Financial Market Development and Bank Capitalization Ratio

Abstract

Financial sector liberalization in many African countries, set in a series of financial sector reforms, aimed at developing the system. Theoretically, reforms that develop the banking sector are expected to improve banks’ performance and reduce excessive bank-risk taking by enhancing bank capital ratio in addition to maintain the stability in the system. Nonetheless, literature also shows that the health of the financial system may be at risk following a liberalization process in the form of contagion effects of financial markets integration. A recent example is the global 2007/2008 global financial crisis. Against this background, this article examines the extent to which banking sector development in selected African countries affect the commercial banks’ capitalization ratio. Employing a dynamic panel regression technique for the examination while controlling for bank-specific and macroeconomic factors over the period 2000–2014, this article finds that banking sector development in the selected countries improves bank capital ratio consistent with the aims of banking sector reforms and the maintenance of stable financial system.

Market structure, institutional quality and bank capital ratios: evidence from developing countries

“…The non-significance of AR (2) shows the absence of serial correlation in differenced residuals, while that of Hansen indicates that the instruments used are valid and the model is not over-identified. Furthermore, the positive and significant coefficients for the lagged bank capital justify the use of a dynamic model and the presence of adjustment costs that may hinder a bank from instantaneous change in capital ratio, consistent with earlier arguments of Brei and Gambacorta (2016), Ozili (2015) and Etudaiye-Muhtar et al (2017).…”

“…It is equally important to note that Eqn (1) is a partial adjustment model that accounts for adjustment costs which arises when banks try to adjust to meet capital requirements. High adjustment costs may prevent banks from instantaneous change in capital when they fall short of regulatory requirements, making them liable to penalties (Brei and Gambacorta, 2016; Etudaiye-Muhtar et al , 2017; Ozili, 2015). To avoid this situation, banks would need to increase the capital ratio, and a positive and significant coefficient of the lagged capital ratio would indicate the presence of adjustment costs.…”

“…To remove duplicate bank-specific information, data are collected from consolidated statements in Bankscope, while macroeconomic and institutional quality data are from World Bank database for the same period. We include banks with at least three years of observations only following the procedures of Etudaiye-Muhtar et al (2017) and Vithessonthi (2014) in anticipation of a small sample size and to guard against small cross-sectional variations. We address the potential effect of outliers in the data by employing a robust regression estimation technique to estimate regression coefficients following the technique of Frank and Goyal (2009) and Verardi and Croux (2009) [5].…”

“…In terms of profitability, higher profit levels enable banks to increase their capital ratios to protect themselves against possible liquidation and signal positive information to the market about bank value (Etudaiye-Muhtar et al , 2017; Rime, 2001). This suggest a positive relationship with bank capital, which is consistent with the pecking order theory and for regions with less developed financial markets such as the ones in this study (Alraheb et al , 2019).…”

Banking Sector Development and Bank Risk-Taking Behaviour: Evidence from Commercial and Non-commercial Banks in Tanzania

“…However, according to our knowledge, literatures that investigates the effect of development in the banking sector on bank risk-taking behaviour specifically for developing countries is scarce and have ambiguous result. For instance, Abdulhamid et al (2019); Etudaiye-Muhtar et al (2017) found that banking sector development reduce banks' risk-taking while Vithessonthi (2014a) observes that there is positive effect of banking sector development on banks' risk-taking behaviour in Southeast Asia region. Because of the ambiguity of results and scarcity of research on banking sector development and bank-risk taking behaviour in developing countries, this contribute to the main motivation for this study which examine the effect of banking sector development on bank risk-taking behaviour measured in terms of capitalization ratio in Tanzania to find more evidence for developing countries.…”