Pan African Banking and Banking System

Stability in Sub-Saharan Africa

Angela C.N. Mjojo

School of Business and Economics, Loughborough University

LE11 3TU, Leicestershire UK

Email: a.c.n.mjojo@lboro.ac.uk: Tel: +447460254506

&

Akinsehinwa Sharimakin

School of Business and Economics, Loughborough University

LE11 3TU, Leicestershire UK

Email: a.sharimakin2@lboro.ac.uk: Tel: +447552606027

Work in Progress (WIP) Paper

A Thematic Research Proposal Submitted to the

African Economic Research Consortium (AERC), Nairobi, Kenya

June 2020
 Angela C.N. Mjojo a, and Akinsehinwa Sharimakinb
a,b
School of Business and Economics, Loughborough University, Loughborough, UK

Abstract

We investigate the relationship between Pan-African bank entry and banking system stability, but
also considered the implications of non-Pan-African foreign bank entry in Sub-Saharan Africa using
annual bank data over the period 2000 – 2016. We also attempt to examine this relationship at the
regional level- West Africa and South-Eastern regions of SSA. We find significant evidence of
improvement in banking stability as the share of Pan African banks in the host country’s financial
system increases. However, we do not find non-Pan-African foreign banks to have a significant impact
on banking stability in SSA even at regional level. From policy perspectives, our findings suggest
that the spread of cross-border Pan-African banks can enhance stability in African financial
system, which in turn can encourage foreign investment and subsequently increases the size of
financial markets.

Keywords: Pan African Banking; Banking Stability; Sub-Saharan Africa; Panel Estimators.

Corresponding author: Department of Economics, Loughborough University LE11 3TU, Leicestershire UK;
Tel: +447460254506; Email address: a.c.n.mjojo@lboro.ac.uk

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1. Background

The financial liberalization reforms of the 1980s and 1990s saw many African systems become
dominated by foreign banks from the developed world that had previously retracted with the passing of
the colonial era. Over the last two decades however, there has been a gradual but increasing shift in the
composition of the foreign bank population across the African continent, with Africa based banks
beginning to expand out from home countries into other countries on the continent. For instance, Beck
(2015) indicates that several South African banks1, most notably Standard Bank and ABSA2
(Amalgamated Banks of South Africa), started expanding throughout the African continent, following
the end of the apartheid era. The more recent period has seen two banks from the West African region
namely: Ecobank and Bank of Africa experiencing rapid expansion across the Sub-Saharan African
countries. Additionally, Moroccan banks have also expanded their reach southwards, while Nigerian
banks are equally expanding to other West African countries and the rest of the African continent.
Similarly, in Eastern Africa, Kenyan banks have joined the league of banks that operate beyond their
borders by establishing subsidiaries in other Eastern African countries, such as Tanzania, South Sudan
and other East African (EAC) member states. The phenomenon of indigenous African banks that were
once domestically based but now operate beyond their borders in other African countries is known as
Pan African Banking (PAB). As noted by Christensen (2013), coupled with regional financial
cooperation agreements3, PAB is the main driver of cross border banking in Africa.

PAB groups which can be defined as a group of banks domiciled in Africa with subsidiaries in
several countries are beginning to account for an increasing share of domestic banking systems in
Africa. According to the International Monetary Fund, Enoch et al (2015), PABs have a systemic
presence4 in around 36 countries in Africa. Overall, the PABs are now much more important in Africa
than the long established European and American Banks, whose influence has been on a declining trend.
According to Mathieu et al., 2019, after sustained and robust growth took off in SSA at the turn of the
millennium, PAB banking groups quickly spread across the African region, displacing the previously
dominant European groups. The expansion accelerated following the GFC in which European banks
retrenched on account of the pressure of stricter regulations and capital requirements. Currently ten
major groups dominate the SSA banking landscape, excluding the Moroccan banking groups that
though have strong presence in SSA, are centred in North Africa. Indeed, out of the 14 main banking
groups in Africa, 10 are SSA based. Currently, PABs have a more significant footprint in Africa than
banks from outside the region. Additionally, between 2006 and 2015 the number of subsidiaries of the
14 largest PABs more than tripled. Mathieu et al (2019) points out that in some PABs (especially the
Standard Bank /Stanbic group), the “home” component of the group is dominant. That is, cross border
subsidiaries, while numerous, account for a relatively small share of the group’s assets, which instead
are concentrated in the home country.

1 Foreign relations of South Africa during the apartheid (a systematic extension of pre-existing racial
discrimination) era (beginning 1948) meant that the country became increasingly isolated internationally until
apartheid was ended and racial equality introduced in the early 1990s.
2 Absa was founded in 1991 through the merger of financial service providers United Bank (South Africa), the

Allied Bank (South Africa), the Volkskas Bank Group and certain interests of the Sage Group
3 (for example, East Africa’s regional grouping - East African Community – EAC regional agreements)
4 Systemic presence: Pan African Bank subsidiaries/branches are defined as having systemic presence (or being

systemically important) if their deposits are larger than 10% of the host country’s banking system deposits or if
their assets are larger than 7% of host country GDP.

3
 Also, the global financial crisis of 2007/2009 further paved way to the spread of these Africa
domiciled banks, following the withdrawal of some of the European banks5 during the crisis. The PABs
are generally organized as subsidiaries of the foreign banks and they operate like domestic banks, taking
local currency deposits. In the case of some countries the PABs take deposits and lend in foreign
currency. PAB is majorly dominated by seven banking groups with respect to geographical dispersion,
(Beck et al., 2014). Of these banking groups, Ecobank, though headquartered in a small country-Togo,
has the widest presence in SSA and operates in 33 Sub-Saharan Africa (SSA) countries due to its
network structure (“network-dominant”). As a result, Ecobank poses a much higher contagion risk than
that of a PAB group like Standard Bank which has a “home-dominant” network. Further, Ecobank
enjoys what is termed extra territorial status, which means that the Ecobank group has no regulator
who assesses the overall exposure and effective capital position of the group.

Meanwhile, Standard Bank (headquartered in South Africa) is the largest PAB group based on the
size of its balance sheet, (as of 2013 its total assets were US$161,197 million). Additionally, around 40
to 60 % of the subsidiaries of Attijariwafa (58%) and Bank of Africa (BOA) (47%), (2 PAB groups
headquartered in Morocco), Ecobank (52%), and Standard Bank (56%)6 are systemically important in
their host countries based on deposit shares. Meanwhile, though the United Bank for Africa
(headquartered in Nigeria) has a widespread presence, its subsidiaries are not yet systemically important
in their host countries’ banking systems. Standard Bank and Ecobank dominate the large cross-border
banking groups in terms of size and number of systemically important subsidiaries, but with very
different structures. Standard Bank is the largest group in size, measured by consolidated assets, with a
traditionally dominant home base. By contrast, according to Beck et al.(2014), Ecobank is characterized
by its network of cross-border operations and has the most diverse footprint and largest number of
systemically important subsidiaries. However, with respect to assets and liabilities, Ecobank is
relatively small compared to the South African or Moroccan banks.

2. Research problem

The expansion of PAB raises pertinent questions about its consequences on banking and financial
system stability in African financial systems. As much as it is said that there are benefits associated
with cross border banking, there are also costs to cross border banking. For instance, an important
implication of expanding PABs is the increase in the risk of financial shocks occurring in one country
spreading to and affecting another country or group of countries (financial contagion) in Africa. This is
because the expansion of these banks has created a network of systemically important banks, whose
financial health might not be known. The channels of contagion could run both ways from the parent
bank to the subsidiary and from the subsidiary to the parent bank, as well as across subsidiaries of the
same group. A further complication from a financial stability view is that PAB groups have become
more complex as they have extended their operations by encompassing nonbank activities like
insurance or securities dealing. This has increased linkages between banks and nonbank financial
institutions of the same group, for example, through interbank securities or derivatives exposure, and
has given rise to additional contagion channels between home and host countries. So far, and generally,
with respect to financial crises and financial instability, unlike Europe and the Emerging markets of
East Asia, financial crises in Africa have not necessarily often occurred on a regional basis. Rather,
these tend to occur within a country’s banking system or financial sector, inevitably affecting the wider

5For example, in Francophone Africa, Credit Agricole sold its stakes in DRC, Cote D’Ivoire, Gabon, Cameroon and
Senegal to AtijariWafa (Morocco) – Finance and Private Sector Development Africa Region, World Bank (2009)
67 out of 12, 8 out of 17, 17 out of 33 and 10 out of 18 of the subsidiaries of Attijariwafa, Bank of Africa,
Ecobank and Standard Bank respectively are reported as systemically important as of 2013, Beck et al (2015).

4
economy. But, with the spread of PAB in sub-Sahara Africa, it is important to consider that systemic
banking crises may well become a significant feature in SSA.

The primary aim of this paper therefore is to examine the effect of PAB on banking system stability
in SSA where banks make up the bulk of African financial systems. Recent works argue that the origin
of a bank matters (Beck et al., 2014;Kanga et al., 2018 and Pelletier, 2018) .That is to say that ownership
of a bank matters as it has implications for the domestic economy of a bank’s host country. For instance,
what does the expansion of foreign banks into an economy imply to the financial sector or real sector
of the domestic economy; do foreign and domestic banks behave differently and do their activities
complement or substitute one another. As already indicated, in addition to African banking groups,
several foreign groups such as the long established European and American foreign banks have a large
presence in SSA. The European banking groups are mostly clustered in regions reflecting colonial
legacy. According to the Beck et al. (2014), their presence is mainly concentrated on Anglophone
countries for U.K. banks, francophone countries for French banks, or Lusophone countries for
Portuguese banks. Foreign banks with a strong presence in SSA include Standard Chartered and
Barclays7 (headquartered in United Kingdom), and Société Génerale (headquartered in France). Other
foreign banking groups mainly have smaller operations; however, they are spread over several
countries. This includes Citigroup (United States) and Bank of Baroda (India), with a presence in 11
and 8 countries, respectively. According to Beck et al.( 2014), these banks have operations in at least
nine countries, and more than one-third of them have systemic importance in the respective host
countries. However, the number of operations of foreign banking groups is considerably smaller than
those of the large PABs and they are less widespread. Overall, the share of systemically important
subsidiaries in the total number of subsidiaries is somewhat higher for the foreign groups (28% versus
24%, excluding home markets); however, the share of systemically important subsidiaries with more
than 25% deposit share is a lot higher for the African groups (33% versus 25%), (Beck et al., 2014).
Thus, given this increase in operations of Pan African banks in the African region, the paper will
investigate how the operations of Pan African banks differ from foreign non-pan African banks in West
and South Eastern African banking systems, and subsequently how these ownership types of banks
affect banking system stability.

2.1 Research questions

Drawing on the studies of Mahawiya (2018) and Dwumfour (2017) the primary objective of this paper
is to investigate the impact of Pan African banking stability in Sub Saharan Africa. More specifically
we are interested in providing answers to the following research questions:

1. What is the effect of PABs on banking stability in Sub-Saharan Africa?

2. Is there any difference in the effect of PABs on banking system stability in the West
African and South Eastern regions of Sub-Saharan Africa?
3. How does the effect of Pan African banking on banking stability compare with that of
the Non-Pan African foreign banks?
a. in Sub-Saharan Africa as a whole?
b. in the western and south eastern parts of Sub-Saharan Africa?

Thus, the hypotheses to be tested in this paper are as follows:

Ho: PABs do not adversely affect banking system stability in Sub Saharan Africa.

7Barclays Bank has had a presence in Africa since 1925. As of 2016, Barclays announced plans to pull out of
Africa. (Various media sources)

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Ho: In comparison to foreign non-pan African banks, PABs do not adversely affect banking system
stability in host country banking systems.
Ho: There is no difference between the effect of PABs on banking system stability in the host countries
of the southern and the western parts of Africa.

The remainder of this proposal is organized as follows. The next section provides an overview of related
literature. The proposed empirical methods are discussed in Section 4. Section 5 discusses the data
requirement for the proposed study. The final section, section 6 gives a short note on the policy
relevance, limitations and dissemination of the research findings.

3. Relevant Literature

3.1 Theoretical literature and Cross-border agency problems

This study relates to a rich theoretical literature exploring the relationship between cross-border banking
and banking stability. The theoretical literature offers two conflicting views on the relationship between
banking stability and cross-border banking. The foreign bank stability states that foreign bank entry
does increase the probability of a country experiencing a banking crisis. However, the foreign bank
fragility posits that foreign bank entry increases the probability of a country experiencing a banking
crisis. These views, however indicates that subsidiaries of foreign banks are not completely independent
from the parent bank or larger holding company, (Stein, 2009)8. The relationship between a parent bank
and its subsidiaries therefore provides a channel through which conditions in a subsidiary foreign bank’s
home country can affect the host country; or indeed the activities of the foreign subsidiary itself in the
host country. These could either enhance the stability of the host country banking system or induce
crises as the interests of the host and home countries differ9. This in turn can constitute significant
agency problems driven by moral-hazard hypothesis where the banks increase their risk positions as
capital/profit declines at the expense of the financial system of the host country (Kanga et al., 2020)10.

More specifically, cross-border banking via foreign-owned branches or subsidiaries can subject the
entering institutions to multiple regulatory jurisdictions and regulators, as well as to many different
legal systems. Consequently, operating across borders presents potential problems for such banks
beyond the fact that there are just more regulations to follow or regulators who may have different
incentives (Eisenbeis and Kaufman, 2005). Bank laws can differ greatly and may even be conflicting
across the different countries. Therefore, regulatory compliance may be uncertain and difficult for
banking organizations with various country operations. Furthermore, bank supervisors and regulators
in both home and host countries typically operate in what they consider is the best interest of their
country, however defined or expected. Again, this can result to serious agency problems to the extent
that the incentives of the regulators, deposit insurance provider and/or failure resolution entity are

8
Stein criticizes World Bank advocating of foreign ownership of banks and their recommendations in World
Development Report 2005.
9
In the face of banking or financial crises that for instance involve a credit crunch in which banks in a financial
system suddenly and drastically cut down on lending, the actions of a foreign bank could either be stability
enhancing or fragility inducing. Should the foreign bank also curtail or substantially reduce extension of credit, it
will exacerbate fragility of the domestic system, (foreign-bank fragility). On the other hand, should the foreign
bank continue to extend credit it will contribute to stabilizing the host banking system (foreign-bank stability).
10
As noted by Chen et al. (2017) agency problems exist in the banking industry, partially due to the separation of
ownership and control that induces managers to pursue their own benefits at the expense of shareholders (Jensen
and Meckling, 1976; Demsetz et al., 1997). In cross-border banking, if supervisory managers at the headquarters
cannot accurately monitor the managerial efforts and quality of junior officers at foreign subsidiaries, the latter
may be motivated to undertake more risk in a fashion of moral hazard, in particular, when they can keep the gains
in the subsidiary but share the losses within the conglomerate (Berger and DeYoung, 2001; Goetz et al., 2013).

6
typically aligned with the residents of the regulators’ home or host country rather than with the interests
of the bank’s customers or customers in the whole market or geographic area within which the
institution operates, (Eisenbeis and Kaufman, 2008).

The incentive conflicts associated with foreign banking agency problems are of two dimensions –
a home country dimension and cross-border dimension (Schüler, 2003). Firstly, in relation to home
country issues, self-gains and incentive conflicts of the classical principal-agent type prevail between
the banking supervisors and taxpayers where the regulators have incentives to pursue policies that
preserve their agencies and also have the incentive to they also pursue their own private self-interests
to ensure their jobs, their future marketability and employment in the banking industry (Kane, 1989,
1991; Lewis, 1997). As a result, the conflicts may lead to the adoption of more adaptable policies in
terms of lowering the appropriate capital requirements and to regulatory forbearance when institutions
get in trouble, thereby potentially shifting risk and any associated costs ultimately to taxpayers as
regulators attempt to ingratiate themselves with constituent banks. Secondly, with respect to cross-
border banking, as foreign banking organizations begin to increase their African market share through
the establishment of branches in the host country, host country regulators face a loss of constituents to
supervise and regulate. In WAEMU and SADC, the home country regulators are responsible for
supervision and regulation of institutions chartered in their country regardless of the location of their
branches. Similarly, the host country is responsibility for financial stability within its boundaries. One
consequence of this structure is that individual country regulators have a country centric focus, which
may be manifested in several dimensions. Nationalistic concerns, may lead to a home country bias as
regulators tend to favour domestic over foreign institutions and attempt to limit the acquisitions of
indigenous banks, or move to create “national” champions which would be protected from outside
takeover11. The implication is, in the short-run, institutions with the more favourable home country
regulatory environment will likely expand at the expense of those institutions with more stringent
operating environments, and this may also occur in the longer-term if the restrictions impose costs rather
than lead to healthier institutions. Thus, different regulatory and supervisory regimes, whether de jure
or de facto, create regulatory arbitrage opportunities (Kane, 1977).

Further, problem may arise as the quality of host country monitoring and supervision may be
reduced with the entry by foreign branches or subsidiaries. Both, host country regulators and the markets
in these countries are generally less able to obtain useful financial information from foreign-owned
institutions than they are from domestic domestically owned banks12. As a consequence, makes
monitoring difficult for the host country regulator. Timely information with high quality is important
when foreign branches come to control a large share of the host country’s deposits, as is the case for
many of the accession countries, because the host country is still responsible for the financial stability
as well as lender of last resort in during financial crisis.

A crucial impediment to the efficient functioning of the financial system is asymmetric information,
a situation in which one party to a financial contract has much less accurate information than the other
party. Schüler (2003) argues that this problem of information access issue constitutes a form of agency
problem between the home and host country regulator. The home country regulator, particularly if its
monitoring and performance is weak, may be incentivised to disguise its poor performance by either
producing disinformation on the performance of foreign branches or be less than diligent in supplying
the host country regulator with timely information. Without adequate and timely information, the host

11Eisenbeis and Kaufman (2008)

12This worry is more particular serious for foreign branches which do not have meaningful balance sheets or
income statements separate from the bank as a whole.

7
country may be in a poor position to assess the potential risks or externalities its citizens and economy
may be exposed to from its foreign branches. These incentive conflicts may be especially acute in host
countries with a large foreign banking presence, particularly in small economies with undeveloped
financial system where a foreign bank may be a significant player, but where those operations are
relatively small compared to those in either its home country or elsewhere13. Moreover, the principal-
agent information problems are likely to be more serious as banking organisation expand and
consolidate many of their management and record keeping functions for cost efficiency gains, especially
in this electronic age where the activities of the foreign banks are increasingly being managed on a
consolidated or integrated basis from the home country14.

A strand in the literature argues that foreign-owned banks may have better access- to capital
markets/information, superior technologies and ability to diversify risks. Hence, foreign ownership
could be associated with lower risk (Berger et al., 2005; Shleifer and Vishny, 1997). Moreover, foreign
banks might realize higher profitability than domestic banks in developing countries due to their higher
operational efficiency and lower cost of funding (Pelletier, 2018; Micco et al., 2007). The difference in
risk sharing and profit making between the foreign-owned banks and home country’s indigenous banks
can lead to significant agency problems as the former can afford to take higher risks in the pursuance
of profit, which can be detrimental to the financial system of the host country. In contrast, the risk theory
argues that foreign banks are riskier than domestic banks because the former face an information
disadvantage (limited knowledge) in the host-country market due to problems in managing from a
distance and accessing ‘‘soft’’ qualitative information about local conditions (Berger et al., 2003). Also,
some studies indicate that new entrants in the banking market incur higher risk (e.g. high level of non-
performing loans) because they compete by granting loans mostly to insolvent customers that shift from
incumbent banks (Chen et al., 2017; Gleason et al., 2006). Again, this can lead to agency problems that
frustrate the growth or act as barriers to entry of foreign institutions in the host country.

The cross-border dimension of the agency problem takes the form where the home country
regulators may take insufficient account of how the externalities that a failure, and the way that it is
resolved, may affect the host country That is, because all the regulators in countries in which a banking
organization operates may have different objective functions and incentives, they may not all be pulling
in the same direction at the same time with respect to prudential supervision and regulation. However,
these conflicts may be important, even when there exist coordinating bodies or agreements and
understandings as to principles, such as in the WAEMU and SADC. As stated above, the home country
is responsible for monitoring the performance of its chartered institutions, including the foreign
branches of those institutions operating in other countries, but the host country is responsible for
financial stability. Therefore, when a crisis arises, responsible parties may take conflicting actions to
benefit their own country’s residents or institutions, which may impair both the home and host
countries’ financial institutions.

3.2 Empirical Literature Review

There is a considerable amount of empirical literature on the phenomenon of the entry of foreign banks
and their effects on domestic financial systems. Beck (2015) notes that the effects of cross border
banking in the form of foreign bank entry on cross border banking on local financial systems have been
varied and controversial among economists and policy makers. The only consensus reached seems to

13
Amidu et al. (2017) discuss some of the externality in terms of information quality associated with cross-border
supervision of banks in Africa.
14
See Niemeyer (2006).

8
be that there is enormous heterogeneity in the effects of cross border banking across countries and time
periods. According to Beck (2015), the effects have often depended on the local markets structure,
financial infrastructure and regulatory framework.

Cull et al. (2017) concur with Beck (2015), indicating that the findings from theoretical and
empirical studies on the effect of foreign ownership on domestic bank performances, including financial
stability, are mixed, given the complexity of the relation. Cull et al (2017) expound on the evidence on
foreign ownership of banks and stability. They explain that foreign banks can have a stabilizing or
destabilizing influence on the host banking sector, depending on the nature of the shocks that hit the
host economy. If shocks are domestic in nature, then foreign banks can play a stabilizing role because
they have access to liquidity and capital from their parents. Also, by virtue of having international
operations, foreign banks are typically more diversified than domestic banks and, hence, should be less
affected by domestic shocks. At the same time, however, foreign banks can import shocks from abroad,
either from their home country or from other countries where they have significant operations, and that
they may not always expand access to credit.

In, studies focusing on foreign banks’ actions in specific countries and during host country crises
confirm the cross-country finding that foreign banks can have a stabilizing influence. Case studies of
Argentina, Brazil, and Mexico from 1994 to 1999 indicate that foreign banks do not pull back from host
countries when these face economic problems, but rather view those difficulties as an opportunity to
become more firmly rooted in those economies (Peek and Rosengren, 2012). In fact, in Argentina and
Mexico, foreign banks had higher growth rates and lower volatility of lending than domestic banks
during the crises of the mid to late 1990s (Crystal, Dages and Goldberg, 2006). More generally, foreign
banks in Latin American countries (Argentina, Brazil, Chile, Mexico, Peru, and Venezuela) showed
more robust loan growth, a more aggressive response to asset deterioration, and greater ability to absorb
losses than did domestic banks during this period Crystal et al. (2001). Meanwhile, in bank-level studies
in Eastern European countries (de Haas and van Lelyveld, 2006), as well as in a broader sample of
countries De Haas and Van Lelyveld (2004), find that credit growth by greenfield foreign banks is
more resilient than that by (private) domestic banks during domestic crisis episodes. Similarly, in Latin
America and Asia over 1989-2001, Arena, Reinhart and Vázquez (2007) show that foreign banks’
lending and deposits rates are less volatile than those of domestic banks in times of crisis .

A study of Malaysian banks around the time of the Asian crisis comes to a more nuanced conclusion
regarding the behavior of foreign-owned banks, in that diversified foreign banks played a stabilizing
role during the crisis in Malaysia (Detragiache, Tressel and Gupta, 2008). Banks that were not
specialized in Asia continued to lend and had substantially higher profits and less non-performing loans
than domestic banks and foreign banks that were mainly active in the region.

While, as described above, many studies find that foreign banks can mitigate the impact of host-
grown crises, the literature also suggests that foreign banks can act as external shock amplifiers.
Exploiting the collapse in Japanese stock prices as an exogenous shock to the U.S. banking sector, Peek
and Rosengren(2012) were among the first studies to show that shocks can be transmitted across borders
through global banks. In response to the decline in stock prices in Japan, these studies show that U.S.
branches of Japanese banks reduced lending in the US. In the same vein, Chava and Purnanandam
(2006) and Schnabl (2012) use the exogenous shock provided by the 1998 Russian crisis and derive
similar results on the effects on bank lending to borrowers in the United States and Peru, respectively.

The recent global financial crisis offers a unique opportunity to ascertain how foreign bank lending
reacted to a major, global external shock. Overall, the evidence suggests that foreign banks reduced

9
their lending earlier and faster than domestic banks during the crisis (Aiyar, 2012; Fungáčová et al.,
2013; de Haas and van Lelyveld, 2014, Claessens and Van Horen, 2015; Choi et al., 2016), in particular
within Eastern Europe (Mihaljek, 2011; de Haas et al., 2015). But it is important to point out that there
are heterogeneous effects, depending on country- and bank-level characteristics. Evidence from cross-
country studies suggests that the transmission of shocks is stronger in host countries that are less
regulated (Anginer, Cerutti and Martínez Pería, 2017), more financially open, and where there is more
competition in the banking sector (Jeon et al., 2013). The degree of transmission is also found to be
stronger for foreign-owned banks with lower levels of capital, profitability, retail funding, and less
independent management (Popov and Udell, 2012; Jeon et al., 2013 ; de Haas and Van Lelyveld, 2014,
de Haas et al., 2015; and Anginer et al., 2017; Choi et al.,2016). As well, the transmission of shocks is
stronger when banks entered host markets via greenfield investment rather than M&A (Jeon et al.,
2013).

Another very important aspect in the discussion of the relationship between foreign bank entry and
banking stability is the element of bank risk taking. (Amri, Angkinand and Wihlborg, 2011) indicate
that foreign ownership is associated with greater risk-taking, consequently that is less stability as
measured by the Z-index (a proxy for distance to default). Meanwhile, using a sample of Latin American
banks, Yeyati and Micco (2007) find that the higher the share is of foreign-owned assets over total bank
assets, the higher the bank stability will be as measured by the Z-index. However, when a bank has been
foreign owned for the last three years, then it is associated with higher risks than domestic banks. Faia
et al (2018) innovate on both theory and empirics in order to explain the relationship between foreign
bank expansion and banking stability in the context of competition in the home and host country market.
They indicate that existing theoretical contributions mostly use static models of banks operating in a
closed economy. The latter tend thus to focus on Cournot-Nash competition. Faia et al (2018) cite
Allen and Gale (2000) analysed competition among banks that could choose the level of assets risk.
They show that more competition leads to more risk taking (therefore instability of the banking system).
The Allen and Gale (2000) model is based on competition in the deposit market. Banks that wish to
attract deposits in a tough competition environment are said to offer higher deposit rates. As a result,
banks go in search for yield in assets, and thus encourage risk taking. In other studies, while
investigating the determinants of stability as measured by the Z-score, Maudos and Amparo (2005) find
support for the “competition-fragility” view when using Lerner indexes as measures of market power.
Meanwhile, Beck, Cull and Bank (2013) show that an increase in competition has a larger impact on
banks’ fragility in countries with stricter activity restrictions. These studies support what is known as
the competition -fragility view. In contrast, Boyd and De Nicolo (2005) look at the relationship between
competition and risk taking from the side of the loans market. More competition they say reduces loan
rates, prompting firms to select projects with lower returns but also lower risk. According to Boyd and
De Nicoló(2005), competition may improve the average quality of the applicants to the loans and reduce
adverse selection. In another study, Kasman and Kasman( 2015) investigate the effect of competition
and concentration on bank stability in the Turkish banking industry. They use the Boone indicator and
the efficiency-adjusted Lerner index as proxies for competition, while Z-scores and nonperforming
loans (NPL) ratio are used as proxies for bank stability. They find that competition is negatively related
to the NPL ratio but positively related to the Z-score. Using the quadratic term of the competition
measures yielded similar results. These studies support the competition -stability view.

In their own empirical investigation, Faia et al (2018) firstly check how foreign expansion affects
bank risk. Secondly, they check whether the sign of the effect of foreign expansion on bank risk is
associated with more or less competition in the foreign market relative to the home one. Therefore,
using a basic empirical specification, they estimate an equation linking bank risk (either systemic or

10
individual risk), foreign bank expansion and a set of controls by OLS. To get rid of possible
endogeneity in the OLS estimation, which could arise from among other things the expansion in foreign
entry itself being driven by the banks’ risk profile (banks with risky portfolios could expand abroad as
well attempting to diversify) as well as the presence of confounding factors, Faia et al. (2018) employ
a two-stage least squares strategy (2SLS). Their 2SLS is like one used by Goetz et al (2016) and Levine
(2015) in a study linking the volatility of equity prices for US banks with their cross-state expansion.
The strategy consists of instrumenting the observed bilateral trade flows (that in general one would
argue depend on countries’ economic performance) with the ones predicted by fixed country
characteristics and geographic variables, (Wu et al., 2017), in a study on foreign penetration and
domestic bank risk, also employ a 2SLS strategy to deal with endogeneity in order to examine the nexus
between them. They put forward the argument that foreign banks may be more inclined to access
markets where domestic banks are more fragile, as they would incur lower costs for mergers and
acquisitions. This reverse causality would thus lead to biased results. They therefore use a 2SLS
instrumental variable to address this problem using the penetration of foreign banks located in the same
region of Central and Eastern Europe and Latin America.

We now turn to the empirical literature on the relationship between foreign banks and stability of
host banking systems on the African front. Though the literature is sparse, studies by Vogel et al.
(2010) , Dwumfour (2017), Ozili (2018) and Mahawiya (2018) shed a bit of light on this relationship.
Table 1 below summarizes some of the studies closely related to this current study. As indicated below,
studies that have specifically focused on foreign bank entry on domestic banking stability are relatively
rare for Sub Saharan Africa. Even more specifically, those that have zeroed in to study the impact of
PAB entry on banking stability are scanty.

Nonetheless, other strands of literature have looked at the relationship between PAB expansion and
other variables. Léon (2016), investigates PAB and bank competition in the West African region of
WAEMU (West African Monetary Union). He finds that competition within the region has increased
over the 2002-2009 period, in tandem with the expansion of African banking groups and the relative
decrease of incumbent traditional foreign banks from advanced countries. Meanwhile, (Kodongo, Natto
and Biekpe, 2014) investigate the drivers of cross border bank expansion in East Africa. Specifically,
they analyze the factors that push Kenyan banks to expand into the surrounding countries of Tanzania,
Uganda and Rwanda. Their findings indicate that Kenyan banks expand abroad on account of efficiency
in operations and deeper financial markets at home, while the follow the client hypothesis plays no role
in the move.

Beck (2015) analyses the impact of cross border banking on access to finance, considering three
types of foreign banks in Africa namely, PABs, foreign banks from developing countries and from
developed countries. He conducts regressions that allow to check if market shares influence access to
finance for firms. His findings show that greater market shares of PABs and of foreign banks from
developing countries have a positive relation with access to finance while the relation is negative with
respect to the market share of foreign banks from developed countries. Using a large sample of African
banks covering 39 African countries over the period 2002-2015, Zins & Weill (2017) investigate the
relation between ownership type and bank efficiency. They find that Pan-African banks are the more
efficient banks in African banking industries, in that these banks combine the best of both worlds: they
have the global advantages of foreign banks and the home field advantages of domestic banks. They
are then able to be more efficient than foreign banks from developed countries but also than domestic
banks.

11
 Table 1: Summary of selected studies on cross-border banking in Africa
Ursula Dependent Variable: Fall in bank flows/ Fall in real credit growth OLS and Seemingly The stabilizing impact of foreign banks pertained only to the
Vogel, Unrelated cross-border element of financial globalization and to mainly two
Winkler and Explanatory Variables: foreign bank asset share in total bank assets, Regression (SUR) regions, SSA and Eastern Europe, with only this component
Vogel (2010) Surge in bank flows/ Fall in real credit growth, institutional quality, OLS being translated to more stable credit growth in SSA
dejure financial openness, export partners’ GDP growth in 2009,
Current Account to GDP in 2007, % change in money market rate,
external debt to Gross national income, Exchange Rate Regime,
International reserves to total external debt in 2007, foreign liability
dollarization, credit deposit ratio in 2007, dummy variables for effects
of country, region and income characteristics

Dwumfour Dependent Variable: Banking Stability - Zscore/Non-performing loans
(2017), to gross loans ratio/Regulatory Capital Ratio
Explanatory Variables: net interest margin, non-interest income to total
income ratio, concentration level of banking industry, percentage of
foreign banks of total banks in domestic banking system, boone index
for level of competition, access (financial inclusion), inflation, banking
crisis dummy variable, institutional quality
Two-step system The net interest margin is the main determinant of banking
GMM system stability in the SSA banking sectors. He also finds that
foreign bank presence is detrimental to the domestic banking
sector as it reduces stability. His findings line up therefore with
the foreign bank entry-fragility view.

Ozili (2018) Dependent Variables: Banking Stability – Insolvency risk (Zscore), loan Fixed Effects
loss coverage ratio, Non-performing loans to gross loans ratio, standard
deviation of financial development.
Explanatory Variables: Cost efficiency, net interest margin, non-
interest income, regulatory capital ratio, competition, bank
concentration, foreign bank presence, banking sector size, rule of law
index, regulatory quality index, corruption control index, political
stability and absence of terrorism index
Banking concentration, size, efficiency government
effectiveness and foreign bank presence appear to be the main
determinants of banking stability in Africa. However, the
significance of each variable depends on the banking stability
proxy employed and depends on the period of analysis employed:
pre, during or post crisis. His results highlight the importance of
institutional quality for banking stability in Africa.

Mahawiya Dependent Variable: Banking Stability – banking crisis dummy Multivariate logit Foreign bank presence in the domestic banking sector robustly
(2018) variable/zscore and two- step reduces the probability of a banking crisis.
system-GMM
Explanatory Variables: financial openness, inflation, credit to private econometric
sector, real GDP per capita, real GDP growth, exchange rate, estimators.
governance, deposit insurance and M2 to foreign exchange reserves
 Recently, studies for instance by Kedir et al. (2018) and Soumare (2019) have gone into a nascent
area of study in the African landscape to look at PAB and its effect on banking stability. Their findings
are outlined in Table 2 below among other studies conducted on PABs.

One important point can actually be drawn from the literature. Despite the extensive literature of
foreign banks and banking stability, studies that have focussed on PABs and their impacts on the
stability of host banking systems remain scarce. The studies by Soumare (2018) and Kedir et al. (2018)
are for instance confined to the West African region, and do not cover the rest of the Sub Saharan
African region where PABs have also spread to and have been deemed systemically important. The
current study considers this and other short fall aspects of these studies. The study tests for either the
foreign banks influx-stability hypothesis or the foreign banks influx-fragility hypothesis but introduces
the element of foreign banks in the context of the PABs and Non-Pan-African foreign banks in host
banking sectors in SSA. Further the hypothesis of the current study and elements are studied in a
comparative analysis between the South Eastern and Western countries in SSA. To the best of our
knowledge, there is no prior study of such comparison.

The South Eastern countries in this study mainly comprise of Southern African Development
Community (SADC) and East African Community (EAC) countries. The West African group of
countries comprise mostly of Economic Community of West African States (ECOWAS) countries. A
comparative study is important as regional blocs are considered as pillars of the Africa Economic
Community and are an increasingly dominant feature today. The study will therefore reveal the
peculiarities of each region as well as the extent by which Pan African Banks impact on banking and
consequently financial stability and why if there is any difference in impact between the two regions.
This will provide a platform for regional policy recommendation. Secondly, insight will be obtained
from separating and comparing the regions in SSA as each member state in each region or regional bloc
endeavours to pursue policies that will allow that particular region to reach the regional convergence
criteria. Thirdly and most importantly, SSA regional integration agreements have incorporated a
financial sector integration agenda and goals. It is important for policy makers to be aware of financial
integration risks such as contagion risks that may come through interconnection of banking systems and
therefore affect financial system stability in the regional blocs. Fourthly, the Basel Committee on
Banking Supervision comprises 28 member countries with South Africa as the only African country.
Decisions and regulations made by this committee therefore do not take on board African financial
system challenges. It is necessary therefore for African countries to investigate important issues that
concern their banking systems in order to inform their banking supervision regulatory frameworks
specifically and directly. As such, our findings could inform African bank supervisory bodies such as
the Committees on Bank Supervision in regional bodies such as SADC, COMESA and ECOWAS.
Table 2: Selected Empirical Literature on Foreign Bank Entry and Banking Stability
Author Data Methodology
Kedir et al., 2018 Dependent variable: Impaired
Loans/Gross Loans
Independent Variables: Bank efficiency
(Cost to income ratio) Bank size (Log of
Total Assets), Bank Capital (Equity to
Asset ratio), GDP growth, GDP deflator,
unemployment rate,
Kanga, Murinde, Senbet and Soumare Dependent Variables: Bank Loans
(2018) (growth rate of loan portfolio from
previous year), Competition – HHI,
Lerner Index
Independent Variables: Foreign bank
presence and Pan African Bank Presence
(number of Pan African out of total
banks) Liquidity (deposit to total assets
ratio, Bank size (log of total assets),
Capital (Bank Capital over its total
assets), Zscore, Output Gap, Real interest
rate, regulatory quality index
Issouf Soumare (2019) Dependent variable: Banking Stability -
Zscore, Alternatively the capital
adequacy ratio (CAR) and its risk
adjusted variant; Return on Assets
(ROA) and its risk adjusted and
Two-step GMM panel estimator
Quantile Regression Technique
OLS and quantile regression estimation
Results
They find that both bank specific and
macroeconomic variables are key drivers
of bank fragility which is measured as
non-performing loans (NPLS). Higher
levels of NPLs in the former period affect
or are transmitted to NPLs in the current
period. They find that the equity to assets
ratio and the log of assets of banks are
inversely associated with NPLS. This
suggests that their potential to provide
buffers to banks and to reduce bank
fragility.
Findings indicate cross border banking
increases competition in WAEMU,
pushing banks to look for alternative
sources of revenues beyond traditional
lending. Also, cross border banking
associated with improvements in firms’
access to bank finance
The author finds that the expansion of
PABs into the WAEMU banking system
more likely increases banking sector
instability. His findings in terms of PABs
and stability support the competition-

Kanga, Murinde, Senbet and Soumare
(2018)
volatility variants, non-performing loans
(NPLs), loans to deposits and loans to
assets ratio.
Independent Variables: Foreign
presence of 3 types of banks, PABs,
French banks and other foreign banks.
These are measured in terms of the
number of PABs, French and other
foreign banks over the total number of
banks respectively in each country.
Control variables: macroeconomic
variables - economic growth and
inflation, as well as bank specific
variables such as the size of banks and
deposits of banks
Dependent variables: Zscore and Loan
Loss Reserves
Independent Variables: Capital to Asset
ratio, Return on Asset, return on equity,
net interest margin, loans to total assets,
Log of total assets, foreign ownership
dummy variables, concentration,
domestic credit, real interest rate,
political stability
15
Partial adjustment framework
Shrieves and Dahl (1992)
fragility view. Meanwhile, he finds that
the expansion of non-African
international banks, especially the
French banks brings more stability into
the WEAMU banking system. As such
his findings in terms of foreign entry of
the non- African foreign banks and
stability supports the competition
stability hypothesis. As such, his
findings line up with Fu et al (2014) that
find that the competition-stability and
competition fragility theories can
simultaneously apply
of Their findings indicate support for the
regulatory hypothesis that is a positive
relationship between risk and capital.
They further find that banks’ capital
positions are counter cyclical in low
income countries of their sample,
mimicking Basel III. Meanwhile, cross
border banking and foreign bank
ownership are found to reduce risk and
profitability in the banking sector.
4. Data and Empirical Model

This study is based on a country level panel of data of 22 Sub-Saharan African countries15 over the
period 2000-2016. The summary statistics and the pairwise correlation of the variables are presented in
Tables 3 and 4 respectively. The data of bank specific and macroeconomic variables come from
different sources. The bank specific variables such as the net interest margin (nim) and access (acc)
have been sourced from the Global Financial Development database (GFDD), which is a key source of
data for financial stability studies. Dependent variable data such as the probability of default of the
banking system (zscore) and the non-performing loans to total loans ratio (npl) were also sourced from
the GFDD. A wider variant of the zscore (zscore2) was alternatively sourced from the Financial Sector
Development Database (FSDD). Data on macroeconomic variables, namely GDP growth and inflation
have been taken from the World Development Indicators (WDI) of the World Bank. The exchange rate
volatility variable (exv) was calculated in Eviews from country exchange rate data using the conditional
GARCH function. Meanwhile, the main explanatory variables (share of Pan African banks and non-
pan African banks out of total banks, pan and foreign respectively) were calculated from data extracted
from the Claessens and Van Horen (2015) bank ownership database. For all data, where applicable, the
outliers from the data were removed in order to reduce their potential biased effect on estimated
coefficients.

Table 3: Descriptive Statistics for macro-financial variables (2000-2016 ) for 22 SSA Countries
Variable Obs Mean Std. Dev. Min Max
zscore 373 11.7 5.9 2.2 46.4
zscore2 374 11.8 5.9 2.2 47.3
npl 366 8.4 7.7 1.1 74.1
pan 314 30.1 19.6 0.0 77.8
foreign 320 29.3 16.5 0.0 81.8
dom 319 42.9 25.6 0.0 100.0
nim 373 6.9 3.0 1.2 16.8
acc 286 5.0 4.4 0.4 22.5
growth 374 5.0 3.0 -7.7 15.4
inf 372 6.4 5.7 -4.8 32.9
exv 374 3.0 3.6 0.0 15.1

The two main risk indicators (zscore and npl) are negatively correlated with a correlation of 13.2
percent. Overall, the correlation coefficients between the independent variables are not high, (less than
50%). The correlation results show that multicollinearity is not an issue in our model.

15
The Central and West African countries are: Benin, Burkina Faso, Cameroon, Central African Republic,
Chad, Congo Republic, Cote d’ivoire, Ghana, Guinea, Guinea Bissau, Mali, Niger, Nigeria, Senegal, Sierra
Leone, Togo. The South Eastern countries are: Botswana, Kenya, Lesotho, Malawi, Mauritius, Mozambique,
Namibia, Rwanda, South Africa, Swaziland, Tanzania, Uganda and Zambia.
 Table 4: Pairwise Correlation Results
zscore zscore2 npl pan for nim acc gr inf exv
zscore 1.000
zscore2 0.999 1.000
npl -0.132 -0.133 1.000
pan 0.072 0.070 -0.323 1.000
for -0.081 -0.068 -0.082 -0.011 1.000
nim -0.016 -0.017 0.253 -0.044 -0.164 1.000
acc 0.137 0.146 -0.270 -0.158 0.107 -0.324 1.000
gr -0.172 -0.175 0.129 -0.019 0.024 0.186 -0.149 1.000
inf -0.059 -0.063 0.152 -0.158 -0.181 0.540 -0.015 0.036 1.000
exv -0.135 -0.137 0.047 -0.080 0.082 0.184 -0.177 0.135 0.305 1.000

4.1 Measuring instability

We use accounting measures of banking in/stability such as the Zscore and non-performing loans to
gross loans ratio on account of these being available indicators for SSA countries. However, it is
important that we point out that we are aware of other measures, including market-based measures
which are deemed to be forward looking but are unavailable for SSA countries.

Financial or banking stability can be defined as the absence of financial or banking instability. As
such, banking instability can be defined by measures of risk such as the nonperforming to total loans
ratio which represents a bank’s credit risk taking and the Zscore, which represents overall bank risk or
the probability of banking system default. The general model representing banking instability can thus
be outlined as follows:

𝑅𝑖𝑠𝑘𝑡 = 𝛼 + 𝛾 𝑏𝑎𝑛𝑘 𝑠𝑝𝑒𝑐𝑖𝑓𝑖𝑐 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒𝑠 + 𝛿 𝑚𝑎𝑐𝑟𝑜𝑒𝑐𝑜𝑛𝑜𝑚𝑖𝑐 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒𝑠 +

𝜎 𝐼𝑛𝑠𝑡𝑖𝑡𝑢𝑡𝑖𝑜𝑛𝑎𝑙 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒𝑠 + 𝜀𝑡 (1)

As commonly used in the extant literature (Demirgüç-Kunt and Huizinga, 2010) our main indicator of
risk of domestic banks is the Zscore. This is on account of the simplicity of the measure and because it
is premised on accounting information which is readily available in developing countries as opposed to
market based risk measures. The Zscore captures the probability of default of a country’s banking
system. It compares the buffer of a country’s banking system (capitalization and returns) with the
volatility of those returns. The Zscore is estimated as:
𝑅𝑂𝐴+𝐸𝑞𝑢𝑖𝑡𝑦/𝐴𝑠𝑠𝑒𝑡𝑠
(2)
𝑠𝑑(𝑅𝑂𝐴)

where ROA is return on assets, sd (ROA) is the standard deviation of ROA. The Zscore is therefore
the number of standard deviations by which a bank’s return on assets must fall for the bank become to
become insolvent. Lower values of the Zscore show instability, while higher values indicate a tending
to stability.

Another common measure of banking risk is the bank non-performing loans to gross loans ratio
(NPL/Gross Loans). It is the ratio of defaulting loans (payments of interest and principal past due by 90
days or more) to total gross loans (total value of loan portfolio) and measures the lending risk of the
banking system. Higher values of the ratio indicate instability, while lower values indicate a move to

17
stability. Another variant of non-performing loans also sometimes used as an instability measure is the
loan loss reserves indicator. This indicator refers to provisions to nonperforming loans.

The bank regulatory capital to risk-weighted assets (%) ratio is another risk measure that is used to
indicate instability of the banking system. It indicates the capital adequacy of deposit takers. It is a ratio
of total regulatory capital to its assets held, weighted according to risk of those assets. It measures the
strength of the banking system in terms of capital adequacy to sustain the challenges of adverse impacts
of crisis like situations. The lower the ratio the higher the instability, while higher values of the ratio
indicate a tending toward stability of the banking system. Besides the Zscore, this paper also uses the
regulatory to risk-weighted assets and the non-performing loans to gross loans and ratio as the main
banking instability/stability indicators.

One other prominent measure of financial banking instability worth mentioning is excessive credit
growth. A financial sector that is developing well is likely to grow. But excessive credit growth is one
of the most robust common factors associated with banking crises, (Demirguc-Kunt et al., 1998 and
Arena, et al, 2007). According to evidence provided by the IMF(2004), about 75 percent of credit
booms in emerging markets end up in banking crises. Nonetheless, the credit growth measure also has
advantages and disadvantages. Although it can be easily measured, it is difficult to assess ex poste if
the growth is excessive.

Besides the Zscore, and the other indicators of banking system instability mentioned above, other
indicators that are used as proxies of banking stability include the, bank capital to total assets ratio, the
bank credit to bank deposits ratio; the liquidity ratios such as the liquid assets to deposits and short term
funding ratio.

In terms of financial markets, the most commonly used indicator for stability is market volatility,
Cihak et al (2005). For instance, the volatility (standard deviation / average) of the stock price index is
the standard deviation of the sovereign bond index divided by the annual average of that index. Another
stock market variable that can be used is the skewness of stock returns, as a more negative skewed
distribution of stock returns is likely to give large negative returns, and likely to be prone to less
stability.

In terms of market based stability measures, Segoviano and Goodhart (2009) also propose some
bank stability measures that represent a set of tools that can be used to analyse banking stability from
three different, yet complementary perspectives by allowing the quantification of common distress in
the banks of a system, distress between specific banks, and distress in the system associated with a
specific bank known as cascade effects. To analyse common distress in the banks comprising the
system, Segoviano and Goodhart (2009) proposed the Joint probability of distress (JPoD) and the
Banking Stability Index (BSI). The latter is based on the conditional expectation of default probability
measure developed by Huang (1992). The BSI reflects the expected number of banks becoming
distressed given that at least one bank has become distressed. The JPoD represents the probability of
all the banks in the system (portfolio) becoming distressed. That is the “tail risk” of the system. In the
case of analyzing distress between specific banks, Segoviano and Goodhart (2009) propose what is
known as the Distress Dependence Matrix. In this measure of bank stability. as per each period under
analysis and for each pair of banks in the portfolio, a set of pairwise conditional probabilities of distress
in the Matrix are estimated. Thus, the matrix contains the probability of distress of the bank specified
in the row, given that the bank specified in the column becomes distressed. For the case of distress in
the system associated with a Specific bank, the Probability of Cascade Effects is proposed. The
Probability of Cascade Effects, given that a specific bank becomes distressed is the likelihood that one,

18
two or more institutions up to the total number of banks in the system becomes distressed. This
measure, as such quantifies the potential “cascade” effects in the system, given distress in a specific
bank. Other market based risk models that may be used in measuring banking stability are the Merton
Failure Prediction Model that use the Distance to default (Dtd) measure (that is distance to insolvency),
and Sy and Chan-Lau (2006) measure of distance-to-capital (DtC) as an indicator of systemic risk.
According to Sy and Chan-Lau(2006) , the DtD ignores the likelihood of regulatory corrective action
well before a banking institution’s default. Nonetheless the DtC solution is derived from the (Black
and Scholes, 1973)option pricing formula and the Merton (1974) pricing model wherein the value of a
firm’s assets, V, should be equal to the sum of the values of its debt, D, and equity, E. Intuitively, the
only difference between the DtD and DtC is the choice of the relevant default barrier, or value of the
call option’s exercise price.

4.2 Measurement of the variables

i) Dependent variables (𝑌𝑖𝑡 ):

Zscore, zscore2 and the non performing to gross loans ratio (NPL)

The chapter uses three indicators for the dependent variable (banking stability): The zscore, a variant
and wider measure of the zscore, zscore2 and the ratio of non-performing loans to total loans (NPL).
The previous section carries a discussion of all three. The zscore and the NPL to gross loans ratio (NPL)
are sourced from the GFDD, while the zscore2 is sourced from the FSSD.

ii) Explanatory/control variables:

Foreign bank presence variables (Share of Pan and non-Pan African out of total banks)

The main explanatory variables are the non-Pan African foreign bank entry (foreignit) and the pan
African foreign bank entry variable (panit). Foreignit is the percentage share of the number of foreign
owned banks to the number of the total banks in a domestic financial system. A foreign bank is a bank
where 50 % or more of its shares are owned by foreigners. Expectations are either a negative or positive
relationship with stability. The Pan African foreign bank variable (panit), is the percentage share of the
number of foreign banks owned by Pan African banking groups to the number of the total banks in an
economy. Expectations are a positive relationship with stability. The foreign bank presence variables
were calculated from data sourced from the Claessens and van Horen (2012) ownership database.

As in equation (1) above, and following Yeyati & Micco (2007), Wu et al (2017), Faia et al (2018) ,
our control variables comprise bank specific and macroeconomic variables. The bank specific variables
are the net interest margin (nim) and the access to financial services variable (acc) representing financial
inclusion.

Financial structure variables

Net interest margin: The Net Interest Margin (Nm), a profitability variable, is an accounting value of a
bank's net interest revenue as a share of its average interest-bearing (total earning) assets. This measure
is used to understand the impact of banking spread with regards to their ‘traditional activities’ on bank
stability. Higher values are expected to improve stability. However, where banks are charging too high
an interest, borrowers are likely to venture into very risky projects to pay their loans and interests. Thus,
it could increase default rates and hence non-performing loans leading to an unstable industry,
Dwumfour (2017). We therefore expect either a positive or negative relationship with stability.

19
Financial Access: Banking access, (Acc), a measure of financial inclusion is measured as the number
of bank branches per 100,000 adults, used to measure financial inclusion. Higher values indicate more
access. Thus, expectations are that increasing banking access improves stability, Beck (2015).

Macroeconomic variables

Macroeconomic variables such as growth rates, inflation, terms of trade shocks and exchange rate
volatility, among others, may have adverse impact on the viability of financial institutions and stability
of the banking industry. They are therefore important in explaining how the environment in which banks
operate affect their performance and viability, (Cihak et al. 2012; Bretschger et al, 2012; Claessens &
Laeven, 2004). We therefore control for GDP growth rate, inflation, and exchange rate volatility in our
model

Inflation: Inflation is measures as year-on-year change in the consumer price index. High inflation
erodes incomes and in turn causes high default rates which translate into higher non - performing loans
causing instability. Hence, the a priori expectation is a negative relationship between inflation and
stability.

Exchange rate volatility: The exchange rate volatility variable is used to test the hypothesis that banking
system distress may be driven by excessive foreign exchange risk exposure either in the banking system
itself or among bank borrowers. Due to financial liberalisation reforms, for those countries that
embraced capital account reforms and relaxation of exchange control rules, domestic banks can borrow
in foreign currency. Depreciation of the domestic currency is therefore likely to leave these banks with
huge liabilities, especially if accompanied by a slow-down in economic activities. For this reasons, we
expect a negative relationship between exchange rate volatility and banking system stability.

GDP growth rate: A rise in real GDP growth is a good indicator of banking stability. A booming
economy increases lending and profits. Conversely declining real GDP growth is an early warning of
bank distress due to slowed economic activities, unemployment and increase in non-performing loans
on banks’ portfolios. Expectation is that GDP growth is positively related to banking system stability.

4.3. Empirical model

The study employs a panel data analysis using a macroeconomic and financial data for a sample of 22
African countries over the period 2000 to 2016. We consider two ownership types of banks observable
in Africa; Foreign PABs and foreign non-Pan African banks. The baseline model is estimated by using
the country-specific fixed effects estimator, chosen because it is commonly adopted in extant research
and on account of some of its merits. Given that the cross-sections cut across different countries in
twenty two Sub Saharan African countries, there is the possibility of a range of time invariant country-
specific unobserved factors influencing the behaviour of each country. Hence, fixed effect is suited to
handle this observational-specific heterogeneity that is fixed over time. Following our fixed effects
estimation, we move on to check the robustness of our findings by using the two stage least squares
(2SLS) estimator, which helps in addressing the potential endogeneity issues between dependent
variables and foreign bank presence. For instance, a relatively stable (unstable) financial market can
encourage (discourage) more cross-border banking, and such reverse causality could lead to biased
results. Drawing on the general model (1) specified above, our model is specified as follows:

𝑆𝑡𝑏𝑖𝑡 = 𝑎 + 𝛾𝑃𝑎𝑛𝑖𝑡−1 + 𝛽𝐹𝑜𝑟𝑒𝑖𝑔𝑛𝑖𝑡−1 + 𝛼1 𝑁𝑚𝑖𝑡 + 𝛼2 𝐴𝑐𝑐𝑖𝑡 + 𝛼3 𝐼𝑛𝑓𝑖𝑡 + 𝛼4 𝐺𝑟𝑜𝑤𝑡ℎ𝑖𝑡−1 + 𝛼5 𝐸𝑥𝑣𝑖𝑡

+ 𝜀𝑖𝑡 (3)

20
where Stbit represents the dependent variable measuring banking stability- as measured by the Zscore,
Zscore2 or the ratio of non-performing loans to total loans (NPL). For the right hand side variables,
Foreignit measures non pan-African foreign bank entry, Panit measures pan-African foreign bank entry,
Nimit is the net interest margin; Accit represents banking access as a measure of financial inclusion, Infit
measures inflation, Exvit measures exchange rate volatility and Grit measures growth of GDP. The
foreign bank variables (Pan and Foreign) come in with the lag because it is expected that the effects of
their entry or presence will at least take a year to affect stability (Wu et al., 2017). Similarly, a change
in economic growth (like some macroeconomic variables) in one period is expected to affect banking
stability in the next period. However, the impact of exchange rate (Exv) is more instantaneous as its
pass-through is very unlikely to take a year to impact stability. Hence, we use exchange rate volatility
instead. To control for unobserved heterogeneity in our data, the error term εit is made up of the
unobserved country specific effect, 𝛼𝑖𝑡 , 𝜇𝑖𝑡 time specific fixed effect and 𝜖𝑖𝑡 the country specific time
variant effect.

5. Empirical Results

We discuss the results of the estimated models in this section. We started our empirical analysis by
estimating Eq. (3) for all sampled countries and for the two different sub regions (south-east and western
Africa) of SSA using the fixed effect estimator16. Also for robustness, we use the 2SLS to account for
the possible endogenity that may prevail in our model, specifically between foreign bank entry and the
dependent variables. The estimated results are presented in Tables 5 – 10.

Table 5: Estimated fixed effect model for SSA (standard errors are in parentheses)
Variables ln (Zscore) ln (Zscore) ln (Zscore_2) ln (Zscore_2) NPL NPL

(Model 1) (Model 2) (Model 3) (Model 4) (Model 5) (Model 6)

Pan 0.0059** 0.0064* 0.0059** 0.0063* -0.0866 -0.0980
(0.002) (0.003) (0.002) (0.003) (0.069) (0.089)
Foreign 0.0036 0.0035 0.0110
(0.004) (0.005) (0.087)
Net int. margin 0.0285** 0.0231 0.0290** 0.0237 -0.5901* -0.6313
(0.011) (0.016) (0.012) (0.016) (0.310) (0.374)
Banking access 0.0081 0.0086 0.0093 0.0090 -1.0372 -1.2373
(0.024) (0.033) (0.024) (0.032) (0.757) (1.059)
Exch. volatility -0.0312*** -0.0330*** -0.0312*** -0.0332*** 0.4103* 0.3394
(0.007) (0.007) (0.007) (0.007) (0.233) (0.243)
Growth rate 0.0002 0.0013 0.0002 0.0013 -0.1343 -0.0834
(0.004) (0.004) (0.004) (0.004) (0.109) (0.120)
Inflation -0.0024 -0.0022 -0.0026 -0.0024 0.1734 0.308**
(0.002) (0.002) (0.003) (0.002) (0.113) (0.124)
Intercept 2.029*** 1.958*** 2.033*** 1.966*** 17.823*** 15.616**
(0.159) (0.186) (0.160) (0.185) (4.995) (5.518)
***, ** and * denote statistically significant at 1%, 5% and 10% level of significance.

16The sub regions were selected on the basis of the regions where Pan African banks and foreign traditional banks
are active and systemically present.

21
5.1 Baseline results

We report the estimation results for our baseline full sample model in Table 5. Columns (2) to (7) differ
in terms of the different dependent variables, that is, Zscore, Zscore2 and the non-performing to total
loans ratio - NPL, respectively. The estimated Zscores are in their natural logarithm. Moreover, we
allowed for flexibility in our estimations by excluding non-Pan African foreign bank (Foreign) from
our estimated model as the case of models 1, 3 and 5 in Table 5 and the rest. The primary results derived
from the estimated fixed effect are as follows. First, we find that the share of Pan African bank entry is
positively related to the Zscore based indicators given the statistically significance of the coefficients
of the Pan variable. The results indicates that the stability of the domestic banking system increases
with a higher presence of pan African banks. The estimated coefficients of Pan in model 1 – 4 on
average (0.006) suggests that a 1% increase in the share of Pan African banks in the domestic financial
system causes banking system stability to rise by 0.6. On the other hand, based on models 2, 4 and 6,
the entry of the non-Pan African foreign banks into Sub-Saharan Africa indicates a positive effect, but
it has no significant impact on banking stability. Our expectations were that PABs would have a positive
and significant effect on banking system stability; and that in comparison to non-Pan African foreign
banks, the PABs would have a positive and significant effect on banking stability. These results
therefore support our first and second hypotheses.

In terms of sign, the result of the nonperforming loans to total loans ratio equation (models 5 and 6)
confirms the findings of the Zscore banking stability measures for the presence of Pan African banks,
with the negative sign suggesting that the more Pan African banks enter the SSA region, the lower the
non-performing loans to gross loans ratio; and hence more stability. One possible explanation is that as
Pan African banks enter the region, competition in the region increases. The higher competition may
lead to lower interest rates, however, banks may be competing on the grounds of quality. This causes
banks to be careful in giving out loans and hence reduces moral hazard and adverse selection in banks’
loan disbursements. This would therefore reduce default rates and hence strengthen banking system
stability. The net interest margin is used to understand the impact of banking spread with regard to
traditional activities on bank stability. Higher values are expected to improve stability as found for
instance by Demirgüç-Kunt et al. (1998). However, sometimes when banks charge too high an interest
borrowers could venture into very risky projects in order to pay their loans and interest, thus increasing
default rates and hence non-performing loans, leading to an unstable industry as hinted on by Dwumfour
(2017). In this case, the results line up with Demirgüç-Kunt et al. (1998), in that the net interest margin
is positively and significantly related to the Zscore indicators and negatively related to the NPL.
Dwumfour (2017) also finds the net interest margin to be positively related to banking system stability
and finds it as being the major determinant of banking stability in SSA.

For the macroeconomic variables, the exchange rate volatility has the expected sign and impacts
negatively and very significantly on banking system stability in terms of the Zscore indicators. Indeed,
high levels of currency value fluctuations are endemic to SSA economies, creating an impediment to
foreign investment in the region. These currency fluctuations are an important risk factor in the African
stock markets and financial system, Senbet and Otchere (2006). The GDP growth rate variable bears
the correct positive and negative signs with respect to the Zscore indicators and the NPL/Gross loans
ratio respectively; that an increase in growth of the economy affects banking stability positively.
Consumers and firms are able to repay loans, and this contributes positively to banking system stability.
It may not be surprising that though the GDP growth rate shows up as positive as would be expected
theoretically, but it is statistically insignificant across the board. This could be on account of the frequent
episodes of high macro-economic instability in SSA that do not allow for economic growth to have any
significant effect on financial /banking stability. The inflation variable also bears the correct negative

22
and positive signs with respect to Zscore indicators and non-performing to gross loans ratio
respectively. Rising inflation erodes the incomes of economic entities, thereby affecting their ability to
repay loans; thus, contributing to an unstable banking system through higher default rates and thus high
NPLs. As can be seen, inflation in SSA is positively and significantly related to the non-performing to
gross loans ratio.

Overall, the baseline results indicate that Pan African bank entry in SSA increases banking system
stability, whereas the presence of non-Pan African foreign bank presence does not seem to have a
statistically significant impact on banking system stability. Our findings in some respects are in line
with those of Ursula et al. (2010) and Kanga et al. (2018).

6.2 The Regional Results

i) South Eastern Africa.

Turning to banking system stability in South Eastern SSA, results indicate that Pan African bank
presence contributes positively and significantly to stability as measured by both measures of the Zscore
in Table 6. The estimated coefficient of an average of 0.8% indicates a 1% rise in the share of Pan
African banks in SSA is associated with a 0.8 increase in the index of banking system stability for both
the Zscore indicators. Whereas the inclusion of the non-pan African foreign bank presence shows a
positive but insignificant relationship with bank stability. Meanwhile, Pan African bank presence
maintains a positive and significant impact on banking stability with the impact of a 1% increase in the
share of Pan African banks increasing banking stability even more by 0.9 with the inclusion of the non-
pan African banks.

With the NPL equation in model 5, pan African bank presence has a negative and significant impact
at the 10% significance level on risk with respect to the non-performing to total loans ratio confirming
Pan African bank presence enhances stability; with a 1% increase in the share of Pan African bank
presence causing a decline of 0.2% in the non performing to total loans ratio. The significance of this
impact rises to the 5% level of significance with the inclusion of the non-pan African bank penetration
(model 6), which despite having a positive sign against the Zscore indicators and a negative sign against
the non-performing to total loans ratio does not significantly impact banking system stability in south
eastern Africa. Indications therefore are that the non-pan African foreign banks presence does not
impact banking system stability. As in the full sample, the net interest margin impacts banking system
positively and significantly, with a 1% increase in the net interest margin increasing banking system
stability by 3% (models 1-4). An interesting factor in the south-eastern Africa sample is the positive
statistically significant impact of the access variable which essentially represents financial inclusion.
Thus, financial inclusion enhances financial system stability in this region. The exchange rate volatility
is statistically significant across the board with corresponding negative and positive coefficients on the
Zcore indicators and the NPL ratio respectively in the south-eastern Africa with the expected negative
and positive signs against the Zscore indicators and the non-performing to total loans ratio, inflation in
south eastern adversely affects banking system stability by erosion of incomes; causing an increase in
default rates and consequently a corresponding rise in non-performing loans.

23
Table 6: Estimated fixed effect model for South-Eastern Africa (standard errors are in parentheses)
Variables ln (Zscore) ln (Zscore) ln (Zscore_2) ln (Zscore_2) NPL NPL

(Model 1) (Model 2) (Model 3) (Model 4) (Model 5) (Model 6)

Pan 0.0079*** 0.0088*** 0.0078*** 0.0086*** -0.1742* -0.2052**
(0.002) (0.002) (0.002) (0.002) (0.085) (0.0736)
Foreign 0.0028 0.0025 -0.0976
(0.002) (0.0025) (0.103)
Net int. margin 0.0309*** 0.0279*** 0.0315*** 0.0288*** -0.1191 -0.0128
(0.006) (0.007) (0.007) (0.008) (0.270) (0.261)
Banking access 0.0367* 0.0382* 0.0384* 0.0398** -0.8973 -0.9484
(0.019) (0.018) (0.019) (0.018) (0.848) (0.861)
Exch. volatility -0.0361*** -0.0374*** -0.0361*** -0.0373*** 0.5602** 0.6041**
(0.005) (0.005) (0.005) (0.005) (0.231) (0.227)
Growth rate -0.0007 -0.0016 -0.0005 -0.0013 -0.2573 -0.2283
(0.004) (0.005) (0.004) (0.005) (0.158) (0.146)
Inflation -0.0016 -0.0017 -0.0019 -0.0020 0.2613** 0.2642**
(0.002) (0.003) (0.002) (0.005) (0.110) (0.108)
Constant 1.7232*** 1.636*** 1.719*** 1.640*** 18.862**
(0.104) (0.078) (0.108) (0.077) (5.471) (7.175)
***, ** and * denote statistically significant at 1%, 5% and 10% level of significance.

ii) West Africa

In the west African region indications are that foreign bank presence, whether that of pan African or
non-pan African foreign banks, does not have impact on banking system stability of the region. Whilst
the share of Pan African banks shows a positive relation to the Zscore indicators, the relationship is not
significant (columns 1 and 3 of Table 7). It remains insignificant even with the inclusion of the non-pan
African foreign bank presence which itself, also has insignificant impact.

A possible explanation to these results is the dominant presence of domestic banks in the region.
Nigeria, the largest economy in the West African sample has a percentage of domestic banks share
ranging from 84% to ninety two percent during the sample period compared to a highest percentage of
five percent and ten percent in terms of pan African and non-pan African banks in the country. This
compares significantly with south eastern Africa where pan African bank presence and other foreign
bank presence can reach approximately twenty two percent (for example in South Africa and Kenya)
of the banking system compared to highest levels of domestic bank share of approximately eighty
percent of the banking system, Allen et al. (2011).

Interestingly, according to the results in Table 7, the exchange rate volatility significantly impacts
the banking system stability as measured by the Zscore indicators. However, the variable enters with a
positive sign. This could be due to the controlled regulatory environment that prevails in some of the
countries in this region such as the WAEMU countries. The West African sample of countries contain
countries that have pegged exchange rate regimes. Thus, their currencies are not prone to depreciations.
Hence the significant but positive sign between the exchange rate volatility and banking stability in this
region. Meanwhile economic growth as measured by the GDP growth rate positively and significantly
impacts banking system stability, with an indication that a percent increase in GDP growth increases
banking system stability by 0.8 in the western African region of SSA.

24
Table 7: Estimated fixed effect model for West Africa (standard errors are in parentheses)
Variables ln (Zscore) ln (Zscore) ln (Zscore_2) ln (Zscore_2) NPL NPL
(Model 1) (Model 2) (Model 3) (Model 4) (Model 5) (Model 6)
Pan 0.0056 0.0056 0.0056 0.0056 0.1553 0.1534
(0.005) (0.005) (0.005) (0.005) (0.103) (0.101)

Foreign 0.0021 0.0021 0.0750

(0.006) (0.006) (0.117)
Net int. margin 0.0089 0.0075 0.0089 0.0075 -1.4271* -1.4781*
(0.026) (0.026) (0.026) (0.026) (0.672) (0.697)
Banking access -0.0808 -0.0801 -0.0808 -0.0801 0.1104 0.1323
(0.057) (0.057) (0.057) (0.057) (2.121) (2.117)
Exch. volatility 0.2635** 0.2491*** 0.2653** 0.2492*** -5.9741*** -6.530***
(0.089) (0.059) (0.089) (0.056) (1.637) (1.747)
Growth rate 0.0079* 0.0086* 0.0079* 0.0086* 0.0772 0.0992
(0.004) (0.004) (0.004) (0.004) (0.122) (0.106)
Inflation 0.0012 0.0010 0.0012 0.0010 0.1324 0.1284
(0.004) (0.004) (0.004) (0.0041) (0.165) (0.171)
Constant 1.642*** 1.627*** 1.654*** 1.639*** 31.043*** 30.462***
(0.393) (0.440) (0.393) (0.440) (4.907) (5.081)
***, ** and * denote statistically significant at 1%, 5% and 10% level of significance.

6.3 Robustness tests

In this section, we use a different econometric methodology to check if our baseline results hold.
Further, just like in the previous section, we use the variant on the zscore as an alternative measure of
risk; and following the commonly used practice adopted in extant literature (for example, Claessens et
al (2001), Laeven and Levine (2009), for robustness we also use the ratio of non-performing loans to
gross loans as another alternative risk indicator. More specifically, following Schaeck and Cihak (2014)
and Wu et al. (2017), we employ the 2SLS instrumental variable estimator to deal with the potential
endogeneity bias due to the possible reverse causation from banking system stability to foreign banks
entry. To address this problem, we rely on the internal instruments- the lags of the endogenous variables
as it is often problematic to find valid instruments. Notwithstanding, we complement the internal
instruments with external instruments. We use the penetration (foreign entry) of pan African foreign
banks in other markets located in the same region (SSA) as the instrumental variable for the level of
pan African foreign bank entry. To be specific we calculated the ratio of the number of pan African
foreign banks, pan (other countries in SSA) / total number of those banks in all other countries in the
same region over the total number of those countries; or the average of the shares of Pan African foreign
banks in the rest of the countries in SSA, (average pan (other countries in SSA)) and used it as an
instrumental variable for the level of Pan African bank entry. We did the same in the case of the non-
Pan African foreign banks and calculated the ratio of the number of non-pan African foreign banks,
foreign (other countries in SSA) / total number of those banks in all other countries in the same region
over the total number of those countries; or the average of the shares of non-Pan African foreign banks

25
in the rest of the countries in SSA, (average pan (other countries in SSA)) and used it as an instrumental
variable for the level of non-Pan African bank entry.

Wu et al (2017) explain that foreign banks may establish their operations more likely in areas where
their peers cluster. They cite that because the common driving factors of foreign bank penetration, such
as home-host cultural and institutional closeness and the expected profitability based on host countries’
economic development, could be similar in near emerging (or developing) countries, foreign banks may
assemble in a region and thereby the level of foreign penetration in one country can be correlated with
that in other near countries. They indicate however that it is unlikely that the stability or risk of
instability of domestic banks in one country would be affected directly by the foreign penetration in
other countries. Thus, the instrumental variables suggested above can be a proper instrumental variables
for foreign bank entry of Pan African banks and non-Pan African banks.

The results of our 2SLS estimation are presented in tables 8, 9 and 10 below. The results are
generally qualitatively consistent with our baseline findings. In general, we find that as the share of
Pan African bank entry increases, SSA banking systems become more stable (table 8). This is also the
case for the south eastern countries of SSA (table 9) as it was in the fixed effects estimation. At this
point however, the 2SLS estimation having considered issues of endogeneity, we draw attention to the
results for the western African sub sample (table 10). We now find that Pan African bank entry also
positively and significantly affects banking system stability in the West Africa region of SSA. A 1%
increase in the share of pan African banks leads to a 0.8 increase in the banking system stability index,
just 0.1 less than the 0.9 increase in banking stability in South East Africa resulting from the same. Our
findings are different from those of Soumare (2018), who finds a contrary result in that PABs in the
WAEMU countries of West Africa detract from banking system stability, while the French non pan
African foreign banks were found to enhance banking system stability. Soumare’s (2018) results were
premised on the “cherry picking” lending practices of the French banks. In our case, we find that using
the overall banking system stability Zscore indicators (Zcore and Zscore2), non-Pan African foreign
banks do not significantly impact stability in West Africa. Meanwhile, the non-performing loan to
gross loan ratio seems to even indicate that a 1.0 percent increase in the share of non-pan African foreign
banks leads to a 0.2 increase in non-performing loans. This seemingly signals the presence of these
banks tending towards a leaning to instability of the banking system by their presence.

The growth of the economy as theoretically expected enhances banking stability in West Africa.
Financial inclusion (access) is however found to negatively affect banking system stability in west
Africa, as opposed to enhancing it in south east Africa. Consistently however, just as in the fixed effects
regression, the exchange rate volatility enters the regression with a positive sign though it significantly
impacts banking stability in West Africa.

These results are solidified in that the 2SLS diagnostic statistics support the validity of the selected
instrumental variables for the level of Pan African and non-Pan African bank penetration. Firstly, the
p-value of the test for endogeneity (table 8) suggests that the potential endogeneity of the pan African
foreign bank entry cannot be ruled out. The null hypothesis for the endogeneity test is that the regressors
are exogenous. Given the p-value outcomes, we reject the null hypothesis that the endogenous
regressors are exogenous. Secondly, we also report the first-stage F statistic based on the Stock and
Yogo (2005) test for weak instruments. The F-statistic registers larger than the critical value (9.08 using
the 10% significance level) constructed by Stock and Yogo (2005). We interpret this as favourable
evidence for the strength of our instrumental variables in the first-stage regressions.

26
Table 8: Estimated 2SLS instrumental variable for SSA (standard errors are in parentheses)
Variables ln (Zscore) ln (Zscore) ln (Zscore_2) ln (Zscore_2) NPL NPL
(Model 1) (Model 2) (Model 3) (Model 4) (Model 5) (Model 6)
Pan 0.0081*** 0.0090*** 0.0080*** 0.0090*** -0.1171*** -0.1310***
(0.002) (0.002) (0.002) (0.002) (0.039) (0.045)
Foreign 0.0038 0.0037 -0.0744
(0.004) (0.003) (0.072)
Net int. margin 0.0319*** 0.0278*** 0.0323*** 0.0284*** -0.6223** -0.5360*
(0.009) (0.010) (0.009) (0.011) (0.260) (0.282)
Banking access -0.001 0.0026 0.0002 0.0038 -0.9192** -1.004***
(0.015) (0.013) (0.015) (0.013) (0.357) (0.370)
Exch. rate volatility -0.0357*** -0.0366*** -0.0358*** -0.0366*** 0.4071* 0.4182*
(0.009) (0.009) (0.009) (0.009) (0.229) (0.234)
Growth 0.0006 0.0009 0.0006 0.0009 -0.1472 -0.1523
(0.003) (0.003) (0.003) (0.003) (0.095) (0.095)
Inflation -0.0019 -0.0021 -0.0021 -0.0023 0.1651* 0.1700**
(0.003) (0.003) (0.003) (0.003) (0.085) (0.085)
Observations 247 247 247 247 246 246
Number of id 22 22 22 22 22 22
Hansen's J Test 0.799 0.970 0.795 0.968 0.300 0.169
Endogeneity test 0.038 0.0398 0.039 0.046 0.082 0.172
Stock and Yogo
F- test 174.5 150.5 174.5 150.5 173.6 148.8

Panel B: First Stage for Endogenous Variables Pan African Bank / Non-Pan African Bank Penetration
L2.Pan 0.6987*** 0.8561*** 0.6987*** 0.8561*** 0.6993*** 0.8568***
(0898) (0.046) (0898) (0.046) (0.090) (0.046)
L3.Pan 0.1343 0.1343 0.1339
(0.082) (0.082) (0.082)
Pan_instr2 0.1075 0.1990 0.1075 0.1991 0.1114 0.2113
(0.076) (0.531) (0.076) (0.531) (0.077) (0.532)
L.Pan_instr2 0.0136 0.0136 0.0050
(0.295) (0.295) (0.296)
L2.Foreign 0.2773*** 0.2773** 0.2790***
(0.091) (0.091) (0.091)
L3.Foreign -0.1643** -0.1643** -0.1653
(0.085) (0.085) (0.085)
Foreign_instr3 0.1335 0.1335 0.1298
(0.935) (0.935) (0.936)
F-Statistic- P. value 0.0000 0.0000 0.0000 0.0000 0.000 0.0000
***, ** and * denote statistically significant at 1%, 5% and 10% level of significance.

27
Table 9: Estimated 2SLS instrumental variable for South-Eastern Africa (standard errors are in parentheses)
Variables ln (Zscore) ln (Zscore) ln (Zscore_2) ln (Zscore_2) NPL NPL
(Model 1) (Model 2) (Model 3) (Model 4) (Model 5) (Model 6)
Pan 0.0088*** 0.0099*** 0.0087*** 0.0097*** -0.2173*** -0.3000***
(0.001) (0.002) (0.001) (0.002) (0.047) (0.045)
Foreign 0.0037 0.0041 -0.254***
(0.003) (0.003) (0.081)
Net int. margin 0.0315*** 0.0265*** 0.0321*** 0.0268*** -0.0854 0.2580
(0.008) (0.009) (0.008) (0.009) (0.319) (0.358)
Banking access 0.0336*** 0.0357*** 0.0354*** 0.0377*** -0.7573** -0.8840**
(0.012) (0.011) (0.012) (0.011) (0.354) (0.365)
Exch. rate volatility -0.0372*** -0.0380*** -0.0372*** -0.0380*** 0.5253*** 0.5770***
(0.008) (0.009) (0.008) (0.009) (0.188) (0.230)
Growth -0.0008 -0.0016 -0.0006 -0.0014 -0.2841** -0.2270*
(0.004) (0.004) (0.004) (0.004) (0.130) (0.116)
Inflation -0.0015 -0.0020 -0.0018 -0.0020 0.2532*** 0.2630***
(0.002) (0.003) (0.002) (0.003) (0.089) (0.087)
Observations 137 137 137 137 136 136
Number of id 12 12 12 12 12 12
Hansen's J Test 0.181 0.053 0.1712 0.068 0.544 0.449

Panel B: First Stage for Endogenous Variable Pan African Bank Penetration (Pan_A)
L2.Pan_A 0.7175*** 0.9322*** 0.7175*** 0.9237*** 0.7189*** 0.9354***
(0.128) (0.045) (0.127) (0.130) (0.128) (0.046)
L3.Pan_A 0.1683 0.168 0.1674
(0.117) (0.117) (0.118)
Pan_instr2 -0.0556 2.1309 -0.0556 0.9628 -0.0506 0.7437
(0.077) (2.577) (0.077) (3.736) (0.078) (0.580)

L.Pan_instr2 0.0555 1.2907 0.0234

(0.382) (2.940) (0.380)
L2.Foreign 0.1939* 0.1854 0.2020*
(0.115) (0.120) (0.114)
L3.Foreign -0.0481 -0.0514 -0.0571
(0.102) (0.102) (0.100)
Foreign_instr3 2.6282 1.3624 1.1471
(2.878) (3.953) (1.109)
F-Statistic- P. value 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000
***, ** and * denote statistically significant at 1%, 5% and 10% level of significance.

28
Table 10: Estimated 2SLS instrumental variable for West Africa (standard errors are in parentheses)
Variables ln (Zscore) ln (Zscore) ln (Zscore_2) ln (Zscore_2) NPL NPL
(Model 1) (Model 2) (Model 3) (Model 4) (Model 5) (Model 6)
Pan 0.0077** 0.0082** 0.0077** 0.0082*** 0.0349 0.0481
(0.003) (0.003) (0.003) (0.003) (0.092) (0.102)
Foreign 0.0046 0.0046 0.227**
(0.007) (0.006) (0.113)
Net int. margin 0.0179 0.0141 0.0179 0.0141 -1.1383*** -1.3410***
(0.015) (0.017) (0.015) (0.016) (0.377) (0.431)
Banking access -0.1043*** -0.0939*** -0.1043*** -0.0939*** -0.7294 -0.1623
(0.032) (0.029) (0.035) (0.029) (0.877) (0.982)
Exch. rate volatility 0.1402* 0.1220 0.1402* 0.1220 -6.2464** -7.1373***
(0.074) (0.077) (0.074) (0.077) (2.480) (2.602)
Growth 0.0083* 0.0100* 0.0083* 0.0100* -0.0139 0.0593
(0.005) (0.005) (0.005) (0.006) (0.120) (0.126)
Inflation -0.0015 -0.0019 -0.0015 -0.0019 0.0444 0.0187
(0.005) (0.005) (0.005) (0.005) (0.117) (0.122)
Observations 110 110 110 110 110 110
Number of id 10 10 10 10 10 10
Hansen's J Test 0.144 0.566 0.144 0.566 0.397 0.464

Panel B: First Stage for Endogenous Variable Pan African Bank Penetration (Pan_A)
L2.Pan_A 0.5349*** 0.5821*** 0.5349*** 0.5821*** 0.5349*** 0.5821***
(0.128) (0.084) (0.128) (0.084) (0.128) (0.084)
L3.Pan_A 0.0853 0.0853 0.0853
(0.116) (0.116) (0.116)

Pan_instr2 0.5936*** 0.7354 0.5936*** 0.7354 0.5936*** 0.7354

(0.171) (0.959) (0.171) (0.959) (0.171) (0.959)

L.Pan_instr2 0.1624 0.1624 0.1624

(0.522) (0.522) (0.522)
L2.Foreign 0.4229*** 0.4229*** 0.4229***
(0.126) (0.126) (0.126)
L3.Foreign -0.3412*** -0.3412*** -0.3412***
(0.148) (0.148) (0.148)
Foreign_instr3 -1.8784 -1.8784 -1.8784
(1.528) (1.528) (1.528)
F-Statistic- P. value 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000
***, ** and * denote statistically significant at 1%, 5% and 10% level of significance.

In summary therefore, given the 2SLS results, we find that Pan African Banks positively and
significantly impact banking system stability in both the South Eastern and Western regions of SSA.
The findings showed a very marginal difference in quantitative impact between the two regions of 0.1
percent. This will be deemed negligible, rendering the result as a similar impact. Furthermore, in both
regions, non-pan African foreign bank penetration was seen to have no significant impact on overall

29
banking system stability. This may be on account that during the sample period, there was a substantial
pull out of these banks from SSA following the GFC, and a tightening of regulatory frameworks as well
as a scaling down of operations. Additionally, the way foreign banks operate in developing countries
could account for their negligible impact. Wu et al (2017) points out that foreign banks sometimes
focus their credit and other financial services on informationally transparent clients (cherry picking)
crowding out their domestic counterparts out of this niche market. In comparison to their domestic
counterparts, they thus tend to take on less risk, and when they do it is through cherry picking. This
could therefore render their impact on banking system stability insignificant. Besides playing their cards
very close to their chest by cherry picking, foreign banks are also prone to follow the prevalent practices
of other banks in the domestic in terms of lending more to the government, as it is regarded as less risky
than lending to the private sector. (Honohan and Beck (2007) in Andrianova et al (2015) report that
only 30.0 percent of the assets of Sub-Saharan African banks are in the form of loans to the private
sector, while in every other region the figure is 60.0 percent–70.0 percent. The report notes that 35.0
percent of Sub-Saharan bank assets are loans to the public sector, 15.0 percent are liquid assets and 20.0
percent are foreign assets). Given these results, we do not therefore find any support for our third
hypothesis that there is a difference in the effect of PABs on banking system stability in the host
countries of the southern and the western parts of Africa.

Whilst the results indicate that Pan African foreign bank presence enhances stability, there is still
need for further and even more detailed investigation into the Pan African Bank presence –
stability/fragility question. Further research could look at the stability question of Pan African Bank
presence in the context of competition, as well as regulatory environment. What would be instrumental
is more detailed data such as that on intragroup exposures within banking system groups such as
Ecobank and Standard Bank group of South Africa that would allow for the different risks to and
elements of stability to be investigated.

7. Policy Implications and Conclusion

In this paper, we used data for 22 SSA countries from the World Bank’s GFDD database, the FSDD
database as well as Claessens and van Horen’s (2014) bank ownership database to explore the impact
of the presence of Pan African Banks on banking system stability in SSA using panel fixed effects and
2SLS Estimation methods. Whilst there are shortfalls to the investigation such as data deficiencies, the
study finds that foreign bank entry in the form of Pan African banks enhances banking system stability.
This finding is in tandem with the foreign ban influx-stability hypothesis. Meanwhile, the presence of
other foreign banks such as the traditional European banks does not seem to impact stability in SSA.
As such the study finds that the presence of these banks aligns with the foreign bank influx-fragility
hypothesis. Given these findings, the policy implication is that the expansion of pan African banks into
Sub Saharan African financial systems enhances competition and thus contributes to stability of the
banking systems. From a regional focus, there did not seem to be a difference in the impact of Pan
African banks in both the south eastern region of Africa, and the West Africa region. Notwithstanding
these findings that seem to indicate policymakers should favour expansion of Pan African banks, it is
important for policymakers to take note of the pace of expansion of the Pan African banks, and the fact
that there are a financial stability risk issues that surround Pan African banks such as the opaqueness of
their structures and operations that need to be thoroughly investigated. Further though the study found
no difference in effect by the PABS on a regional basis between the South Eastern and Western regions
of SSA, this will need further investigation. Indeed, the issue of the need to consider home and host
country specific characteristics has been raised in the paper as a pertinent issue that would assist in
enhancing research on Pan African Banks and banking system stability. The regional integration blocks
and their bank supervision and regulatory committees need to research into these and other areas in

30
order to further the knowledge on these issues, especially if the goal is toward a unified and integrated
SSA and Africa.

Additionally, it should also be pertinent to note that the non-pan African foreign banks have also
operated in SSA for a long time, with no huge SSA regionwide adverse impacts. It is therefore
imperative also that Pan African banks be encouraged to learn some of the useful practices that have
assisted these banks. There are many questions that remain unanswered about Pan African banks that
were consistently raised throughout the paper. This study has focussed on one question, which can be
reinvestigated in numerous other ways, or indeed can be enhanced to contribute more to the knowledge
base about Pan African banks.

31
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Appendix

With the rapid expansion of cross-border banking, supervisory challenges of the banking industry
especially at the regional level has become more problematic given the key weakness in the national
and regional regulatory framework. A notable challenge in regulating cross-border banking services
includes difference in legal, financial structures, laws and regulatory requirements in the jurisdictions
where the banks operate. All these make compliance and banking supervision/regulation difficult at
national level and even more at regional level. The supervision/regulation of banking activities at
regional level in SSA is shared between the national and regional authorities. However, the extents in
which these authorities influence banking activities differ between the regions.

In the EAC, the supervision/regulation of cross-border banking activities is shared between the
national and regional authorities with national authorities play the leading role. National regulators in
the ECA countries have demonstrated commitment to cross-border cooperation in recent years. The
EAC Treaty (Article 85) on banking development emphasises the integration of banking services and
the associated regulatory frameworks, which is the long-term agenda of the East African Monetary
Union signed in 2013. With the creation of the Monetary Affairs Committee in 1997, efforts have been
made via regular meetings being attended by the central bank governors to institutionalize supervisory
cooperation among member countries. Memorandum of understating (MOU) was signed in 2008 by the
EAC central banks to facilitate cooperation in bank’s consolidated supervision; allowing for the
exchange of supervisory information with a view to promote regional financial integration and to
facilitate training opportunities and supervisors participation in bank examination on a cross-border
basis.

As appealing this may seems, the regulatory frameworks in the EAC are generally weak with flaws
including unproductive and inefficient court system which lack basic administrative tools, obsolete
paper-based banking system and impaired judiciary system due to corruption. At regional level, these
flaws make it difficult to proceed to a financial common market because the fundamental requirement
for efficient and fair cross-border financial services enforcement cannot be put into practice.

Unlike the EAC, the supervision/regulation of cross-border banking in ECOWAS is shared between
the national and sub-regional authorities. The inability of ECOWAS to proceed towards a single
currency in 90s led to the emergency of two sub-regions namely the West African Monetary Zone
(WAMZ) and the West African Economic and Monetary Union (WAEMU)17. In WAMZ, the
regulation of banking activities including licensing and supervision rests in the hand of the national
central banks. Although, progress towards a single currency has been slow, but there is a plan towards
a monetary union to enhance supervisory cooperation and harmonizing supervisory process. To this
effect, the West African Financial Supervisory Authority (WAFSA) was formed in 2010 to bring
supervision under a common authority, facilitate examination of banks with cross-border subsidiaries
and promoting cooperation with other central banks through MOUs.

In contrast to the EAC and WAMZ regulatory frameworks, banking supervision and regulation in
the WAEMU is the responsibility of a single Banking Commission (BC)18. However, the national
authorities are responsible for bank license after a binding opinion with the BC and they also supervise
the smaller financial institutions like micro-finance banks. The formation of the BC has paved way for

17
The WAMZ is predominantly of the English-speaking countries (Anglophones), while the WAEMU is
predominantly of the French speaking countries (Francophones) with a common currency (CFA franc)
18
The BC was established in 1990 after an agreement was reached by member states to replace the national
authorities that supervised financial institutions in each country.

36
a single banking law in the WAEMU zone. As a result, there is now a single set of prudential norms
that governs banking operations.

The regulatory framework in the SADC is like that of WAEMU, as tremendous efforts have been
taken to collaborate in core elements of financial infrastructure to facilitate harmonisation and
coordination of regulatory and supervisory policies among member countries. Besides the strong
encouragement from the Protocol on Finance and Investment to the SADC countries to foster
harmonised standards of practice and regulations, two regional institutions have been established to
harmonise the regulatory standards and banking services of the SADC countries. The committee on
Central Bank Governors and the SADC Subcommittee on Banking Supervisors serve as coordinating
assemblies for cross-border regulatory cooperation with the latter established to deal with the
harmonisation of activities relating to banking supervision. The more recent development was the
formation of a common settlement system (SADC Integrated Regional Electronic Settlement System)
that allows banks within the SADC countries to settle regional transactions among themselves on a
gross basis.

While these efforts appearing satisfactory, more work needs to be done for regional integration of
financial services to function effectively, and for single market to work, the execution of financial
contracts in one member state should be enforceable in all other member states and laws and regulation
guiding the provision of financial services must be harmonised.

37