Abstract
Political instability is a major issue that affects the operational development of banking institutions across the world. This paper considers the essential elements of political instability in African countries and their proposed effects on the banking system in Africa. Theoretical arguments on effects of political environment and the political economy of African countries are discussed with reference to the banking system. The problems facing African countries that have led to poor performance of the banking sector also forms key component of the paper. Financial fragility and prosperity to financial crises, developmental effects and negative deflation are discussed in greater heights. The paper gathers data from the World Bank and African Bank of Development as well as extensive literature research to provide insights of effects of African political instability to the banking system. It is concluded that there exists strong political cases for African countries to ensure that their own banking systems are adequately regulated based on individual requirement of each country. While this paper provides researched-validated recommendations, it is essential to note that most of the points are applicable within the banking system of the African continent.
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Introduction
Economists regard political instability as a serious malaise harmful to the performance of the banking sector. Political instability has been criticized for its potential ability to shorten the horizons of the policy makers leading to sub-optimal short-term macroeconomic policies that consequently affect the banking sector. Economists provide that political instability leads to more frequent switch of policies creating volatility, thus negatively affecting the performance of the banking sector as one of the macroeconomic indicators. For this reason, based on its damaging repercussions on the performance of the economy, the extent to which political instability is pervasive across the African countries is quite surprising. According to La Porta, Lopez-de-Silanes and Shleifer, (2002), the measure of political instability is done through cabinet changes, meaning, and the frequency in a year that a new Premier is named, or more posts in the cabinet are occupied by new ministers. Indeed, the African countries have witnessed a widespread in cabinet changes displaying remarkable adverse effects on the African banking system.
The political instability among the African countries has suffered throughout the history that has led to negative performance of the African banking institutions. The political conditions in the African countries has affected and continues to affect the activities of both local and international banking institutions to quite an extent that the African Development Bank supervises the activities of all domestic banks in Africa. Political instability has resulted to fear of the international investors in keeping their financial resources in the African banks as they fear of frauds and unstable trends (La Porta, Lopez-de-Silanes & Shleifer, 2002). The diverse phenomenon of policy and political instability in African continent and its negative implications on the performance of the banking system has arisen the interest of numerous financial experts. Therefore, the profession has produced an ample literature documenting the adverse consequences of political instability on various economic variables such as private investment, GDP growth, and inflation. A study by Jayaratne and Strahan, (1996) that used data from 23 African countries from 1950 to 1983 provides that GDP growth is significantly lower in the African countries during the periods of high prosperity of government collapse. Most recent paper by Jayaratne et al. (1996) establishes inflated degrees of political instability lead to lower performance of the banking system.
Greene, (2004) documents that socio-political instability leads to an uncertain political and economic environment, raising risks to the banks and lowering their growth. Greene, (2004) through a private investment shows that socio-political instability leads to higher rates of inflation thus affecting the banking sector. According to the paper, political instability shortens the horizons of governments in disputing long-term economic policies conducive to a better financial system and performance. This paper revisits the relationship between political instability and the African banking system. Previous research has ignored tackling the fundamental questions of the relationship between political instability and Africa banking system. As such, this dissertation aims to validate the possible impact of political instability in the banking system in African n countries.
Statement of Problem
The reported failure of the banking system in most African countries is shocking. Therefore, understanding the causes of the recent costly failure of the banks in Africa is the essential to preventing a recurrence. While there is a difference between epidemics of microeconomic and macroeconomic varieties, the syndrome of continued economic failure of African countries is associated with pervasive government involvement. The political interference in African countries in the business sector is the Achilles heel of the banking regulatory system. Understanding the banking crisis based on political interference is essential for providing remedial measures in the banking system. Understanding the implications of Africans political instability on the banking system of the countries is significant for analyzing the current economic situation. Political instability has caused numerous issues to the African banking system, thus validating the need for research in this area. This research is central to the validation of the contribution of the political instability in Africa to the banking system.
Significance of Study
The prevalence of the banking system failures in African countries has continued to worsen. These countries have incurred a resolution cost of $ 250 billion over the previous years. Sadly, these costs have been borne by depositors and creditors of failed banking systems. However, the government has in one way or the other footed the bill in these countries. While these costs amount to economic losses, the magnitude of the problem facing African banking system cannot be doubted. Indeed, there is a clear reflection of waste of investible resources in African countries where potential capital productivity and required sound credit decisions are significant (Farazi, Feyen & Rocha, 2011). Additionally, government assumptions of unforeseen and substantial bailouts costs have potentially destabilized fiscal consolidation programs and additional deadweight cost of taxation. It is clear that lessons have been learnt that political uncertainty in African countries has led to bank failures (Frieden, 1991). However, research has shown that these impediments can be avoided to enable success in the banking sector. Since bank isolation is inevitable, and it would be unadvisable to aim for zero tolerance, the widespread failure in Africa that has analysed, a wide system of banks can be avoided. In similar spirit, this paper provides empirical and theoretical insights that indicate the degree of effect of political instability in Africa that as paralyzed the wider section of the banking system.
Theoretical Overview
Theoretical and empirical arguments discussing the effects of political instability on the banking system among the developing countries are relatively flimsy. As such there are open grounds of skepticism based on the claims made by the votaries of various documented measures. However, there are reputable platform for questioning the pattern and extent of the banking system in African countries considering poor performance and high instances of political turmoil. It is worth noting that extreme political uncertainty in African continent is detrimental to the development f the banking sector and robust measures are required to provide a speedy solution.
Current literature provides a broad range of opposing views on the role of government in stabilizing the banking system. A model developed by Jha, (2008) and Herbst, (1997) based on comparability perspective and conflict perspective provides a link between political environment and economic development the comparability perspective belongs to a school of economists and political scientists that observes that political stability leads to democratic institutions that has a beneficial effect on economic growth both indirectly and directly. Conversely, the conflict perspective is a second school of thought maintaining that political maturity does not necessarily mean that the formed democratic institutions have a beneficial effect on economic development. Conflict perspective defenders provide that developing countries that have achieved super growth, such as South Africa and Rwanda regardless of their political structures. Proponents of comparative perspective, on the other hand, argue that democratic institutions arise due to political maturity and this leads to creation of a system of checks and balances that controls the power of government and limit potential implementation of unjust policies.
LITERATURE REVIEW
Capital Adequacy and Political Instability in Africa
Most of the African economies are currently undergoing substantial reforms in the financial sector and especially the banking sector. For instance, the reform of the central bank of Nigeria is considered a great achievement in the country that led to the increase of bank capital above 1000 percent. The reform of Nigeria banking system resulted in the reduction of a motley group of family anemic 89 banks to 25 stronger, bigger, and more resilient banking system. According to Chafer (2002), reforms are needed in the African banking system to engineer the revolution in the financial services. This, Chafer (2002) writes, would lead to increased quality of financial products and quality of service available for the Africans and to checkmate the banks’ capital adequacy. Furthermore, Chafer (2002) defines capital adequacy as the percentage ratio of a financial institution’s primary capital to loans and investments (assets), necessary for estimating its financial stability and strength. The Bans of International Settlements (BIS) establishes that the capital adequacy standard requires the banks to have a primary capital base equivalent to at least 8 percent of their assets. For instance, a bank that lends 10 dollars for every dollar of its capital is within the recommended limits (Ghate & Zak, 2003). However, the effects of political instability among the African countries have set myriad challenges to the capital adequacy for numerous African banks. According to Ghate and Zak (2003), the assessment of African banks’ capital adequacy for precautionary reasons has been problematic owing to the high nature of political instability in the African continent that constantly changes the financial and economic services industry.
Kaminsky and Reinhart, (1999) indicates that the role of capital is best understood holding to the fact that a bank depends on a critical extent upon the confidence of the public. Likewise, there exists a strong aspect of public relation to capital adequacy. Kaminsky et al. (1999) recognizes that capital availability is neither a perfect indicator of success in the banking sector nor a sufficient condition to ensure confidence maintenance of the creditors and debtors. However, there is no doubt capital adequacy factor represents a significant element in shaping the perception and solidarity of the banking institutions. The level of capital is used by government economic regulators to restrict the expansion of credit (Kaminsky & Reinhart, 1999). Therefore, the aspect of capital adequacy explains the fact that political instability among other factors has attracted the attention of African bank managers in determining the potential relationship between total credit loan, inflation rate, money supply and political instability. As a result, Levine (2005) establishes that political instability in Africa has negatively compelled the African banking system to meet the requirements of capital adequacy that has led to more borrowing to meet their credit expansion target.
With reference to significant role of banking system, that is, financial intermediaries, capital adequacy and political instability among the African countries has emerged as a key indicator of a bank capital. The resultant negative consequences of political instability in the African countries are the increase of inflation. For example, the economic indicators of the Zimbabwe indicate that the rate of inflation is so high that it has led to erosion of capital of the banks in the country. Indeed, a study by Honohan (2004) established that the development of the banking sector is related is related to economic sustainability and development. Therefore, capital adequacy in the banking sub-sector in the African financial and economic development provides significant validations for investigating the effects of political instability in bank ratios and balance sheets. Owing to the significance of banks’ role as financial intermediaries, analysis of capital adequacy in the banking sector has malnourished due to high political instability in the developing countries, according to a qualitative assessment of sectoral behaviour patterns and growth trends in the African banking sector. The subsequent failure of management of African banks and their products is tentative to the high political instability since independence of these countries. While divergent opinion has been witnessed among the experts in banking and finance sector based on what constitutes adequate capital, most of them has converged and agreed that it is an age-long issue for which there is no doubt about the negative consequences of political instability factor.
Jappelli and Pagano, (2002) applied a non-parametric analytic technique in measuring the performance of the Nigerian banking sector with respect to capital adequacy and political instability. According to the study findings, the data devolvement analysis can be utilized as an alternative to ration analysis for evaluating the performance of the banking sector with attention to political instability economic indicator. The correlation between the bank holding company profitability provides a significant evidence of the reversion of the Nigerian financial industry based on its political instability in the 1988/1989 period. According to Jappelli et al. (2002), Kenya is one the African countries that has witnessed bad political will that has led to high political temperatures. According to him, the Kenyan banking system provides that it has been performing its expected roles albeit at less than optimal standards. The high political bad will have led to recurring financial system crisis providing a testimony that the banking sector performance in Kenya still leaves much to be desired. The Central Bank of Kenya (CBK) that is the apex regulatory body in the Kenyan financial system that came to the fore under the act of parliament in 1967 has experienced several enactments. The CBK Act has undergone numerous amendments and changes made with the responsibility of “promoting monetary stability” and sound financial structure in Kenya. However, politics of interest has seen the Parliament amending the laws to serve their political interests rather than serving its mandates (Jappelli, & Pagano, 2002).
Honohan, (2004) investigated the performance of the African banks with a case study of Nigeria. According to Honohan, the Central Bank of Nigeria in 2009 declared five banks insolvent. The banks named were Union Bank, Bank PHB, Oceanic Bank, Afribank, and Intercontinental Bank. Furthermore, the Central Bank of Nigeria in 2011 declared to take over Sterling Bank, Bank PHB, and Afribank by the investors. There have been incidences of bank failures in the country before the establishment of Central Bank of Nigeria. Political instability, Honohan (2004) notes, was documented as one of the significant determiners of bank failures in Nigeria. Political instability led to inappropriate capital adequacy that triggered the first bank failure in Nigeria in 1989 where 8 banks were reported to be weak, and the number further increased to 31 banks in 1989. Likewise, in 2004, Nigeria experienced their third bank failure were a total of 64 banks were reduced to 25 banks. Honohan, (2004) reports that political instability provided core reason for the inability of the financial regulators to oversee the activities of the banks.
Political Instability and Economy of Africa
Several economic papers have documented the significance of the political environment for promoting the development of the economy. Levine, (2005) indicates that sound political institutions foster economic transitions mainly by reducing investment risks. The problems related to African political instability is a direct consequence of its leadership impediments. The governments of Africa are operated in a way that is far from the modern western state systems. According to Laeven and Majnoni (2005), despite the bleak predictions, the banking system of Africa is performing below the optimal standards. The African political instability, according to Levine (2005), weakens the development of the banking sector as a key indicator of economic development. This has been associated with strong internal and external links with particular interest among the elites of Africa. Therefore, the resource in Africa that has the potential of developing the banking sector has never been a blessing, rather a curse to the bank performance. The existing economic conditions in African countries are based on western policy prescriptions that have also led to deprivation of the African populations of the special services pertinent to the development of the banking sector.
While Levine (2005), establishes that sound political environment reduces investment risk, debates have emerged on the uncertainty concerning the concept of democracy most African countries are advocating. The democratic campaigns in the developing countries are believed to be an impediment to economic performance, as provided by La Porta, Lopez-de-Silanes, and Shleifer, (2002). According to him, there is a non-linear relationship between political freedom and growth of the economy. As such, it is provided that too much and not enough democracy witnessed in Africa has potentially impacted the growth of the banking system. Political uncertainty among African countries is based on the fact that democracy yearned for and practiced in most countries covers numerous realities and democracy differs widely in their characteristics. Likewise, dictatorship in some African countries such as Egypt has disaggregated the political regime features in Africa to be able to pin down accurately the impact of political instability on the development of the banking system.
The role of Political Instability
Economists have long raised a consensus concerning the impact of political instability on the financial system growth, yet the concept of instability is itself ambiguous. The term political instability highlights both the legal changes of heads and governments alongside violent takeovers. While legal changes refer to political changeover, violent takeovers are more related to instability that has broadly acknowledged the negative impact of the banking system growth (Göhlmann & Vaubel, 2007). Secondly, there is the concept of the elite instability that Ghate, Le and Zak (2003) define as fewer dramatic events to social unrest, which is political violence and demonstrations. According to him, the negative correlation between political instability in Africa and growth of banks can be explained by impaired factors of production within the banking system. Instability, Göhlmann and Vaubel (2007) writes, prevents political institutions from ensuring the rights of property. This in turn elevates the probability that returns on investment are expropriated. Therefore, political instability leads to high risk and as result investment in the banking sector is undertaken. Ghate et al. (2003) shows that political instability affects human capital accumulation as it lead to brain drain. The political instability in some African countries such as Egypt with revolutions, Ghate and colleague (2003) argues, leads to breaks in the process of production, thus reducing the level of GDP.
The factor of production accumulation correlates with the negative consequences on the productivity of the banking sector. Indeed, the implication of human capital accumulation and investment on banking growth performance depends on the political-institutional context as efficacy of banking production factors is certainly improved in a stable political environment (Göhlmann & Vaubel, 2007).
Furthermore, political instability, Acemoglu, Johnson, and Robinson, (2001) documents, affects the performance of the banking sector with reference to political economy. This he explains, leads to time horizon reduction that politicians might suffer from elevated political instability. With reference to high instability, the politicians in Africa continent, by nature, tries to avoid the structural financial reforms and lead to wait-and-see policies rather, in order to limit the disagreements with the political parties and the population (Acemoglu, Johnson & Robinson, 2001). A study by Acemoglu et al. (2001) indicates that most governments in Africa tend to choose to pursue similar policy of economy in spite of all the evidences to emerge a political victory by defeating the opponents. The literature of political economy by Acemoglu et al. (2001) has documented such schemes to affect the economic growth of the countries and subsequent reduction on the performance of the African banks. Based on similar perspectives, Acemoglu et al. (2001) considers that short-term financial policies do not help the politicians to keep their commitments. Moreover, a government threatened by instability may be tempted to use corruption to ensure the loyalty of the banking sector that might help to remain in power. According to Greene (2004), most African countries have their central banks as the regulators of the local and international investors in the banking sector. However, the management of the central banks has been politicized, and their management board chooses on the basis of political loyalty. This, Greene (2004), explains, has resulted to mismanagement and embezzlement of funds in the largest banking institutions and subsequent decrease in growth. Politicians appoint people that are loyal to them to such senior posts that would promote their political agendas and ensure they stay in power.
Despite the diverse and unique datasets alongside the methodologies applied, the investigative studies on the banks of Africa suggest a negative correlation between political instability and growth of banks. Greene, (2004) goes ahead to show that political instability coupled with instability in trade are the pillar factors behind poor banking system in African countries. Following the role of financial sector in economic development, economics have documented that banks play a significant role in alleviating market frictions that influence the rates of saving, technological innovations, investment decisions, and, therefore, long-term bank growths (Greene, 2004). The financial institutions and markets arise to mitigate the implications of transaction costs and information that leads to the prevention of the direct pooling and investment of society savings. However, political instability has been raised as a major impediment in the banking system to deliver on its mandate of providing payment services that facilitate movement of services and goods, mobilizing and pooling savings, produce and process investment project information that enables efficient fund allocation, diversify and transform risk management, and monitor investment and exert corporate governance over the allocate funds (Greene, 2004). The bulk of the literature from financial development in Africa suggests that affluent financial systems play a causal and independent function in promoting long-term growth of the economy.
Channels
Following the concept of channels, there is an emerging debate whether financial institutions are directly affected by political instability in African countries. However, Acemoglu, Johnson, and Robinson, (2001) argues that political good will is significant for establishing a conducive environment for conducting business. The conclusive impact of political instability points towards an indirect and direct influence as outlined by (Acemoglu, Johnson, and Robinson, 2001). Moreover, complex models provides by the Beck (2008) justifies interlink between political spheres and financial system development. Purposefully, Beck (2008) investigated the impact of a young democracy in most countries in Africa on the banking institutions. While scholars agree that democracy affects growth, simultaneous equations from the study provide that two channels, that is, political instability and human capital, emerge highly influential to the banking system development. The role of human capital accumulation, Beck (2008) indicates, provides the channel through which political instability affects the banking system. Political instability decreases the accumulation of human capital necessary for the growth of the banking sector in Africa. Beck, (2008) proves his point based on an analysis of interactive variables in the specification. As a result, the impact through which investment prevails since adding up and withdrawal of human capital variable from the equation promotes substantial effect on the results. With reference to the African countries, results of the banking system audit show that political instability directly affects the residuals of the growth equation.
Impact of political instability on income distribution, poverty, and financial development
The impact of political instability on poverty and financial development has also formed an instrumental area of empirical research over the past. While theoretical perspectives provide conflicting information on this area, the development of finance exhibits disproportionately beneficial impact on the poor. Indeed, the informational asymmetries produce credit constraints that specifically bind on the poor. Political instability in most African countries has made a larger percentage of the population poor who finds it difficult to fund their own investments due to inadequate resources. Bad politics in these countries has made an investment an instrument of politics as only the individuals with political connections are at upper hand of securing their investments (Acemoglu, Johnson, Robinson & Yared, 2008). Political economy theorists have argued that better functioning banking system makes the financial available to a wider population segment, rather than restricting them to politically connected and active incumbents. Nonetheless, others argue that access to financial credit only benefits the rich and the politically connected during the early stages of economic development. Therefore, despite the significant role of financial development in promoting bank growths, its impact on income distribution is still unclear. The access to credit improves the aggregate growth of the economy, and a higher number of people meet the requirements of joining the formal financial system. While the relationship between development of banks and income distribution may be non-linear, political instability takes blame for the adverse effects of poverty on the financial institutions development, especially at early stages (Acemoglu, Johnson, Robinson & Yared, 2008).
In a cross-country regression analysis of the African countries, Beck (2008) investigated how the development of banks influences the rate of growth of income among the poor African societies. According to the results, finance leads to a disproportionately large and positive impact on the poor, hence reduces income inequality. However, bad politics is considered an impediment to financial access among the poor people that leads to poor growth (Beck, 2008). Banks, like any other financial institution, depends on the interest accruing from credit for expansion. As such, they must increase their lending rates and make increased revenue returns. However, research shows that poor people that forms the larger percentage of the African societies lacks securities and the knowledge of borrowing money from the banks. In turn, the banks make limited profits from the few incumbent politically connected and affluent individuals. Poor politics has been blamed for increased income inequality among the Africans that has led to insufficient knowledge of the benefits of the formal banking systems (Beck, 2008). While more empirical research applying microdata sets and diverse methodologies are needed to confirm these initial findings, understanding the mechanism through which political instability affects the banking system through inequality in income distribution and poverty is no doubt clear.
The rise of political instability among the African countries has led to high prices of commodities. Therefore, the general public has become conscious of their spending and potential decrease in their disposable income. The citizens in the African continent fear of insecurity due to political bad wills and thus prefer squandering their financial resources and entertaining fewer saving. As a result, the growth of the banks in Africa has decreased based on the deposits. Furthermore, political uncertainty has potentially affected economical and situations of law and order. Therefore, this has led to the lack of trust among the Africans in their financial institutions. The high rate of illiteracy due to lack of education or bad education policies has also left the financial sector for the few vibrant people in the African societies. Most of the African countries experience a high level of illiteracy, and the public are unaware of the benefits of using the banking system. For instance, the level of illiteracy in Morocco stands at 56 percent for women and 52 percent of men. Therefore, the little percentage of the population cannot provide adequate deposit to the banks for sustainable development.
Indeed, Hermes and Lensink, (2003) provides that bad politics is the founder of poverty among the African societies. While human activists such as Nelson Mandela observed that education is the weapon for fighting poverty, political instability in the African continent has discouraged the implementation of education policies to enable education for all citizens. Therefore, the majority of the people of the African continent are less educated and ignorant of the operations of the banking sector. As such, rumors have created a great panic, thus potential problems to the financial sector (Hermes & Lensink, 2003). As established, the effects of political instability in African continent have substantial effects on education access and to the financial sector, in the long run. The politicians who form the elites of the African communities continue to implement policies that suit their political interests. As such, most politicians feel that providing education to the public would increase political competition and criticism from the public domain. Therefore, politically- driven hindrance to education for the Africans through political bad will have substantially affected the banking system of the continent.
Political Instability and Financial Liberalization in Africa
Benhabib and Rustichini, (1996) defines financial liberalization as the measures directed at diluting or dismantling regulatory control over the financial instruments, institutional structures and activities of agents in various segments of the financial sector. The removal or reduction of financial controls on the interest rates is greatly affected by political instability that manipulates the financial agents. While the central bank has been traditionally the significant administrator that rate the financial structures through adjustments to its discount rates and open market operations, African countries has experienced massive manipulation of the practices of central banks through various amendments and political loyalty (Benhabib and Rustichini, 1996) However, deregulation of banks removes the interest rates ceiling and brings competition among the financial firms, thus increasing debtors. Therefore, Benhabib et al. (1996) asserts, the competition for price increases and forces the banks to depend on other volumes to ensure returns. Furthermore, the withdrawal of government from the activity of financial intermediation with privatization and conversion of the development banks into regular banks is not healthy on the market signals allocation of capital. Thus, political instability that dictates the role of government in financial regulation is usually accompanied by the decline of directed credit and elimination of requirements for special credit allocations to politically affiliated sectors.
Moreover, political instability in African countries, according to Diamond, Larry, Linz and Seymour (1989), has led to the easing of conditions for participating in the banking institutions and stock market investment. This has been achieved by permitting greater freedoms to intermediaries, for instance, stock brokers. Likewise, relaxing the conditions with reference to investment borrowed funds and borrowing against shares in the banks is pertinent to the political environment. Political instability in Africa, especially in Nigeria has experienced instances of high financial regulation that has led to keeping of separate different financial sector segments such as merchant banking, banking, insurance, and mutual fund business. According to Diamond et al. (1989), Nigeria has witnessed conflict of interest due to the creation of agent segment that invest in the financial sector. Political instability has promoted the insufficient change in the regulatory walls separating financial sectors. Therefore, there has been limited growth towards the emergence of universal banks that has reduced interlinks pyramiding and between the financial structures (Diamond, Larry, Linz & Seymour, 1989). Thus, reduction of the sources from and instruments through which financial agents and firms can access funds for development.
Research has long validated that the inadequacy of liberalization rules governing African banking and other financial institutions prohibits the growth of banks. Therefore, there is a lack of transformation to the traditional role of the banking system as the principle intermediary bearing risk in the system. As a result, most banks in Africa, for instance in Zimbabwe, continue to accept relatively small individual liabilities of short maturities that involve lower income and is highly liquid, thus increasing risks in the banking system. There are strong regulatory constraints over the banking institutions in Africa leading to stagnation and poor performance of the sector. Lack of liberalization leads to decreased generation of financial assets that transfers risk to the portfolio of institutions willing to hold them. The failure of politically implemented policies that is the key driver of liberalization has promoted the financial crisis in most countries sin Africa because the central bank has assumed numerous roles rather than limiting their role to limited monitoring and supervision of the entire banking system (Mohamoud, 2006).
Theorists have provided divergent arguments for financial liberalization based on some basic monetarist postulates. Mohamoud, (2006) provides that money supply is exogenous rather than endogenous to the banking system and can only be controlled by monetary authorities. These authorities, he observes, are the relevant bodies that can pursue well-defined targets for money growth. Subsequently, it is established that economic growth determines the availability of supply factors of production such as labor and capital and the rate of growth of productivity. The changes in the money supply, according to Mohamoud (2006), do not exhibit any substantial impact on economic activity and growth of bank output. Lastly, theoretical concepts indicate that inflation is attributable to an excess money supply as opposed to the real growth of bank output. Therefore, Mohamoud (2006) concludes that these postulates can be argued to support the formation of independent central banks with an essential role in controlling inflation through monetary market levers to control supply of money. However, there is no clear correlation between inflation and growth of the money supply.
The aforementioned policies are a direct result of political instability in African countries. These policies have led to financial oppression in these countries. Most African countries have advocated the need to eliminate financial repression in favor of financial liberalization, Ong’ayo, (2008) argues. According to him, the repressive policies in Africa are inimical to financial deepening. This is particularly true based on the premise of the observed empirical relationship between banks growth and financial deepening in some African countries, such as Uganda. As a result, political instability has led to financial repression that has depressive effects on the savings rates of the Africans resulting to capital shortages within the banks that in turn affects their growth adversely (Ong’ayo, 2008). Moreover, financial repression as a direct consequence of political instability tends to ration out riskier projects selectively, irrespective of social and economic relevance, because the ceilings of interest rates implies on the adequate risk premiums cannot be changed. Therefore, the large theoretical literature on the African financial system shows a structural imperfect growth of the banking system.
Impact of Financial Liberalization in Africa
The financial systems in developing countries are often much marginalized as compared to the global finance. Most African countries banking system are considered to be small and this leads to underperformance since they suffer from difficulties in exploiting economies of scale, concentration of risk and thus, become more vulnerable to external shocks (Khabele, 2003). In theory, African countries fall short of minimum efficient scale, and liberalization may provide a lot of significances and sourcing some of their financial services from abroad. However, this can only be achieved under well-structured institutions based on political goodwill of the country. Robust literature on international financial and macroeconomic issues provides evidence supporting financial liberalization and political stability (Khabele, 2003).
Impact of Exchange Rate Policy on Financial Fragility
It is the role of the government to establish interceptive environments to ensure appropriate exchange rate regimes for the developing countries in Africa. Debates over these issues raises the importance of appropriate exchange rate regimes since its choice possess significantly influential impacts of external shocks affecting financial stability. According to Charles (1998), flexible exchange rates witnessed in most African banks such as in Kenya and South Africa may expose their banks to stabilizing effects on their financial system because the exchange rates potentially exposes them to economic shocks considering the poor management regimes. Furthermore, flexible regimes have the potential of curtailing the tendency of the African countries of over-borrowing in foreign currency, thus discouraging the banks from funding riskier lending booms through external credit (Charles, 1998). Therefore, fixed exchange rates and lender of last resort operations should be limited since it puts the domestic monetary expansion on risks through undermining confidence in the currency peg (Khabele, 2003). On the contrary, the lack of effective political leadership that enhances effective leader of last resort often encourage risk-taking bankers, thus increasing the likelihood of the banking crisis. Lastly, African countries are pegged with lack of political credibility and limited access to international markets. As a result, these countries suffer most the effects of exchange rates volatility due to greater liability dollarization (Charles, 1998).
Empirically, Honohan and Vittas (1996), shows that African countries with fixed exchange rates are equally susceptible to the banking crisis. Besides, his studies on the effects of dollarization on financial fragility similarity evidence the risks. Indeed, dollarization, Charles (1998) hints, is a symptom of volatile real exchange rates and weak domestic currencies hence gets associated with financial fragility. Arteta, (2003) perform a similar investigation using data from Africa Development Bank to measure fragility using average Z-Scores and non-performing loans across 29 African countries. Arteta, (2003) results established that dollarization positively related to the measures of bank fragility. While more research is needed because of conflicting literature, the impact of exchange rates in developing countries, numerous economists agree, is an impediment to the banking system.
Facilitating Access
Economists have previously increased their emphasis on access to financial services over the previous years. Accumulating evidence of financial access is financial growth; thus it is believed that limited financial access is a contributor to high poverty levels (Alesina, Devleeschauwer, Easterly, Kurlat & Wacziarg, 2003). Besides, evidence shows that poor households and small enterprises in that form the majority of African societies face much greater obstacles in their ability to access finance. Demirgüc, (2006) explains that financial access entails numerous dimensions such as cost, availability, range and quality of the offered financial services. Further definition by Demirgüc, (2006) provides that financial access dimensions refers to convenience, how easy to access finance, reliability, whether finance is available when desired, flexibility, where the product is tailored to the household needs and continuity, ability to access finance repeatedly. Broad data unveiled from African countries concerning their financial development, however, provides limited data on the access and usage of finance for the firms and households. Therefore, analysis of the impact of financial access among the African households is scarce. Financing obstacles data, nevertheless, are found to be the highest and most contrasting for the growth and development of smaller financial firms (Alesina, Devleeschauwer, Easterly, Kurlat & Wacziarg, 2003).
It is established that at household level among the African households, there is insufficient credit access that takes blame for the perpetuated poverty because poor households is characterized by education insufficiency and higher levels of illiteracy (Banerjee & Newman, 1993). According to research based on 7 African countries, Barth, Caprio and Levine, (2004) found that lack of political stability to establish child abuse campaigns has led to high rates of child labor linking the issue with underdevelopment of their financial systems. Meanwhile, Barth et al. (2004) shows that transitory income shocks have led to increased child labor in African countries due to poorly functioning financial systems. Banerjee et al. (1993) indicates that a better understanding of the chief obstacles to improving financial access and the magnitude of the impact of poverty levels and slower growth needs political intervention. Numerous reasons have been documented why the poor do not have access to saving accounts, finance loans, and other banking services. Barth et al. (2004) writes that due to bad governance, securing such services from a bank requires a social network, a factor that the poor lacks. Moreover, lack of education makes it difficult for the poor to overcome the challenges with filling out loan applications and small number of transactions they are likely to prefer may make the financial advisors think t not worthwhile to assist them (Barth Caprio & Levine, 2004).
According to Beck, Demirgüç-Kunt, and Levine, (2006) a banking institution is likely to exist in richer localities and avoid poor people. In particular, for access to credit services, there are two dominant challenges. Firstly, the poor societies lack collateral and cannot borrow against their uncertain future income since they lack stable jobs or income streams to keep them on the track. Secondly, financial institutions consider dealing with small transactions costly. Thus, ceiling on the rates banking institutions can charge backfire and limited financial access to the poor. Most African countries have experienced mushrooming of microfinance-specialized institutions that tend to favor the requirements of the poor. Nonetheless, most of their loan officers come from more or less similar socio-economic status as the borrowers and go for the poor instead of waiting for the poor to come to them (Akerlof & Romer, 1993). Besides, group lending and microcredit education schemes have received boost for their positive contribution to monitoring peer pressure and building support networks.
Nevertheless, the question still begs, has the microfinance fulfilled the promise? According to Beck et al. (2004), microfinance banks allow the poor people to access more direct financial access. However, their development around the developing countries provides a mixed result, with significant rates of penetration in African countries, for instance, Uganda, Kenya and Zimbabwe (Beck, Demirgüç-Kunt & Maksimovic, 2004). Politics still takes the center of blame with economists indicating that group lending is very costly since the labor cost per dollar transactions should be designed to be high. Therefore, the most controversial aspect of microfinance mentions the degree of subsidy to provide this access (Beck, Demirgüç-Kunt & Maksimovic, 2004). Indeed, the sector of microfinance remains subsidy and grant dependent heavily. Beck et al. (2004) provides that economic skeptics have raised concerns whether microfinance is the most appropriate approach to provide financial access to the poor societies. It is pointed out that the development of mainstream banking sector is a more promising procedure of reaching out the poor and fight poverty in significant ways.
Above all, sound political economy highlights some of the reasons why developing countries should not emphasize on the poor for financial access and provides measures of making microfinance more viable and available to all. Bencivenga and Smith, (1992) writes that the poor lacks the political clout to demand better services and subsidies given by these banks may spoil the culture of credit. A broad definition of the issue incorporates the middle class who also lack financial access, and this would make it more likely that financial access promotion is a political priority. While figures are all pointing to the government promote financial access for development of the finance sector, political stability is pertinent to access by making and encouraging improvement of banking infrastructure (Bencivenga & Smith, 1992). Politically stable government can foster better payment systems, better legal system, and information system as well as other supportive structures that can allow technology to reduce the costs of transactions. Research indicates that most African countries have numerous small, inadequate banking institutions that use external finance, particularly, less bank finance, to imperfect substitutes(Bencivenga & Smith, 1992). For instance, Bencivenga et al. (1992) illustrates, at the household level, providing national identification number for every individual and creating credit registries where the lenders share information based on the records of their clients would assist since all borrowers could borrow using collateral credit access.
Furthermore, government regulation plays a significant role in this matter. Stable political environment is essential for the removal of usury laws to allow the banks to charge the rates they need to make profits and improve financial access. While these regulations are mostly practiced in most countries in Africa, the victims are the poor households who bear the consequences of service supply that often ends up completely dry (Ayyagari, Demirgüç-Kunt & Maksimovic, 2005). Political goodwill is significant for enhancing truth in lending through protective legislation since the households may be tempted to over-borrowing by unscrupulous lenders. Furthermore, reducing the cost of repossessing and registering collateral is a significant role of the government. For instance, in Ghana and Rwanda, the inability to repossess property has contributed to high cost of housing finance program, hence keeping the mortgage rates too high for the less fortunate societies (Ayyagari, Demirgüç-Kunt & Maksimovic, 2005). Political selfishness has led to discriminatory policies against the poor ethnic groups leading to high poverty levels and poor banking institutions.
Banerjee et al.(1993) hints that governments in developing countries such as Africa that practice financial regulations has prevented the emergence of better banking institutions suited to the demands of the larger population that is of low income. These governments have enhanced rigid chartering rules strict accounting requirements and high capital adequacy that has potentially reduced the ability of banking institutions to serve the poor segments of the society. According to Banerjee et al.(1993), many households in developing countries are interested in saving services but not in credit services, thus the banking institutions has net been able to mature considering low levels of profits accruing from savings as opposed to credit services. For example, the extension of bank supervision and regulation in South Africa to microfinance institutions has reduced their capacity to offer their banking services profitably (Ayyagari, Demirgüç-Kunt & Maksimovic, 2005). Still on the role of government, technological innovations are essential for improving banking services around the world as research validates. For example Jayati (2005) indicates, in Nigeria, the government developed a program through the Central Bank of Nigeria to allow the small suppliers to use their receivables from large credit worthy buyers to receive their working capital. Demirgüc, (2006) refers to this as reverse factoring trade that effectively allows small firms to borrow based on the credit worthiness of their buyers.
More directly, the government has a role in stimulating financial access through increasing of bank accounts. Political stability is essential to developing credit access improvement among the public. For instance, in United States, the US Treasury’s Electronic Transfer Accounts and US Reinvestment Act (CRA) has been used to increase bank accounts and improve credit services respectively (Beck, Demirgüç-Kunk & Merrouche, 2010). However, comparing the political maturity between US and African countries, it may be challenging to introduce such services on the African land considering high instances of political intolerance. Furthermore, Aghion et al. (2004) adds that there is little consensus about the success of such schemes in African countries. According to him, the experience with credit extensions, improving maturity debt structure and reach the SMEs, in particular, are not extensive in developing countries of Africa. As such, financial economists projects that the effectiveness of such interventions is much more doubtful in Africa because of the high levels of political insatiability (Bank for International Settlements, 2006). Perhaps, increasing competition in the financial sector may come easy for African countries. As the banks resume to their traditional business coming under competition, they may opt to secure innovative lines of making profits including lending to the poor and SMEs. However, the lack of stable policies and government support to provide the right incentives has limited the approach by private sector to develop and make use of new technologies such as credit scoring (Aghion, Angeletos, Banerjee & Manova, 2004).
Financial Liberalization, Political Reforms and Financial Development
Research shows that most countries in Africa have made efforts to liberalize their financial systems with mixed results reported. According to Bekaert, Harvey and Lundblad (2005), liberalization as well as interest rates deregulation and relaxed entry policies led to significant repression, yet the enthusiasm through which liberalization of finance got adopted in some countries in Africa indicates an absence of or sluggish implementation of institutional development thus leaving most the banks vulnerable to systemic crisis (Bekaert, Harvey & Lundblad, 2005). Furthermore, financial liberalization in African countries is based on poor sequencing due to political uncertainty that promotes the breeding of poorly prepared supervisory and contractual environment contributed to bank insolvencies, for example in Nigeria where 64 banks were reduced to 24 banks in 2004 (Bekaert, Harvey & Lundblad, 2005). Likewise, most African banks are protected by explicit and implicit government guarantees that aggressively take advantage of the new opportunities to increase the risk with ill-informed intentions and without necessary skills of lending.
Research provides that most sub-Saharan African countries have liberalized their credit allocation and interest rates and privatization of banking institutions by allowing entry of reputable foreign banking investors that led to formation of lower intermediation and access to financial services (Bekaert, Harvey & Lundblad, 2005). This has been established to be a result of absence of an effective informational and contractual framework in the Sub-Saharan African countries. Furthermore, it economists has claimed that liberalization has failed in African countries due to lack of government intervention in the financial sector. Additionally, these countries has failed financial liberalization due to the unfavorable political environment where the leaders lack interest in interventions in the banking sector, a factor that could help the public by boosting the economy and developing capital infrastructure (Bekaert, Harvey & Lundblad, 2005 and World Bank, 2001).
Impact of Foreign Investors in African Countries
Globalization and financial liberalization have made more developing economies in Africa to allow foreign financial institutions. Although most governments in Africa have expressed their dissatisfaction on allowing foreign banks to take huge ownership share in their banking system, supporters indicate that foreign banks would damage the economic performance and financial system (Bank for International Settlement, 2006). However, economists assert that foreign banks should be welcomed in politically stable environments. According to Honohan (1997), foreign banks spur competition, lift the quality of financial infrastructure, improve banking efficiency, and expand financial access. Research drawn from the African experience illustrates that the entry of foreign banks in the local maker, however, cannot guarantee rapid development of banking system in the absence of sound informational and contractual weaknesses pertinent to political uncertainty (World Bank, 2001). Poor political structures in low-income countries in Africa are believed to promote contractual and informational gaps, thus cannot fully benefit from opening their markets to foreign providers of financial services. Therefore, this provides an empirical explanation of the greater penetration of foreign banking in Africa and its association with lower levels of financial development in African countries.
Impact of International Capital Flaws
While optimists express that financial liberalization promotes development of financial systems, economist has expressed their concerns that this exposes them to crisis and vitality in the banking system (Honohan (1997). It is the role of the government to demonstrate political maturity to provide policies that focuses on proper designs of capital controls with the potential of mitigating and preventing negative consequences of sudden shifts in foreign capital Honohan (1997), writes. Demonstration of political stability would foster capital control in the form of outflow restriction, restriction of short-term flows and restriction on aggregate inflows. Besides, it can promote the establishment of Tobin tax aimed at imposing small uniform tax on every foreign exchange transactions, irrespective of their nature (World Bank, 2001).
An extensive body of economic and financial banking literature covering the effects of capital controls suggests that this would temporarily promote the growth of the banking system, with effects of diminishing returns over time. Besides equity flows and debt. Funds received from migrating workers abroad, workers’ remittances, would grow substantially and become source of external finance (Bank for International Settlement, 2006).
Political economy and Poor financial Liberalization in Africa
Financial liberalization promotes some negative consequences to the economic and social life of the African people due to poor political environment. The promotion of financial liberalization by the “democracy” in the government among African states has led to financial fragility and prosperity of crisis in the banking sector. Most countries in Africa are currently prone to currency and financial crises in relation to international banking and related crises as well as currency crises emerging from more open capital accounts. Political instability has born the persistent blame of the origin of several crises that advocated the shift from liberal and more open financial regime (Chandrasekhar, 2004). This is established to unleash a dynamic that pushes the banking system towards oligopolistic structure, poorly regulated banking system, thus corresponding fragility. The increased freedom of investment in the African continent in sensitive sectors such as stock markets and real estates, increased regulatory forbearance, and increased exposure to banking sector has resulted in increased instances of financial failure in African countries, according to(Chandrasekhar, 2004). Additionally, the emergence of universal banks has increased the degree of entanglement of financial agents and creation of domino effects in the financial system, particularly, the banking sector.
Poor policy implementation, a direct consequent of political instability, has left financial markets in Africa themselves, while this Feldstein, (2003) argues widely known for failure since the pubic goods characterization of information that banking agents must process after tedious process of enquiring. Therefore, individual shareholders have avoided investing financial resources and time resource in acquiring information on sound management hoping that others will do it. As a result, there is decreased monitoring leading to banking malpractices and risky decisions. Banks and other financial institutions wanting to reduce the costs of monitoring may follow the larger financial firms in making investment decisions leading to herd instinct characteristic of financial players. Therefore uncertain political environment in African countries has promoted the suppression of access to finance by some agents and over-lending of some banks, a failure that Akyuz, (2002) provides to have systemic effects on the banking system of Africa. Particularly, political uncertainty has led to increased prevalence of information externalities that has in turn increased banking malpractices, thus failure, a factor that has triggered fears of the depositors in banks, resulting in a run on deposits and substantial lack of development of the banking system in Africa.
Deflation and Banking Developmental Effects
Political uncertainty and increased financial liberalization, according to Demirgüç-Kunt and Detragiache, (1998), relates to enhanced crisis possibility and bias towards deflation of the macroeconomic policies and forces in African banks. The increased thirst by most politically unstable countries in Africa with intentions of attracting internationally mobile capital translates that there exist limits to the chances of enhancing capital taxation in such developing countries. Indeed, simultaneous trade liberalization in countries such as Kenya, Tanzania, Rwanda, and South Africa has already reduced the index tax revenues of these countries promoting financial liberalization through their democratic structures. The immediate effect, writes, is limited government spending since the finance capital is opposed to large fiscal deficits. According to him, this affects the possibility for the countercyclical macroeconomic stances of the country as well as the reduction of the growth-oriented activities of the banks (Demirgüç-Kunt & Detragiache, 1998).
The promotion of financial interest by political selfishness is against deficit-financed spending by the government. According to Demirgüç-Kunt et al. (1998), deficit financing practiced by the African governments’ increases the liquidity overhang in the banking system and is criticized as a potential inflammatory to the economic indicators and particularly to the banking sector. High inflations as witnessed in Zimbabwe and other countries in Africa is viewed as an anathema to banking system since it erodes the real value of bank assets, especially the financial asset (Otker, Pazarbasioglu, Johnsen, Hilbers, 2005). Moreover, since the government spending in developing countries is often described as autonomous in nature, the use of debt by these countries to finance an autonomous budget introduces the financial markets as an arbitrary player, rather than that driven by revenue return motive and whose activities can render interest rates differentials that leads to profit uncertainty in the banking sector (Otker, Pazarbasioglu, Johnsen, Hilbers, 2005). The banking institutions with intentions of safeguarding against the possibility tend to oppose deficit spending. Finally, since the impact of political uncertainty on financial interest is privileged to the role of markets, the presence of government agencies as the interventionist and regulator is observed to de-legitimize the role of banks, and this explains why the banking institutions prefer the control and reduction of government deficits.
Legal and Information Infrastructure
The banking system requires a fully developed legal and information infrastructure to function adequately (Chafer, 2002). The ability of any bank to raise external finance in the formal financial system is extremely limited if the political dictators limit the rights of the outside investors and fails to offer protection. Foreign bankers are characterized by reluctance to invest in African countries since most of the countries policies do not allow them to exert corporate governance and protect their investment from the controlling shareholders. Thus, political uncertainty in these countries limits the protection of property rights and effective contract reinforcements that are key elements in the development of the banking system. A study by Chafer (2002) on Zimbabwe banking system shows that the banks are unable to access external finance in nations where legal enforcement is stronger, and that better protection of the creditor increases credit to private banks. According to him, more effective legal system reinforced by political stability permits more flexible and adequate conflict resolution, thus increasing banks’ access to growth. Additionally, countries with effective legal system the banks have lower interest rates spread and highly efficient (Chafer, 2002).
Furthermore, the availability of quality information on time helps reduce information asymmetries between the lenders and the borrowers. Political reinforcement that enhances strong legal system and provision of timely and quality information enhances the use of borrowing history, collection processing and other relevant information about the banking sector necessary for growth of private and pubic banks (Griffith Stephany & Jose, 2000). The improvement of computer technology has also lead to access to improved information that can be analyzed to assess the creditworthiness, for instance through credit scoring techniques. Government plays a significant role in this process of legal and information structure enhancement. While public credit registries establishment may discourage private investors in the banking sector, numerous cases have been shown to encourage private registries to invest in banking in order to provide deeper and wider banking services. Moreover, the government is important in creating and supporting the legal system needed for contract reinforcement and conflict resolution, and strengthening accounting infrastructures to enable financial development and banking system improvement (Griffith Stephany & Jose, 2000).
The technological advancement has simplified and broadened the functions of the banking sector across the globe. Indeed, technology has created diverse opportunities for all the industries. Currently, there are automated teller machines that have replaced the conventional tellers, and the entire banking system has promoted transparency leading to improved customer trust towards the financial institutions (Haber, Maurer and Razo, 2003). Likewise, the internet technology has promoted the new working avenues such as online banking system commonly witnessed in the West nations and is gaining popularity in a few of the African countries. Despite the technological improvements across the world, political instability in the African continent has led to limited growth of such technology. For instance, Haber, Maurer and Razo, (2003) provides that the countries experiencing domestic and political clashes have kept foreign technological investors at bay. This has led to limited technological improvements in the banking sector too. Countries such as Somalia and Algeria considered highly unstable due to political factors, for example, has not been able to implement the M-banking technology. Telecom companies and mobile companies have increased their collaboration with the banking sector to promote mobile banking and reach out to customers more efficiently. However, the politicians in these countries have developed a political angle in technological progress, thus limited progress.
A study by Klapper (2006), on political instability and law and order, provides astonishing results with regards to the banking sector. Political instability has destabilized the legal system, and the judiciary has lacked freedom that has impaired growth and development of the economy hence lowering investment in the banking system. The situation of law and order in the African countries has become from bad to worse, hence discouraging foreign investors. While countries such as Kenya has enforced laws on micro financing, the law limits growth of the banking sector since it requires all the banks to establish at least three of its branches in the rural sector (Klapper, 2006). The influences of political instability have led to more than two-fold loan increment portfolio over the previous year, which according to Klapper (2006), is so high. While most banks in Africa has promoted a robust expansion, critics argue that it is accompanied by diversification across sectors as the banks have ventured into new areas such a lease financing, mortgage financing, aggressive lending tendencies, and project financing that has negatively affected their asset quality (Klapper, 2006).
Results from an empirical study by Stiglitz (1993) indicate that the volume of bank credit is significantly higher in developed countries with enhanced sharing of information. Besides, the banks in such countries report lower operational obstacles with respect to finance and better credit information. Stiglitz, (1993) established that speedier enforcement of contracts and better aces to information in the banking system are associated with deeper development strategies even in low-income countries, such as African countries. In comparison to the industrialized countries, lower income countries credit information and legal enforcement matter greatly for development of any firm. As such, the entire process calls for political stability in order to enforce sound legal structures and access to information. Therefore, this explains the laxity of development among the banks in African countries since most of them are stuck in political instability demands.
The role of Government in Making Finance Work
While it is widely recognized that, finance thrives on market disciplines and may fail to contribute the development of the banking sector hints the presence of interventionist policies. Therefore, the government is mandated a crucial role to play in promoting the banking system and other financial institutions. It is the role of the government to provide a stable macroeconomic and political environment, well-functioning legal and information infrastructure, fiscal discipline and good governance, and a strong supervision and regulation that permits a wider monitoring of the market without unnecessarily distorting the incentives of banks in marketing participation. Likewise, the government has a role in improving the contestability and efficiency of the banking system by avoiding financial institution ownership and liberalizing systems to include allowing foreign investors. The policies implemented by the government can also assist in efforts to facilitate a wider access to financial services that will ensure constant improvement of the banking system towards its functions.
Political Instability and Macroeconomic Environment
African countries have over the past demonstrated historical factors favorable to the development of the banking system. However, political turmoil experienced in these countries has led to macroeconomic instability and deterioration of the banking system among other businesses. An exploration by Jayati (2005) on the implications of political turmoil in the banking sector in Africa provides shocking results. According to him, the ethnic, inter-clan, and terrorism wars and civil strikes among the laborers that indicate bad governance and political instability destroy the capital infrastructure leading to a slower rate of growth in the financial market. Moreover, high rates of corruption and crime that thrives well in the politically unstable countries, such as Somalia, Kenya, and Uganda increases the cost of doing business and creating property rights uncertainty. Jayati, (2005) writes that despite the technological boost in the banking sector, countries such as Kenya still experience high instances of bank robes as one of the most prevalent crimes in the country. According to research, low-income countries dominating the African continent experiences great political instability and corruption that altogether provides a detrimental effect on the development of finance institutions.
Demirgüc, (2006) investigate the business environment for 28 countries in the African continent and established that crime and political instability are significant obstacles to firm growth, particularly the banking sector that depends on capital infrastructure that is scarce in these countries. According to the research, corruption negatively affects growth of enterprises hence limiting their growth. Tybout, (1986) asserts that a politically stable environment promotes a well-functioning financial system. However, fiscal discipline is necessarily required in such environments and provision of stable macroeconomic policies from the government side. Indeed, fiscal and monetary policies affect the taxation of financial intermediaries, such as banks, and provision of financial services (Demirgüc, 2006). The governments often require huge financing that crowd out private investment by elevating the necessary government security returns as well as absorbing the bulk of savings mobilized by the banks and other financial systems. Notably, the profitability of the banks suffers given the low yields on these securities in developing countries. While some opponents provide that when the securities are high, the banks do not suffer; however, the ability of the banking system to allocate resources efficiently is severely curtailed, according to (Aisen & Francisc, 2007). Empirical studies in 17 African countries indicated that these countries had lower and unstable inflation, thus experienced low levels of banking and stock market development. However, in normal circumstances, a country should have a lower and more stable inflation rate to boat the development of the stock market and banking system (Frieden, 1991).
Regulation and Supervision
The existence of banks on any land requires a stable government to establish policies that regulate them. Although numerous economic scholars agree that it is government’s role to supervise and regulate the financial system, the stability of the government is a significant factor as it dictates the extent of government involvement in this issue (Čihák, Demirgüç-Kunt, Feyen & Levine, 2012). Debates are streaming from all over, one extreme view the invisible or laissez-faire approach, where the government has no significant role to play in the financial institutions. However, this approach has attracted sharp criticism as it believed to ignore market depositors, small depositors, in particular, that would find it too costly to be effective monitor (Čihák, Demirgüç-Kunt, Feyen & Levine, 2012). Therefore, the government’s role in the financial system is to act as delegated monitors for depositors thus exploiting economies of scale to overcome the costly information concerns.
Secondly, interventionist approach also considered extreme is where the government regulation is observed as a solution to failures of the markets (Ong’ayo, 2008). However, Ong’ayo (2008) hints that based on this view, there are powerful supervisors that are expected to ensure banking system stability and provide proper guidance to the banks in their business decisions through supervision and regulation. Besides, it is assumed that the government knows better than the markets, and they act in the best interests of the society. However, in African countries, this is often the opposite of the scenario because the leaders are corrupt and politicians regulate the banking system to suit their political interests and ensure their political agendas sail through. Most of the African leader does do not have their societies at heart and the assumption is only vague based on the political immaturity in the African countries. Likewise, political turmoil in African countries, according to Ong’ayo (2008), inhibits the appointment of qualified individuals in supervision and regulation roles to monitor the financial system. Politicians in these countries appoint individuals based on ethnic and political affiliations, rather than the qualifications of the candidate. As such, individuals with limited knowledge and expertise in making financial business decisions is a true subject to regulatory and political capture, and the assumptions are rendered invalid (Ong’ayo, 2008).
Between the two extremes of control and supervision of financial markets lies the private empowerment view. Aslam, Kiran, Memon, and Fahmeeda, (2011) establishes tat this view recognizes the potential significance of market failures that motivates the government to intervene. The political or regulatory failures in African countries, however, suggests that the agencies supervision the financial markets does not necessarily have incentives of easing the market failures. While the central point of view is enabling the financial markets, there lies a significant role for the government in enhancing the incentives and ability of the private powers to overcome the information and transaction costs. Therefore, the private investors can exert effective supervision and overall governance over banks. Moreover, the private empowerment, Aslam et al. (2011) hints, has been viewed to provide the supervisors with the authority and responsibility to induce the banks to disclose accurate information to the public, hence the private agents can more effectively monitor the banks.
Indeed, empirical evidence supports the view of private empowerment to enhance the stability of the banks. However, due to political turmoil in the African countries, evidential research shows that regulations and supervision of the banks force are political affiliates of the political elites in these countries. In fact, in some countries, report indicates, the businesses are owned by politicians that enforce policies that benefit their interests ignoring the interest of the public (Aslam, Kiran, Memon & Fahmeeda, 2011) While there is limited literature supporting the empowerment of regulators to enhance bank stability, there exists robust evidence that regulatory and supervisory practices that enables provision of accurate information disclosed to the public and promotion of the private sector monitoring boost the overall level of the banking system as well as stock market development (Aslam, Kiran, Memon and Fahmeeda, 2011). Nadia and Thomas, (2009) indicates that bank supervisory practices tat leads to disclosure of accurate information eases the constraints on external financing firms. Besides, the countries that empower their official supervisors make external financing constraints more severe by elevating the degree of corruption in lending by the banks. A study by Livingston (2011), provides consistent results with these findings through investigation of 12 African countries with their compliance with the Basel Core Principles of financial market regulation and supervision. Based on the study results, Livingston (2011) indicates that only the rules of information disclosure provide significant impact on the soundness of the banks. Lastly, Livingston (2011) finds a little significant impact of regulatory and supervisory practices on development of finance of low-income countries in Africa.
Following the debate on the various approaches to regulation and supervision, Nadia et al. (2009) hints that it is efficient to establish whether the regulation and safety nets designed for African countries can be transplanted into developed countries to determine their accuracy. According to the research, the financial sector policy that gets considered instrumental in more advanced economies can prove ineffective in the politically unstable and weak institutional environments in African countries that are still developing. Indeed, powerful regulators are never associated with corruption in the banking system experienced in most African countries due to political turmoil. Therefore, this can lead to greater corruption in already corrupt institutions in lower income countries in Africa (Čihák, Demirgüç-Kunt, Feyen & Levine, 2012). While studies support market empowering and focusing on the disclosure of information as policies that promote the stability of banks in Africa, it is only effective in countries with strong rule of law. However, African countries are instances of lawlessness and some have criticized the leaders in these countries because it seems that the laws are made for the fewer fortunate people in the society, and when a politician breaks law they becomes untouchable (Livingston (2011). Therefore, as Nadia et al. (2009) puts it, the complicated procedures and laws for determining government conditions and bank capital adequacy pre-suppose expertise do not exist in most African countries.
Similarly, Jennifer and Boaz (2014) through an empirical investigation questioned the safety net design, adoption of deposit insurance, in particular in African countries considered to be still developing. Research done highlights the potential cost of explicit schemes, higher financial fragility, lower market discipline, and lower financial development in African countries where the complementary institutions are still weak to keep these costs under control. The findings significantly provide literature reference point for African countries with underdeveloped financial institutions due to political uncertainty. For instance, Jennifer et al. (2014) also established an explicit deposit insurance system do not lead to additional deposit mobilization in most low-income countries, that is African countries particular and the contrary is associated with lower deposit levels.
Contestability and Efficiency
Globally, policy makers express frequent concerns on whether the banks in their countries are well-designed to enable their functionality and stability. The effects of consolidation in the banking system have spurred interest in this concern, thus stemming active public policy debate. Political environment of the African nations has led to the emergence of competition policies in the banking sector that has further resulted to trade-offs (Nicolas, 1998). While optimists express that greater competition may enhance the efficiency of banks leading to positive economic implications, critics have voiced their concerns over stiff competitions among the African banks that has led to destabilizing of the bank with costly repercussions for the economy of numerous African countries as Nicolas (1998) observes. Most recent research on Nigerian banking system shows that contrary to conventional wisdom, there are no challenging trade-offs when it comes to the competition in the banking system. According to the study, the country has experienced instances of greater competition, greater banking freedom, fewer regulatory concerns, and better institutional development. However, economists have raised concerns over regulations that interfere with banking competition as it has made the banks less efficient, reduce financial access, and become more fragile (Nicolas, 1998). While it is essential for the African governments to enact policies that ensure banking competition, political turmoil has restricted the reduction of unnecessary impediments to entry and activity restrictions leading to poor performance.
Research has long credited the practice of foreign banking for its overall positive outcomes; however, most African countries practice state ownership banking that Demirgüc, (2006) hints that is associated with less access, higher margins, and greater fragility. Demirgüc, (2006) acknowledges the significance of eliminating the impediments to foreign entry and provide further banking justification privatization policies. Contrary to the expectation, the political temperatures in most African countries have discouraged foreign investment based on security concerns. Indeed, most foreign investors always prefer exerting corporate governance on their investments, yet most governments in Africa are against the policy. Likewise, political turmoil that has led to wars, corruption, and hostile labor issues has discouraged foreign investment in Africa continent. Finally, the concentration of banks that focuses more on policy discussion is considered a bad proxy for the overall competition environment per se, additionally; its impact depends on the existing institutional and regulatory framework (Nicolas, 1998). As a result, governments should emphasize more on improving the underlying regulatory and institutional environment as well as the structure of ownership to promote stable financial systems, rather than making efforts to reduce concentration levels in banking as in the case of Nigeria (European Central Bank, 2010).
African Financial Institution Ownership
Most African countries’ policymakers have pushed for the need to retain bank public ownership. However, Alexandra (2011), provides that in any environment, government bank ownership, essentially, in developing countries, such as African countries, leads to lower levels of financial development lower economic growth, more concentrated lending, and higher systemic fragility. In most cases, Alexandra (2011) insinuates, the policymakers in these developing countries allocate insufficient credit to the state-owned banks to unveil commercial projects and favours their politics that fit most cases necessitates costly recapitalizations, according to (Alexandra, 2011). Based on empirical evidence, ownership of financial firms in areas where the public sector tends to lack a competitive advantage weakens the economy and financial system.
While privatization has been argued to provide better development of the financial firms, economists have indicated that it entails risks and needs a politically stable nation to ensure extremely careful design. Ajayi and Atanda, (2012) indicates that the process of the privatization strategy requires moving slowly, yet deliberately with banking privatization, in particular. The preparation of state banks for sale and addressing weaknesses in overall incentive environment is pertinent to political stability. Averagely, Ajayi et al. (2012) argues, privatization of banks tends to improve performance as opposed to state ownership with potential merits to full rather than partial privatization. Besides, the weaker institutional environments inviting foreign investment and selling to a strategic investor increases stability of the banking system. However, privatization is never a panacea, and privatizing banks without addressing the weaknesses underlying the market structure, political domains, and overall incentive environment may not lead to deeper and more efficient financial system (Ajayi and Atanda, 2012)
RESEARCH METHODOLOGY
Traditional literature on the effects of political instability in developing countries has taken numerous methodological approaches. However, in contrary, this paper adopts a non-static approach to discussing the related issues. Traditionally, research papers consider the implication of political characteristics and its implication on economic performance of countries at war. Nonetheless, here we investigate of the banking institutions to social and political unrest using both primary and secondary literature. This research draws it primary qualitative data from World Bank and African development bank working papers that highlight real analysis of performance of banks in Africa and political and social unrest affecting their development. Furthermore, this paper deals with dynamic political responses to political instability and their consequences on the banking system. Qualitative literature and causality tests are used to establish the relationship between the banking system and political immaturity in African countries. Most of previous papers on economic performance and political environment investigation rely on yearly and aggregate data because of constraint on macroeconomic data (Jha, 2008). However, the qualitative datasets allow robust analysis of individual African country political and economic environment based on the real working papers that provide primary information.
Collecting Qualitative Data
Ruling out Specific Syndromes
Based on the assumption that the financial system supervisory authorities are sensitized to the risks presented by regime changes, it is still important to detect the early signs of emerging crisis. Banking problems in African countries can be described by use of standard techniques skillfully based on per-group analysis. However, if the entire system is paralyzed, there may be methodological and data vacuum to describe the syndrome. Metaphorically, political instability syndromes provide a significant principle of organizing and sharpening the inferential value of such data collection. Political syndrome is an area widely covered by the African Development Bank and World Bank working papers that provides accurate information on the effects of political instability in Africa and its effects on the banking system (Ellis, Stephen, & Janet MacGaffey 2006).
Structural Indicators
Tracking the indicators of political instability in African countries is essential for validating the research objectives. This section provides some significant indicators of political syndrome that can be useful for providing primary data.
Endemic Crisis in Government –Permitted Banking System
In most of the African countries, the functioning and the role of the banking system is to link with the financing of government as well as on behalf of the government with significant intimacy. However, the involvement takes numerous approaches, ranging from programs directed investment or lending, government ownership to distorting and complex subsidy and tax regimes both implicit and explicit (Beck, Demirgüç-Kunt & Merrouche, 2010). As such, these linkages objectives of the government permeate the banking system activities in this condition. Thus, the banks are not autonomous profit-seeking entities, however, they operate as a quasi-fiscal mechanism, in either lesser or greater extent, differing from the budget chiefly in the degree to which employed funds can circulate rather than being out and out grant.
Data shows that in good times, the African banking systems appears functioning optimally (Dessus, Lafay & Morrison, 2012). The steady economic development generates growth from the deposit liabilities at low-interest rates that significantly funds the steady flow of borrowing from government-owned banks or other favored borrowers and even in case the borrowers are hard pressed, they are called upon to pay. Government occasional fund injections to support the balance sheet may be described in a positive fashion. Furthermore, even if a relatively high proportion of borrowers are willing and able to service their bank loans, provisioning and inadequate loan pricing mean that even a small and steady flow of interest capitalization and lending to poorly performing borrowers are significantly insolvent in economic terms (Alesina, Ozler, Roubini & Swagel, 2009). Therefore, adverse shocks such as an increase in interest rates and a reduction in deposit trends are essential for exposing the underlying insolvency. However, government policies are typically resulting in simultaneous problems in banks.
Anatomy of Regional Governments
Government loan delinquencies and their unpaid suppliers have contributed to leveraging insolvencies of state-owned banks in African countries such as Nigeria (1993) (Clague, Keefer, Knack & Olson, 1996). The central bank has stepped to provide liquidity support. In effect, the county banks have been able to leverage loans indirectly from the national government banks. As a result, the regional banks have had to bear substantial losses from the debts of banks that partly fails due loans to county enterprises the government suppliers in the country.
Quasi-fiscal Aspect
Nonetheless, the African government-owned development banks have encouraged the idea of irrecoverable lending by the fiscal authorities. World Bank working paper provides that lending has been designed to defer a fiscal challenge by making a standard loan to support a government policy objective. From this viewpoint, liquidating costs and restructuring costs such as banks are considered redemption of a quasi-fiscal liability incurred in previous years leading to banking problems. The cost of a 10 percent of GDP restructuring cost can be easily understandable in case it represents the accumulation of a decade of hidden quasi-fiscal deficits.
Transition Economies
The African banking system emerged from planned economy and constituted the largest initial element of transition African economies. Indeed, the financial system represents an extreme example of government permeated banking. In most countries in Africa, their planned regime has restricted bankers from making essential assessment to creditworthiness, and rather their jobs have been to implement and monitor the credit plan devised elsewhere (Barro, 2001).
Recklessness and Fraud
Theoretical and practical assertions confirm that management of banks tends to adopt a riskier lending than it would be socially optimal due to the existence of official deposit guarantees, implicit or explicit. Therefore, in the absence of deposit guarantees, private depositors must have adequate interest remuneration to compensate them for the expected portfolio riskiness. Additionally this would have to satisfy the private depositors to the original level. The existence of deposit guarantee eliminates the fear of depositors of default allowing the equity holder to adopt riskier strategies offering higher return on equity if successful, and with unnecessary higher interest costs.
However, the World Bank working papers provide that a parallel behaviour of dealers exists in the African trading and treasury department banks. The huge bonus received payments when their trading ran successful and nothing else to loose apart from their jobs if unsuccessful, the sad risk-preferring behaviour is easily explained. Government structures in Africa have limited control over the risk behaviour in trade markets and treasury based on these inappropriate structures. Furthermore, looting behavior is considered an impediment in the banking system. However, some African countries have set clear margins of looting legality leading to bank frauds. Fraud is a problem with the African banks at various levels of government-owned banks (Fosu, 2012). Small-scale staff fraud potentially brings down banks and management fraud is a different matter. Since there are criminal sanctions, African bank managers involve in large scale frauds even if the bank is already in a parlous situation so that the alternative fraud and looting are unattractive.
Determinants of Political Context
There are political and economic determinants of banking institutions in African countries. The economic determinants of the political context are a significant factor of political maturity and democracy according to (Tavarès &Wacziarg, 1996). The correlation between the political context and economic growth, however, remains unclear. Economists agree that weak economic performance spurs political conflicts and destabilizes the economy. Political determinants of the institutional environment are considered to be a democracy that helps strengthen political stability. Democracy, according to Johnston and Pazarbasioglu (1995) involves the rules and opposition force that limits the risk of arbitrary decisions.
Construction of Political Indicators
Following the political uncertainty in African countries recently published by African Development Bank and African Economic Outlook (2009) assess the interaction between economic performance and institutional context. The two sources provide a computational data on the political indicators in African countries. African Economic Bank and African Development Bank collaboratively build the data from information taken from weekly newspaper, according to the methodology first proposed by Dessus, Lafay and Morisson (1994). The newspaper data further strengthens the qualitative information that was computed as 0-1 variables with 0 representing non-occurrence and 1 representing occurrence. Consequently, 2 represent medium intensity and 3: strong intensity. These indicators of political indexes are essential for measuring political instability and social unrest.
Political Instability
· Strikes
0 = non-occurrence,
1 = 1 strike or below 1000 strikes
2 = 2 strikes or below 1000 strikes
3 = 3 strikes or below 5000 strikes
Unrest and Violence (Number of Injured and Death cases)
Dead
0 = none, 10
1 = between 1 and 10
2 = between 10 and 100
3 = higher than 100.
Injured
0 = none,
1 = between 1 and 50
2 = between 50 and 500
3 = more than 500
Demonstrations
0 = non-occurrence,
1 = 1 demonstration or below 5 000 strikes
2 = 2 demonstrations or below 5 000 and 10 000 strikes
3 = 3 demonstrations or below 10 000 strikes
Political Regime Softening
- · Measures in favours of human rights
- · Releases of political prisoners
- · Lifting of state of emergency
- · Political governance improvements (fight against corruption…)
- · Relinquishment of political rehabilitation, persecution, returns from exile
Political opening and democracy measures
1 = Discussion between government and the opposition,
2 = Opposition entry to power,
3 = Opening of election regime.
· Strikes and demonstration lifting rules
· Lifting of bans on public or press debates
Hardening of the Political Regime
- Arrests, incarcerations
- State of emergency
0 = non-occurrence,
1 = from 1 and 10 (not incorporated).
2 = from 10 and 100 (not incorporated).
3 = more than 100.
· Additional resources for, propaganda, police or censorship
· Political environment toughening (expulsions, curfew, dismissals, and political parties dissolution)
Perpetrated Violence by the police (number of dead and injured)
Dead 0 = none,
1 = from 1 and 10 (not incorporated).
2 = from 10 and 100 (not incorporated).
3 = higher or equal to 100.
Injured
0 = none,
1 = between 1 and 50 (not incorporated).
2 = between 50 and 500 (not incorporated).
3 = higher or equal to 500.
Closing of schools
Prosecutions, executions
Forced demonstrations
Bans on strikes and demonstrations
Bans on press or public debates
(African Development Bank & Organization for Economic Co-operation and Development, 2007)
The African Economic Outlook (2011) report collected the data as tools for following the political developments in African countries. The samples covered Equatorial Guinea, Egypt, chad, Botswana, Ghana, Gabon, Kenya, Cameroon, Burkina Faso, Ivory Coast, Mali, Senegal, Nigeria, South Africa, Namibia, Tanzania, Uganda, Morocco, Mozambique, Senegal, and Zimbabwe. The data did not include the countries experiencing wars due to logistical problems. However, the overall sample accounts for two-thirds of the continent’s GDP and 75 percent of its population.
Structural Indicators in Practice
The measure of impression of how structural indicators might perform in practice, this research complied dataset on the proposed variables for selected African countries (African Economic Outlook, 2011). The countries (listed above) are divided into six different groups A to D considering the difference in main banking crisis and political syndromes. Industrial countries have been included in order to rely on very small countries, especially in group A.
The indicators according to IMF financial statistics are as follows
- Loan deposit ration
- Growth rate of relay bank credit
- Foreign borrowing
- Government share lending
- Bank discretion over use funds
- Central bank financing
- Government deficit
(African Development Bank & Organization for Economic Co-operation and Development. 2011).
The report indicates that a comparison of the average values of these indicators of the various groups shows that performance is sharply dissimilar between the investigated countries. This confirms the diverse nature of banking crises and political weaknesses likely to be present. According to Welman, Kruger, Mitchell and Huysamen (2005) reports from international working papers are significant primary sources of information used in research validations.
Challenges Facing African Countries in Developing Banking Systems based on Data Collected
Economic scholars have provided numerous recommendations for improving the banking system in developing countries believed to benefit African countries as well. While the general information on improving banking system may not be applicable in all political and economic environments in Africa considering their differences, Demirgüc (2006) provides that the African financial sector needs to improve in different countries. Reforms from World Bank are very challenging for developing countries with low income, where political stewardship encourages legacy of state ownership and financial repression. Indeed, this has hampered the development of a vigorous privatization of the finance sector, where underlying information and legal infrastructure is weak, and attaining a minimum efficient scale is difficult (Charles, 1998). Therefore, sound development of the banking system requires support from a stable and sustainable government t to implement macro policies. The government of African countries should prioritize in divesting itself of bank holdings and attract reputable international banking investors. Most countries in Africa have fought for democracy including Kenya and Rwanda; however, their level of democracy is still weak as political oppression by the capitalist still exists. Weak democracy and high ethnic conflicts prevail a significant degree of uncertainty in the political system, which in turn deters entry of reputable foreign banks (World Bank, 2001).
African countries, according to Charles (1998), as weak legal and information infrastructure, thus require political tolerance to strengthen their financial systems for essential development. Likewise, the government is mandated to offer communication and infrastructural resources to boost development of banks. However, African countries are characterized by poor infrastructural and communication development despite the positive effects of globalization that as opened the trading borders. In fact, Khabele (2003) notes that some countries in Africa, such as Somalia have less that a quarter of the roads tarmacked. Poor politics in countries such as Kenya and Uganda as seen some areas in the countries without banks and the residents are to travel hundreds of kilometers to secure the services of a financial institution. Still, critics point figures in the government and political leaders that as taken government resources to promote their political agendas. The high rate of corruption has slowed down transport and communication development projects that would have attracted reputable foreign bank investors to uplift the financial system of these countries. Khabele, (2003) provides that in financial regulation, corruption, and political capture is a potential issue in Africa; therefore, independence, transparency, and accountability is significantly compromised.
Furthermore, markets in African countries are underdeveloped coupled with a weak rule of law. However, the emergence and empowerment of their market to participate in monitoring through disclosure and education would benefit the countries, in the long run (Bank for International Settlement, 2006). The temptation by most political elites to extend government guarantees to bolster confidence in the banking system is not efficient and should be resisted. This is particularly true because its research has shown that it creates moral hazards and backfire (World Bank, 2001). Most African countries are too poor or too small to sustain liquid securities market; therefore, this area should be ignored till the priorities of developing the banking system are addressed. Based on the empirical literature, reducing the concentration of banks may not be a worthy goal in African countries. Instead, focus on policy should be given heavy attention to improving the contestability through fewer restrictions on banking activities, lower entry barriers, and freedoms, according to (Demirgüc, 2006). As such, improving banking competition in this approach intertwined with institutional reforms is required to increase the availability and reduced credit costs to enterprises with reputable opportunities for growth.
It would be upright for the government to remove the barriers that prevent lenders and borrowers from accessing international capital markets, as banking system improvements are implemented. While most countries in Africa are small, exploring possibilities for local cooperation may bore some fruits in refining high financial service qualities (Beck, Demirguc-Kunt & Maksimovic, 2004). Finally, the technological advances as a result of entry of foreign know-how and greater competition, according to Beck et al. (2004), has promising innovations in the areas of payments, deposits, credit, and risk management thus making basic banking services available to low socio-economic households and small firms. This would reduce public debt and ensure sustainable development of the banking sector as well as improving the living standards of the poor societies predominantly present in African countries.
CONCLUSIONS
As discussed in the findings of the literature, a well-functioning and transparent financial system provides one o the key foundations of sustained economic and social development of any society. Previous research evidences tat the banking sector development plays a significant, casual and independent role in promoting long-term economic benefits. More recently, evidential research on the political economy and banking system shows that finance is both pro-poor and pro-growth. Therefore, a reputable and transparent financial system is related to more rapid development of the income poor, thus providing them with a platform to catch up with the rest of the best performing world economies as it grows. While the development of financial systems differs greatly among the countries in Africa even at similar income levels, individual countries have marginal levels of financial development.
Therefore, a reputable and development-oriented financial system follows numerous recommendations on stable macroeconomic policies and strong legal and information systems. The government is a crucial figure in improving financial system by developing improvements in its infrastructure since this is a priority. Political stability also promotes policies for a contestable financial sector, as shown by the lower entry barriers and fewer bank regulatory activities. Besides, implementing policies that ensure greater banking freedoms is a significant factor in improving efficiency, depth and access to banking services. As such, limiting government ownership through well-calculated domestic, privatization, and international liberalization, including foreign entry permissions is essential for the development of banks. While there are risks accompanied by opening up the financial sector, there needs to be synchronized improvements in the financial institutions to eliminate or reduce the high degree of risks such as a financial crisis.
Political instability and banking system in Africa is entirely dependent on the role of government to play various roles. Essentially, the government is mandated to exercise political maturity and play a regulation role without specific political interests. Evidential studies suggest that empowering the market is one of the best approaches to the banking system regulation, rather tan creating all powerful regulators who are subjects of political capture and corruption. As established, market empowering entails enforcing timely and accurate disclosure and information and offering the correct market incentives for the participants to ensure they remain vigilant monitors. Likewise, the wisdom of transplanting First World practice to developing countries as also raised concerns. As indicated, the regulations used in advanced economies have been proved inappropriate for developing economies as witnessed in African countries as they have weaker banking institutional settings. Powerful supervisors may be prone to corruption, and explicit deposit insurance may destabilize the financial system it aims to protect. Hence, it is essential to strengthen banking institutional factors to support these policies.
Furthermore, political maturity is required for the government to be able to facilitate broad access to financial services, such as, expanding the availability of various financial services to capture larger set of communities and economic sectors. Better information and legal systems, distributing systems that allow technological boom to lower the cost of the transaction requires demonstration of political maturity. Besides, promoting competition among banks and allowing foreign institutions is also essential for the development of the private sector to reach the under-served segments and elevate the speed of technological improvements and consequently access to financial services. In the meantime, consumer protection laws such as anti-predatory and anti-discriminatory regulations would be of significant help to the banking system improvement. Besides, it would remove interest ceilings that are considered harmful to the lower social and economic class societies. While general messages from research validations will be similar in most circumstances, the extent and priority required to improve the African financial sector rests on the demonstration of political certainty and robust policy implementation that ensures reforms in the banking system.
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