seem to 

find enough empirical support (Gschwandtner, 2005). Besides, while there is an extensive 

empirical Persistence of Profit (POP) literature based on manufacturing data, only a handful of 

studies investigate POP in banking (Goddard, Liu, Molyneux & Wilson, 2013), and in only a few 

countries (Goddard, Liu, Molyneux, & Wilson, 2011). Indeed, even fewer still consider the 

determinants of profit persistence where they exist. Also, previous studies have generally ignored 

differences in determinants of profit persistence across countries.  

 

Chortareas et al. (2013) has also noted that studies that consider the effects of economic freedom 

on bank performance typically treat the freedom index as one of the control variables, and also 

focus on the aggregate (economic) freedom index and not on the specific financial freedom 

counterparts, which gives rise to the possibility of misspecification bias.  

 

Moreover, most of the above-mentioned studies on competition and bank performance have 

concentrated on the developed economies, particularly the U.S and European banking markets. Of 

course, some studies have covered our broad areas of interest in contexts similar to our own. For 

the competition-stability relationship, studies similar to ours include Tabak, Fazio, and Cajueiro 

(2012) for Latin American countries, Turk-Ariss (2010) for developing economies, Amidu (2013) 

and Amidu and Wolfe (2013a) for emerging and developing countries. On the competition-

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profitability nexus, studies in similar context include Beck and Hesse (2009) for Uganda, Perera, 

Skully, and Chaudrey (2013) for South Asian banks, Al-Muharrami and Matthews (2009) for the 

Arab Gulf Cooperation Council (GCC) region, Hossain (2012) for Bangladesh, Chortareas, Garza-

Garcia, and Girardone (2012) for Latin American banking, Maudos and Solís (2009) for Mexico, 

Amidu and Wolfe (2013b) for emerging and developing countries, Ahokpossi (2013) for Sub-

Saharan Africa, Aboagye et al. (2008a) for Ghana, and Chirwa and Mlachila (2004) for Malawi. 

In regard to the competition-efficiency relationship, we also have studies such as Turk-Ariss 

(2010) for the developing economies, Mlambo and Ncube (2011) for South Africa, and Pruteanu-

Podpiera, Weill, and Schobert (2008) for Czech banks, among many others. Kouki and Al-Nasser 

(2014) also recently examined the impact of market power on bank efficiency and stability in 

Africa. Even so, these studies ignored the potential effect of financial freedom on the competition 

and bank performance relationships. 

 

1.3 Research Questions 

The study provides empirical evidence on competition, financial freedom and bank performance 

that seeks to answer the following key questions: 

i. What is the relationship between competition, financial freedom and bank stability in 

Sub-Saharan Africa?  

ii. What is the relationship between competition, financial freedom and bank profitability 

in Sub-Saharan Africa?  

iii. What is the relationship between competition, financial freedom and bank efficiency 

in Sub-Saharan Africa?  

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iv. What are the determinants of bank profit persistence in different countries in Sub-

Saharan Africa?   

 

1.4 Research Hypotheses 

Based on the theoretical predictions and the available empirical evidence, as well as the African 

context, ten main hypotheses related to the research questions above, are developed in this thesis. 

 

Generally, the few studies on the effect of competition on bank stability in emerging and 

developing countries (Turk-Ariss, 2010; Amidu, 2013; Kouki & Al-Nasser, 2014) suggest that an 

increase in the degree of market power (or less competition) leads to greater bank stability, and 

that increased competition may undermine bank stability. Given the similarities in economic and 

institutional context, we expect a similar result for this study on Sub-Saharan Africa. Hence, this 

leads to our first hypothesis: 

 

H1: Competition has a negative effect on bank stability. 

 

The effect of financial freedom on bank stability is yet to be tested in the literature, but there are 

suggestions that excessive financial freedom may contribute to financial institutions’ propensity 

to take on greater risks, which in turn may have contributed to the recent global and European 

crises (Chortareas et al., 2013). One could expect that higher financial freedom (or less restrictions 

in the banking sector) is likely to open up banking markets and engender greater competition, 

which could result in instability. Thus we formulate hypotheses 2 and 3 below: 

 

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H2: Financial freedom has a negative effect on bank stability. 

 

H3: The effect of competition on bank stability increases with financial freedom. 

 

Even though the empirical evidence on the market structure and bank profitability relationship 

presents no consensus, we expect that in the highly profitable developing country context, 

increasing competition is likely to result in reduced profits, as more banks compete for essentially 

the same customers. Our fourth hypothesis is thus formulated as: 

 

H4: Competition has a negative effect on bank profitability. 

 

On the other hand, higher financial freedom may allow banks to explore new markets and 

activities, resulting in advantages from economies of scale or scope, and better management of 

variability in earnings across product lines, thus increasing their profit potential (Goddard et al., 

2011). This leads us to the following hypothesis: 

 

H5: Financial freedom has a positive effect on bank profitability. 

 

Also, the negative effect of competition on bank profitability may be enhanced by the existence of 

higher financial freedom, but this is yet to be tested in the banking literature. In harmony with our 

expectation we suggest the following hypothesis: 

 

H6: The effect of competition on bank profitability increases with financial freedom. 

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The empirical evidence on competition-efficiency relationship has been inconsistent, but since we 

measure competition and efficiency using the same framework, we expect to find a negative 

relationship between competition and bank efficiency (a rejection of the QLH), just like previous 

studies that followed a similar approach (see Koetter et al., 2012). Our hypothesis is: 

 

H7: Competition has a negative relationship with bank efficiency. 

 

The effect of financial freedom on bank efficiency has only recently been tested in the banking 

literature and found to be positive (Chortareas et al., 2013; Lin, Doan & Doong, 2016). We 

anticipate a similar finding, and thus hypothesize as: 

 

H8: Financial freedom has a positive effect on bank efficiency. 

 

 

Further, we test whether financial freedom moderates the effects of competition on bank 

efficiency, which has so far not received attention in the literature. Our hypothesis is: 

 

H9: The effect of competition on bank efficiency increases with financial freedom. 

 

 

 

Finally, given the peculiar characteristics of individual economies, coupled with the regulatory 

and institutional environments, we anticipate that different factors account for bank profit 

persistence in various countries, leading us to the following hypothesis: 

 

H10: Determinants of bank profit persistence vary across countries. 

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1.5 Objectives of the Study 

The main objective of this study is to examine the effects of competition and financial freedom on 

bank performance. Specifically, the study seeks to: 

i. evaluate the effects of competition and financial freedom on bank stability. 

ii. ascertain the effects of competition and financial freedom on bank profitability. 

iii. assess the effects of competition and financial freedom on bank efficiency. 

iv. examine the determinants of bank profit persistence. 

 

1.6 Significance of the Study 

This study enhances our understanding of the ambiguous relationship between competition and 

bank performance, by considering the potential effect of financial freedom on this relationship. It 

differs from most of the other studies in the literature in the following ways: First, we assess the 

impact of financial freedom on the competition-efficiency, competition-profitability, and 

competition-stability relationships (which is new in the literature). Second, we carry out a joint-

estimation of competition and efficiency using the same model. Although very necessary, given 

the close relationship between competition and efficiency, only a handful of studies have jointly 

estimated competition and bank efficiency using the same framework (see Koetter et al., 2012 for 

the few exceptions). Most studies estimate competition and efficiency separately, and then assess 

their relationship. This approach confounds our understanding of the relationship between 

competition and bank efficiency. Thus using a common framework in this study should result in a 

more appropriate policy response.  Third, we test the quiet life hypothesis which has received very 

little attention in banking as noted by Coccorese and Pellecchia (2010), especially in developing 

countries. Policy makers often take the view that promoting competition or reducing bank market 

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power will enhance efficiency, but that may not necessarily be the case in the SSA region, given 

the differences in institutional arrangements between developed and developing economies. 

Fourth, we test for a non-linear relationship between competition and bank stability (a new 

development in the literature following the theoretical work of Martinez-Miera and Repullo, 

2010). Fifth, we assess the determinants of bank profit persistence and variations across countries, 

which is largely ignored in the literature. Sixth, we provide a more comprehensive assessment of 

bank performance by considering bank efficiency, profitability and stability together. Most studies 

consider only one or two of these at a time which does not provide a complete picture.  

 

The Sub-Saharan African (SSA) banking markets serve as a fertile ground for a study of the 

relationship between competition and bank performance. Generally, banking markets in this region 

are less competitive compared to other regions of the world. African banks are also well-

capitalized, quite liquid, more profitable and fairly stable (Beck & Cull, 2013; Honohan & Beck, 

2007; Moyo, Nandwa, Oduor, & Simpasa, 2014; Beck, Maimbo, Faye, & Triki, 2011). 

Competitive conditions continue to improve with the gradual relaxation of remaining restrictions 

on banking activities as pertains in the developed markets in the Western world. For instance, the 

index of financial freedom developed by the Heritage Foundation (2015) which gives an indication 

of the freedom with which banks conduct their activities clear of government intervention and 

control, has increased in many of these countries over the last decade (with an average of 51 by 

2012).  

 

But as competition gets more intense in SSA banking markets along with greater financial 

freedom, how will bank efficiency be affected? Will banks in these markets continue to be 

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profitable, well-capitalized and stable? Or are we likely to witness bank crises again, as 

experiences from the developed markets suggest, especially given the poor institutional 

environment in these areas? Will the comparatively high net interest margins decline or increase?  

Our study contributes significantly to the literature by addressing some of the issues raised above 

and other related matters. 

 

1.7 Scope of the Study 

This thesis is limited to a discussion of the effects of competition and financial freedom on bank 

cost efficiency, profitability and stability over the 7-year period from 2006 to 2012. The study 

period was largely influenced by the availability of banking data in the Bankscope database, which 

was the main source of data for the study. Our goal was to use as much data as possible, but we 

focused on the dominant financial institution, commercial banks, and specialized financial 

institutions whose nature and operations are akin to that of commercial banks. We excluded other 

financial institutions such as investment banks since their sphere of activities are dissimilar. 

 

Our initial sample comprised of banks in all SSA countries, but due to data limitations, especially 

inadequate data points at the country level required for some of the regression estimates, we settled 

on data from 139 banks operating in 11 countries in SSA. Also, banks with less than three 

consecutive years of observations were excluded. Besides, some banks did not have values needed 

for some of the key variables used in the study and had to be excluded. The final sample is an 

unbalanced panel with 700 bank-year observations. Even so, the results should generally reflect 

the situation of the banking industry in this region, and may be applicable to other developing 

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countries as well, given that our sample comprise most of the largest banking markets in SSA 

(www.eiu.com). 

 

1.8 Structure of the Thesis 

This thesis has been organized into five chapters. Chapter one provides a general introduction to 

the thesis, including background of the study, the problem statement, research questions, research 

hypotheses, research objectives, significance and scope of the study. In chapter two, we review the 

relevant theoretical and empirical literature related to competition and bank efficiency, 

profitability and stability. Chapter three covers the various methodologies employed to assess the 

relationships of interest, while chapter four deals with the analysis and discussion of the results 

obtained. Chapter five concludes the thesis with a summary of the findings, contributions of the 

study, conclusions and policy recommendations, as well as limitations and suggestions for further 

research. 

 

 

 

 

 

 

 

 

 

 

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CHAPTER TWO 

LITERATURE REVIEW 

 

2.1 Introduction  

 

This chapter reviews relevant literature on the broad areas of competition, economic freedom and 

bank performance. Section 2.2 begins with a review of the theoretical framework, methods of 

measuring competitive conditions, and general determinants of competition in banking markets.   

Section 2.3 gives an overview of the bank stability literature, drawing on both the theoretical and 

empirical literature, as well as the more recent works aimed at addressing the ambiguity of the 

competition-stability relationship. Section 2.4 deals with the bank profitability literature, while 

section 2.5 provides literature on bank efficiency. Both sections begin with an overview of the 

theoretical literature, before considering the empirical evidence. We review bank profit persistence 

literature in section 2.6, and economic freedom and bank performance literature in section 2.7. In 

section 2.8, we provide a brief overview of the African banking sector. The chapter concludes with 

a summary and gaps in the literature in section 2.9. We focus particularly on recent empirical 

studies on areas closely related to our research objectives: effect of financial freedom and 

competition on bank stability; effect of financial freedom and competition on bank profitability; 

effect of financial freedom and competition on bank efficiency; as well as the determinants of bank 

profit persistence.   

 

 

 

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2.2 Theoretical Framework and Determinants of Bank Competition 

 

The seminal work of Klein (1971) provides the conventional framework for examining the 

competitive behavior of banks. Klein (1971) considers a bank as a monopolistic firm engaged 

principally in two activities: taking deposits and making loans. Thus the cost function of the 

intermediation services of a bank could be represented as: 

 

C = f (D, L),        (2.1) 

 

where D refers to the volume of deposits and L represents the volume of loans produced by the 

bank. The monopoly model of Klein (1971) assumes that the banking firm operates in an 

environment characterized by imperfect competition in both the deposit and credit markets. This 

implies that the bank has monopoly power to set prices (interest rates) in at least one of the markets 

where it operates, usually the credit market. According to Klein (1971), the monopoly power of 

the bank explains its scale of operations, its asset and liability structure, as well as its decisions on 

interest rates on assets (loans) and liabilities (deposits). Thus, in this model, the spread of a banking 

firm is basically a reflection of its ability to charge a price that is higher than its marginal cost of 

production in both the loan and deposit markets.  

 

As shown by Oreiro and de Paula (2010), in a context where r is the inter-bank market rate; rL is 

the interest rate charged on loans produced by the bank; rD is the interest rate paid on deposits with 

the bank; α is the reserve requirements as a proportion of the bank’s deposits; ԑL is the interest 

elasticity of loan demand; ԑD is the interest elasticity of deposit supply; CL is the marginal cost of 

loan services; and CD is the marginal cost of deposits services, and supposing that the banking firm 

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is risk neutral and that its behaviour is aimed at maximizing profits, then the optimal interest 

margin on loans and deposits is given by: 

 

*

*

*

)(1

L

LL

L r

Crr 



        (2.2) 

 

*

*

*

))1(1

D

DD

D r

rCr 





       (2.3) 

 

Equations (2.2) and (2.3) suggest that a banking firm that operates in a monopolistically 

competitive environment prices its loans and deposit services in such a way that the Lerner indices 

are equal to the inverse of the interest elasticity of the loan demand and deposit supply functions. 

This implies that the greater the sensitivity of loan demand and deposit supply functions to interest 

rate changes, the smaller the bank’s margin in both loan and deposit taking services, and, hence 

the smaller the bank margin. However, if the banking firm faces an oligopolistic market structure 

in granting loans and taking deposits, then the optimal interest margin on loans and deposits is 

given by: 

 

*

*

*

)(

L

LL

L r

Crrs 



        (2.4) 

 

*

*

*

))1(

D

DD

D r

rCrs 





,       (2.5) 

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where s is the market share of the nth bank. Equations (2.4) and (2.5) show the bank interest margin 

on loan supply and deposit taking as a growing function of its market share. This is understood to 

mean that a reduction in the number of banking firms due to mergers or acquisitions results in 

increased banking market concentration and thus interest margins. Thus a banking firm’s interest 

margin is a growing function of the banking sector market structure (da Silva, Oreiro, de Paula & 

Sobreira, 2007). 

 

The Klein (1971) monopoly model has been criticized for assuming (for the sake of simplicity) 

that interest rate changes reflect the key risk faced by banks, and for its inability to capture the 

hedging behavior of banks adequately (Ho & Saunders, 1981). Consequently, Ho and Saunders 

(1981) proposed a ‘dealership model’ to explain bank profitability.  

 

The Ho and Saunders (1981) model considers a bank as a risk-averse dealer between the users and 

suppliers of funds. Given that the arrival of deposits and loans are not synchronized, the bank has 

to set interest rates on loans and deposits in such a way as to compensate it for providing immediate 

liquidity service at the risk of losing money, as a result of exposure to changes in money market 

interest rates (i.e. interest rate risk).  

 

Suppose a new deposit (loan) is contracted at a long-term interest rate rD (rL). If this deposit (loan) 

arrives earlier than a new loan (deposit), the bank will have to invest (borrow) the funds at the 

short-term money market rate r. In providing these services, the bank faces a reinvestment 

(refinancing) risk at the end of the decision period should the short-term rate, r, fall (rise). Hence, 

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the bank will transfer these financial costs which arise from the uncertainty in the provision of 

deposit and loan operations to economic agents. 

 

As a result, each bank participating in the market will set a loan and deposit interest rate, rD (and 

rL) that reflects these financial costs as follows: 

          

arrD  ; brrL  ,         (2.6) 

 

where a and b represent the financial costs related to the provision of deposits and loans 

respectively, and r is the expected money market interest rate.  Thus, the net interest spread is: 

 

)( barr DL           (2.7) 

 

Maudos and de Guevara (2004), extended the Ho and Saunders (1981) model by explicitly taking 

into account, banks’ operating costs, and used a direct measure of the degree of competition, the 

Lerner index in addition to the degree of concentration of the market (the Herfindahl index). They 

postulate that, given the initial wealth of the bank as the difference between its assets and liabilities, 

and incorporating the production costs associated with intermediation (which are assumed to be a 

function of the deposits and loans), the final wealth of the bank will be: 

 

E[U(W)] =  U(W*) + U´(W*)E[W-W*] + ½U´´(W*) E[W-W*]²    (2.8) 

 

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This assumes that banks are maximizers of expected utility, and that a bank’s utility function, U, 

is approximated using the Taylor expansion around the expected level of wealth. It is also assumed 

that the bank’s utility function is continuous and doubly differentiable such that U´ > 0 and U´´ < 

0, so that the bank is risk averse. 

 

Hence, the optimal interest margin is determined principally by the following: 

• The competitive structure of the markets  

• Average operating costs  

• Degree of risk aversion  

• Volatility of money market interest rates  

• Credit risk 

• The covariance or interaction between interest rate risk and credit risk 

• The average size of the credit and deposit operations 

 

The subsequent sections discuss further extensions on the theoretical literature on competitive 

behavior of banks, and its implications for performance.  

 

The main drivers of competition identified in the literature include size, default risk, 

diversification, efficiency, equity, concentration, market share, ownership, monetary policy, 

inflation, and financial depth (Aboagye, Akoena, Antwi-Asare & Gockel, 2008b; De Guevara & 

Maudos, 2007; De Guevara, Maudos, & Pérez, 2005). For instance, De Guevara et al. (2005) have 

shown that bank size has a positive and significant effect on market power. Larger banks enjoy 

greater market power due to either cost advantages or to their capacity to impose higher prices.  

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Mirzaei and Moore (2014) report that banks located in countries with good-quality institutional 

development face greater competition for emerging and developing economies, whereas inter-

industry competition from insurance industries, together with financial freedom, seem to be the 

main drivers in increasing competition amongst developed economies. Chortareas et al. (2013) 

also suggest that an open and transparent banking environment facilitates access to financing and 

encourages competition to provide efficient financial intermediation between households and 

firms, as well as between investors and entrepreneurs.  

 

Similarly, Claessens and Laeven (2004) find that banking systems with greater foreign bank entry 

and fewer entry and activity restrictions tend to be more competitive. But they find no evidence 

that the competitiveness measure negatively relates to banking system concentration. On the 

contrary, they find some evidence that more concentrated banking systems are more competitive. 

Their findings confirm that contestability determines effective competition especially by allowing 

(foreign) bank entry and reducing activity restrictions on banks. The results on the lack of 

importance of market structure suggest that competition policy in the financial sector is more 

complicated than perhaps previously thought. Hence, they posit that developing proper 

competitiveness tests and methodologies will remain an important area of research and policy 

focus. Again, Casu and Girardone (2006) suggest that the degree of concentration is not necessarily 

related to the degree of competition in EU banking markets. They also find little evidence that 

more efficient banking systems are also more competitive. 

 

 

 

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2.3 Bank Stability 

 

This sections covers a review of the theoretical and empirical bank stability literature with a focus 

on the competition-stability relationship.  

  

2.3.1 Theoretical Review of Bank Competition-Stability Relationship 

 

The theoretical literature on the relationship between competition and bank stability presents no 

consensus.  Two opposing views are theorized in the literature. One view, called the competition–

fragility or competition-instability view, and pioneered by the influential work of Keeley (1990), 

asserts that competition in banking reduces market power of banks, decreases profit margins, and 

results in reduced franchise value that encourages banks to take on greater risks. Using U.S data 

to illustrate his model, Keeley (1990) finds that the increased competition and deregulation that 

followed the relaxation of state branching restrictions in the U.S. in the 1980s, eroded monopoly 

rents and resulted in an increase of bank failures. On the other hand, higher market (or monopoly) 

power in the banking market leads to greater stability because the greater lending opportunities, 

higher profits, higher capital ratios and charter values of incumbent banks, put them in a better 

position to survive demand-side and supply-side shocks, which in turn provides a dis-incentive for 

excessive risk-taking (Keeley, 1990; Allen & Gale, 2000, 2004; Carletti, 2008). 

 

Hellmann et al. (2000) makes a similar argument, stating that financial liberalization increases the 

potential scope for gambling by banks, since it often leads to intense competition among banks, at 

the same time that banks gain greater freedom to allocate assets and set interest rates. They point 

out that in a dynamic economy, capital requirements may not be as powerful as previously thought, 

because in addition to a one-period capital-at-risk effect that minimizes the incentive to gamble, 

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there is a future-franchise-value effect that increases the incentives to gamble. Further, Besanko 

and Thakor (1993) used a theoretical model to show that lending rates decrease and borrowing 

rates increase as more banks enter the market and each tries to differentiate itself from the 

competition. This results in a reduction in bank margins and charter values giving banks greater 

incentives to gamble or take on greater risk. 

 

In addition, Allen and Gale (2000) and Allen and Gale (2004) suggest that greater competition in 

banking reduces incentives to properly screen borrowers and increases the risk of fragility, since 

banks earn less informational rent from their relationships with borrowers. Allen and Gale (2000) 

also show that a small number of large institutions in a concentrated banking system makes for 

more stability and resilience to shocks, since banks are easier to monitor and supervisors are less 

burdened. 

  

In contrast, the competition–stability view came out strongly from the work of Boyd and de Nicoló 

(2005), who argued that competition leads to greater bank stability. They assert that as banking 

markets become more concentrated (and less competitive), banks tend to show market power by 

charging higher interest rates to borrowers. This worsens moral hazard incentives and makes it 

more difficult for borrowers to repay, as they also take on greater risks in search of more profits, 

and the result is an increase in the possibility of loan default and therefore the risk of bank 

portfolios. On the other hand, a reduction in interest rates on loans as a result of greater competition 

would encourage borrowers to seek safer investments, thus minimizing the risk of default and bank 

portfolio risk. Similarly, while Caminal and Matutes (2002) show that banks with more market 

power (in less competitive markets), have to contend with monitoring costs and are more likely to 

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create risky loan portfolios, Beck, Demirguc-Kunt, and Maksimovic (2004) state that both greater 

concentration in banking markets and higher competition are more conducive to bank stability. 

 

Recently, Martinez-Miera and Repullo (2010) questioned the theoretical predictions of Boyd and 

de Nicoló (2005) by arguing that lower loan rates resulting from greater bank competition also 

reduces the interest payments from performing loans (which provide a buffer against loan losses) 

because of imperfect correlation of loan defaults.  According to Martinez-Miera and Repullo 

(2010), in addition to the risk-shifting effect in the Boyd and de Nicoló (2005) model, there is also 

a margin effect that goes in the opposite direction, so that the final effect on the risk of bank failure 

is in principle ambiguous. They show that the risk-shifting effect tends to dominate in monopolistic 

markets, whereas the margin effect dominates in competitive markets, so a U-shaped relationship 

between competition and the risk of bank failure generally obtains. 

 

2.3.2 Empirical Evidence on Competition-Stability Relationship 

 

Similar to the conflicting theoretical predictions of the competition and bank stability relationship, 

empirical evidence in support of the competition–fragility or competition–stability views is also 

inconclusive. 

 

Recent studies that provide evidence for the competition–fragility hypothesis include Beck et al. 

(2006) who show that crises are less likely in economies with more concentrated banking systems 

even after controlling for differences in commercial bank regulatory policies, national institutions 

affecting competition, macroeconomic conditions, and shocks to the economy. Berger et al. (2009) 

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also find evidence consistent with the traditional “competition-fragility” view that banks with a 

higher degree of market power in developed nations also have less overall risk exposure.  

 

Besides, Turk-Ariss (2010) finds that an increase in the degree of market power (less competition) 

leads to greater bank stability, and suggests that increased competition may undermine bank 

stability, and may have significant repercussions for stressed banking systems in developing 

economies. Amidu (2013) also suggests that the relatively low insolvency risk among banks in 

emerging and developing countries during 2000–2007 could be attributed to the high degree of 

market power and the use of internally generated funds. Similarly, Fungacova and Weill (2013) 

find that increase in bank competition could undermine financial stability in the case of Russian 

banks, for the period 2001–2007. For Africa, Kouki and Al-Nasser (2014) argue that gains in 

market power will increase the stability and reduce the risk for the banking system. 

 

More recently, Diallo (2015) reports that bank competition is detrimental to bank stability, and 

also shortens the survival time of banking systems, using data from 145 countries over the period 

1997–2010, and three measures of bank competition, namely the Boone indicator, the conventional 

Lerner and the adjusted Lerner indices.  

 

In contrast, a number of studies have found support for the hypothesis that competition enhances 

bank stability. For example, Uhde and Heimeshoff (2009) find that Eastern European banking 

markets which exhibit a lower level of competitive pressure are more prone to financial fragility, 

and that national banking market concentration has a negative impact on European banks’ financial 

soundness.  

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Also, using the Panzar and Rosse (1987) H-statistic as a measure of competition for 45 countries, 

Schaeck et al. (2009) find that more competitive banking systems are less prone to experience a 

systemic crisis and exhibit increased time to crisis. Again, with a sample of European Banks, 

Schaeck and Cihak (2014) report that competition is stability-enhancing, and that the stability-

enhancing effect of competition is greater for healthy banks than for fragile ones.  

 

2.3.3 Is There a Transmission Mechanism Between Competition and Stability? 

 

The results of some other recent studies suggest that the relationship between competition and 

bank stability is not straightforward and may actually depend on other factors previously ignored 

in the literature. For instance, Agoraki, Delis, and Pasiouras (2011) investigate whether regulations 

have an independent effect on bank risk-taking or whether their effect is channeled through the 

market power possessed by banks. Using data from the Central and Eastern European banking 

sectors over the period 1998–2005, the empirical results suggest that higher activity restrictions in 

combination with more market power reduce both credit risk and the risk of default, while official 

supervisory power has only a direct impact on bank risk. Overall, it appears that ignoring the 

interactions between regulations and market power leads to erroneous inferences about the impact 

of regulations on both credit risk and overall solvency risk. They contend that this provides 

stimulus for a more disaggregate analysis of the impact of bank regulations on risk-taking 

activities. In particular, it would be interesting to analyze which of the elements used to compose 

the regulatory indices are the most relevant in explaining bank risk. Also, another possible area for 

future research could be to provide a more detailed analysis of the different country-specific 

institutional characteristics that may affect bank risk and how these characteristics are affected by 

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the competitive conditions in the banking sector or of other industries that were involved in the 

recent financial turmoil, such as the insurance industry. 

 

Tabak et al. (2012) also corroborate the conclusions of Martinez-Miera and Repullo (2010) in 

finding that competition affects risk-taking behaviour in a non-linear way in Latin American 

countries as both high and low competition levels enhance financial stability, with the opposite 

effect for average competition. In addition, bank size and capitalization are found to be essential 

factors in explaining this relationship. On the one hand, the larger a bank is, the more it benefits 

from competition. On the other hand, a greater capital ratio is advantageous for banks that operate 

in collusive markets, while capitalization only enhances the stability of larger banks under high 

and average competition. 

 

Likewise, Liu et al. (2013) find evidence pointing to the fact that an inverted U-shaped relationship 

exists between regional bank competition and stability, using regional data to examine bank 

stability in 10 European countries over the period 2000-2008, thus providing support for the 

argument for a U-shaped relationship between competition and the risk of bank failure proposed 

by Martinez-Miera and Repullo (2010). Jimenez et al. (2013) also tested this hypothesis using data 

from the Spanish banking system and find support for this non-linear relationship using standard 

measures of market concentration in both the loan and deposit markets. However, when direct 

measures of market power, such as Lerner indices, are used, the empirical results are more 

supportive of the original franchise value hypothesis, but only in the loan market. They argue that 

the overall results highlight the empirical relevance of the Martinez-Miera and Repullo model, 

even though further analysis across other banking markets is needed. 

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Using a sample of 978 banks in 55 emerging and developing countries over 2000–2007, Amidu 

and Wolfe (2013a) report that competition increases bank stability as diversification across and 

within both interest and non-interest income generating activities of banks increases. Their analysis 

identifies revenue diversification as a channel through which competition affects bank insolvency 

risk in emerging countries.  

 

Further, Beck et al. (2013) document large cross-country variation in the relationship between 

bank competition and bank stability, and show that an increase in competition will have a larger 

impact on banks’ fragility in countries with stricter activity restrictions, lower systemic fragility, 

better developed stock exchanges, more generous deposit insurance and more effective systems of 

credit information sharing.  

 

Fu, Lin, and Molyneux (2014) also suggest that greater concentration in Asian banking markets 

nurtures financial fragility and that lower pricing power also induces bank risk exposure. In other 

words, the findings provide support for a neutral view of the competition-stability nexus, indicating 

that the competition-stability and competition-fragility theories can simultaneously apply to Asia 

Pacific banking markets.  

 

Forssbæck  and Shehzad (2014) also investigate the relationship between market power and risk 

for a large panel of banks worldwide and find that both loan and deposit market power  have a 

stable, monotonically negative effect on risk, irrespective of risk measure. The effect is larger for 

asset risk, and is independent of charter value and capital ratios. However, the effect on default 

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risk tends to decrease in the quality of banking regulation, whereas the conditioning effects of 

deposit insurance protection are mixed.  

 

2.4 Bank Profitability 

 

This section reviews the literature on bank profitability, including some basic theoretical concepts, 

empirical evidence on the competition-profitability relationship, and general determinants of 

profitability. However, we have separate discussions for bank profitability in general, and net 

interest margins in particular. 

 

2.4.1 Theoretical Review of Determinants of Bank Profitability 

  

A number of other extensions have been made to the basic Ho and Saunders (1981) model. As 

explained in Almarzoqi and Naceur (2015), some simplifying assumptions of the Ho and Saunders 

(1981) model have since been relaxed. For example, Allen (1988) provides for heterogeneity in 

the model (since banks offer different types of deposit and loan services), and show that pure 

interest margins may be reduced as a result of diversification of bank services and products. This 

approach deals with the cross–elasticities of demand between bank products and services. 

McShane and Sharpe (1985) replaced the volatility of the deposit or loan rates, as in Ho and 

Saunders (1981), with a more relevant variable, the volatility of the money market interest rate. 

Angbazo (1997) also extended the Ho and Saunders (1981) model by incorporating credit risk and 

its interaction with interest rate risk. Wong (1997) derived an alternative model to explain the 

bank’s optimal net interest spread in which banks are assumed to set the deposit and loan rate 

simultaneously. More recently, Carbo and Rodriguez (2007) further developed the model of Ho 

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and Saunders (1981) by including both traditional and non-traditional activities in order to study 

the effect of specialization on bank spreads, using a multi-output model for European banking.  

 

Besides the monopoly theory of Klein (1971) and the dealership model of Ho and Saunders (1981), 

two other competing theories explaining the relationship between market structure and bank 

profitability emerged from the industrial organization literature, specifically the Concentration-

Profit Theory proposed by Bain (1951).  The theory as applied to banking, asserts that higher 

concentration in banking markets results in collusion among banks who take advantage of their 

market power to set higher prices and gain substantial profits. However, Demsetz (1973) proposed 

an alternative explanation for the market structure-profitability relationship (the Efficient-

Structure-Hypothesis).  

 

Thus, as explained by Tregenna (2009), the traditional literature falls into two broad approaches: 

the Market Power (MP) and Efficiency Structure (ES) paradigms. These approaches provide 

different suggestions for the direction of causality between concentration and profitability. For the 

MP hypothesis, the direction of causality runs from market structure to behaviour, and then 

performance. In other words, a concentrated structure promotes the use of market power in ways 

that may enhance banks’ profitability. In contrast, the ES hypothesis perceives causality as running 

from individual firms’ efficiency to their market share and profitability. 

 

Further, within the MP paradigm, two different approaches emerge in the literature: the Structure–

Conduct Performance (SCP) hypothesis, and the Relative Market Power (RMP) hypothesis. The 

SCP hypothesis asserts that concentration in a banking market gives rise to potential market power 

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by banks which allows them to set prices that are less favorable to consumers (lower deposit rates, 

higher loan rates) which may then increase their profitability. A related theory is the relative-

market-power hypothesis (RMP), which posits that only firms with large market shares and well-

differentiated products are able to exercise market power in pricing their products and earn 

supernormal profits (Shepherd, 1982). Thus, whereas the SCP hypothesis would predict generic 

benefits to banks arising from higher concentration, the RMP hypothesis sees any benefits as 

accruing to individual banks based on their own market share. According to the latter approach, 

only large banks can influence prices and increase profits (Tregenna, 2009). 

 

Again, within the ES paradigm there are also two theories that explain the positive relationship 

between profits and either concentration or market share: the X-efficiency (ESX) and Scale-

Efficiency (ESS) hypotheses. The X-efficiency version of the Efficient-Structure hypothesis 

(ESX) asserts that firms with superior management or production technologies have lower costs 

and therefore higher profits. Such firms tend to gain larger market shares, which may manifest in 

higher levels of market concentration, but without any causal relationship from concentration to 

profitability. The scale efficiency approach within the ES paradigm emphasizes economies of scale 

rather than differences in management or production technology. Larger firms can obtain lower 

unit costs and higher profits through economies of scale. Again, as these firms have higher market 

shares, which may manifest in higher concentration, there may be an apparent—yet spurious—

relationship between concentration and profitability. Thus, according to the ES approaches, a 

positive correlation between concentration and profitability need not indicate a causal relationship, 

especially not through market power (Tregenna, 2009).  

 

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The two market-power (MP) hypotheses have radically contrasting implications from the two 

efficient-structure (ES) hypotheses for merger and antitrust policy. To the extent that the MP 

hypotheses are correct, mergers may be motivated by desires to set prices that are less favorable 

to consumers, which would decrease total consumer plus producer surplus. But to the extent that 

the ES hypotheses are correct, these mergers may be motivated by efficiency considerations that 

would increase total surplus. Thus, advocates of the MP hypotheses tend to see antitrust 

enforcement as socially beneficial, while ES advocates tend to see policies that inhibit mergers as 

socially costly (Berger, 1995).  

 

In a distinguished contribution to this literature, Berger (1995) entered the debate on the profit-

structure relationship in banking very strongly, by adding direct measures of both X-efficiency 

and scale efficiency to the empirical analysis, in order to test all four hypotheses, in a single 

specification. Using 30 separate cross-sectional datasets, he regressed profits against measures of 

concentration, market share, X-efficiency, and scale efficiency. He also regressed concentration 

and market share against the efficiency variables to test the necessary condition of the ES 

hypotheses that efficiency affects market structure. The empirical results provide some support for 

the RMP and partial support for the X-efficiency version of the ES hypothesis (ESX). However, 

support for the other necessary condition of ESX, that X-efficiency is positively related to 

concentration or market share so that it can explain the positive profit-structure relationship, is 

much weaker. 

 

While some prior studies did control for scale efficiency, they generally did not control for X-

efficiency, and so were unable to distinguish whether the profit-structure relationship observed 

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reflected superior management or greater market power of firms with large market shares. Prior 

studies also did not test whether efficiency has the predicted efficient-structure effects on market 

structure (Berger, 1995). 

 

2.4.2 Empirical Evidence on Determinants of Bank Net Interest Margins 

 

Empirical research on the impact of competition or market structure on bank interest margins have 

produced conflicting results. As noted by Saunders and Schumacher (2000), the effect of market 

structure on bank spreads appears to vary across countries. The more segmented or restricted the 

banking system, in terms of geographic restrictions on branching and universality of banking 

services, the larger appears to be the monopoly power of existing banks and the higher their 

spreads. Other studies that have found a positive relationship between market power and net 

interest margins or a negative relationship between competition and net interest margins include 

Almarzoqi and Naceur (2015) for Caucasus and Central Asia, Hawtrey and Liang (2008) for 

OECD countries, Hossain (2012) for Bangladesh, Chortareas et al. (2012) for Latin American 

banking, Van Leuvensteijn et al. (2013) for euro area banks, and Maudos and Solís (2009) for 

Mexico. 

 

In addition, Amidu and Wolfe (2013b) found that the high net-interest margins of banks in 

emerging and developing countries can be explained by the degree of market power. Poghosyan 

(2013) also analyze factors driving persistently higher financial intermediation costs in 48 low-

income countries-LICs (including some countries in Sub-Saharan Africa), relative to 67 emerging 

market-EM country comparators (including some countries in Northern and Southern Africa) for 

the period 1996–2010. Overall, he finds that concentrated market structures and lack of 

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competition in LICs banking systems and institutional weaknesses constitute the key impediments 

preventing financial intermediation costs from declining. The results provide strong evidence that 

policies aimed at fostering banking competition and strengthening institutional frameworks can 

reduce intermediation costs in LICs. 

 

For Africa, Ahokpossi (2013) examined the determinants of bank interest margins using a sample 

of 456 banks in 41 Sub-Saharan African (SSA) countries. The results show that market 

concentration is positively associated with interest margins, but the impact depends on the level of 

efficiency of each bank. In particular, compared to inefficient banks, efficient ones increase their 

margins more in concentrated markets. This indicates that policies that promote competition and 

reduce market concentration would help lower interest margins in SSA. Similarly, while Aboagye 

et al. (2008a) found that increases in bank market power (or concentration) significantly increase 

net interest margin in Ghana, Chirwa and Mlachila (2004) suggest that the observed high spreads 

in Malawi can be attributed to high monopoly power. 

 

In contrast, Maudos and de Guavara (2004) analyze the interest margin in the principal European 

banking sectors (Germany, France, the United Kingdom, Italy and Spain) in the period 1993–2000 

using a panel of 15,888 observations, and identifying the fundamental elements affecting this 

margin. They followed the methodology developed in the original study by Ho and Saunders 

(1981) and later extensions, but widened it to take banks’ operating costs explicitly into account. 

The results show that the fall of margins in the European banking system is compatible with a 

relaxation of the competitive conditions (increase in market power and concentration), as this 

effect has been counteracted by a reduction of interest rate risk, credit risk, and operating costs. 

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On the other hand, while Kasman et al. (2010) found market power to be a vital determinant of 

bank interest margin in both new and old EU member countries, the effect was opposite for the 

two groups. They suggest that the apparent difference might be the fact that increases in the degree 

of concentration in the old member countries influenced by the process of mergers and acquisitions 

triggered an upward pressure on the competition, thus narrowing the interest margins. Beck and 

Hesse (2009) also found little evidence for market structure explaining variation in spreads or 

margins over time for Uganda. 

 

The empirical literature on the relationship between bank size and interest margins presents 

contrasting results. Among those reporting a positive relationship are Almarzoqi and Naceur 

(2015), Aboagye et al. (2008a), and Maudos and Solis (2009). On the contrary, Kasman et al. 

(2010) Fungacova and Poghosyan (2011), and Maudos and de Guevara (2004) suggest a negative 

relationship between bank size and interest margins. 

 

Most studies have reported a positive relationship between credit risk and interest margins 

indicating that banks charge additional risk premiums to compensate for credit risk (Naceur & 

Omran, 2011; Hossain, 2012; Chortareas et al., 2012a; Amidu & Wolfe, 2013b; Ahokpossi, 2013). 

However, similar to Fungacova and Poghosyan (2011), Almarzoqi and Naceur (2015) found a 

negative correlation between credit risk and interest margins, and considers that as being reflective 

of inadequate interest spreads (mispricing of risks) to compensate for provisions for non-

performing loans.  

 

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Likewise, with regard to risk aversion (or capitalization), most empirical findings report a positive 

effect on net interest margins. Among others, Saunders and Schumacher (2000), Aboagye et al. 

(2008a), Hawtrey and Liang (2008), and Fungacova and Poghosyan (2011) found that the level of 

capitalization has a positive and significant impact on bank interest margins, suggesting an 

important policy trade-off between assuring bank solvency—high capital-to-asset ratios—and 

lowering the cost of financial services to consumers—low net interest margins. It appears that as 

banks deploy higher equity, they charge their customers more so as to earn enough to service the 

higher expected returns of shareholders (Aboagye et al., 2008a). 

 

Kasman et al. (2010) report that managerial efficiency (measured by the ratio of operating cost to 

income) is negatively and significantly related to net interest margins, implying that higher 

managerial efficiency stimulates banks to offer higher deposit rates and lower loan rates to their 

clients. Angbazo (1997), Maudos and de Guevara (2004), Hawtrey and Liang (2008), and Claeys 

and Vennet (2008) report similar findings, but Gischer and Juttner (2003) suggest that improved 

quality of management should narrow down the interest margin due to efficiency. Almarzoqi and 

Naceur (2015) note that more recent studies find that banks with well-developed non-interest 

income sources have lower net interest margins, suggesting that banks may tend to offer loans with 

small or even negative margins to attract clients and compensate with higher fees. In contrast, 

Chiorazzo, Milani, and Salvini (2008) and Elsas, Hackethal, and Holzhauser (2010) assert that 

revenue diversification enhances bank profitability via higher margins from non-interest 

businesses. Nguyen (2012) also found that net interest margin is not always inversely related to 

diversification. 

 

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Naceur and Omran (2011) suggest that macroeconomic and financial development indicators have 

no significant impact on net interest margins, except for inflation. On the other hand, regulatory 

and institutional variables seem to have an impact on bank performance. Likewise, Ahokpossi 

(2013) found inflation to be positively related to interest margins, but there is no conclusive 

evidence that economic growth has any impact on margins. However, as pointed out by Ahokpossi 

(2013), there is a dearth of research on interest margins in Sub-Saharan African (SSA).  

 

2.4.3 Empirical Evidence on Determinants of Bank Profitability 

 

A sound and profitable banking sector is better able to withstand negative shocks and contribute 

to the stability of the financial system. Therefore, the determinants of bank profitability have 

attracted the interest of academic research as well as of bank management, financial markets and 

bank supervisors (Athanasoglou, Brissimis, & Delis, 2008). Most recent studies on the relationship 

between bank competition and profitability test the SCP and/or the ES hypotheses. Generally, the 

results have been mixed. While some have found support for the SCP, other studies find no 

evidence of market structure or market power having an effect on bank profitability. Instead, some 

have found that the level of bank profitability is explained by efficiency. Of course, even when 

market structure or market power is found to affect profitability, the outcome is not always the 

same. In some cases profitability is positively affected by market structure, while the effect is 

negative in other situations.  

 

For instance, Tregenna (2009) analyses the effects of structure on bank profitability in the U.S 

from 1994 to 2005. He found evidence that market concentration increases bank profitability. This 

holds even when the largest banks are excluded from the sample, suggesting that the relationship 

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between concentration and profitability acts in a generalized structural way and that the higher 

profits arising from concentration are at the expense of the rest of the economy. The analysis points 

to various policy implications relevant to the current crisis, in particular in terms of the legitimacy 

of expectations of the restoration of pre-crisis profit rates and the need for much stronger regulation 

of the banking sector, especially in terms of the structure of the sector, pricing behaviour and use 

of profits. Closely related to this is Fu and Heffernan (2009), who investigate the relationship 

between market structure and performance in China’s banking system from 1985 to 2002, a period 

when this sector was subject to gradual but notable reform. Their results lend some support to the 

relative market-power hypothesis in the early period. 

  

Similarly, Perera et al. (2013) find that even though increasing competition (arguably driven by 

on-going deregulation and liberalization of the financial services industries) exerts negative 

pressure on bank profitability, high levels of industry concentration still allows South Asian banks 

to earn higher profits. And for the Arab Gulf Cooperation Council (GCC) region, Al-Muharrami 

and Matthews (2009) find that the performance in banking industry is best explained by the 

mainstream SCP hypothesis. Also, Jeon and Miller (2002) examined the evidence, if any, of the 

relationship between several measures of bank concentration at the state level (in the U.S) and the 

average performance of banks within that state. They find a robust positive correlation between 

bank concentration in a state and the average return on equity within that state. Moreover, the 

linkage appears to run from increasing bank concentration to increasing bank profitability, and not 

the reverse. Those observations, they conclude, imply that the market power, rather than the 

efficient-structure, hypotheses holds for the U.S. banking industry during the last quarter of the 

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20th century. They suggest that bank regulators need to monitor the consolidation process within 

the banking industry to head off the accumulation of monopoly power.   

 

Mirzaei et al. (2013) empirically investigate the effects of market structure on profitability of 1,929 

banks in 40 emerging economies (Eastern Europe and Middle East) and advanced economies 

(Western Europe) over 1999–2008 by incorporating the traditional Structure-Conduct-

Performance (SCP) and Relative-Market-Power (RMP) hypotheses. They observe that a greater 

market share leads to higher bank profitability being biased toward the RMP hypothesis in 

advanced economies, yet neither of the hypotheses is supported for profitability in emerging 

economies. The evidence also highlights that profitability increase with increased interest margin 

revenues in a less competitive environment for emerging markets. In addition, Goddard, 

Molyneux, and Wilson (2004) find some evidence of a positive association between concentration 

and profitability, but little evidence of a link between bank-level x-inefficiency and profitability. 

 

In contrast, Seelanatha (2010) suggest that the traditional SCP argument is not held in the banking 

industry in Sri Lanka, and that bank profitability does not depend on either market concentration 

or market power of individual firms but on the level of efficiency of the banking units. Likewise, 

Chortareas et al. (2011) suggest that despite the significant rise in takeovers from foreign banks 

and the increase in market concentration, banks’ profits do not seem to be explained by greater 

market power in Latin America. Instead, efficiency (particularly scale efficiency) seems to be the 

main driving force of increased profitability for most countries. The key implication is that policies 

aimed at removing the remaining barriers to competition should be expected to benefit the banking 

system without being detrimental to consumers.  

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And while Flamini, Schumacher and McDonald (2009) assert that bank profits are high in Sub-

Saharan Africa (SSA) compared to other regions, they do not obtain conclusive results as to 

whether market power influences bank returns. 

 

In regard to other determinants of bank profitability, Athanasoglou et al. (2008) show that bank 

capital is important in explaining bank profitability, while increased exposure to credit risk and 

high operating expenses lowers profits, showing that cost decisions of bank management are 

instrumental in influencing bank performance. Similarly, Liu and Wilson (2010) find evidence that 

well capitalized, efficient banks, with lower credit risks tend to outperform less capitalized, less 

efficient counterparts with higher credit risks in Japan. Perera et al. (2013) also reveal that well-

capitalized banks and those with relatively more efficient production processes in South Asia are 

the more profitable. On the contrary, Goddard et al. (2004) and Goddard et al. (2013) show that 

ba