The Steinhoff Saga Management review - University of Stellenbosch Business School

July – December 2018

Bank competition in sub-Saharan African countries:
Has anything changed in light of the 2007-2008 global financial crisis?

Steve Motsi, Oluseye Samuel Ajuwon and Prof Collins Ntimc

  • OCT 2018
  • Tags Features, Finance
23 minutes to read


Steve Motsi, Oluseye Samuel Ajuwon and Prof Collins Ntimc

Why increasing competitiveness among banks matters

How did the competitive behaviour of banks in sub-Saharan Africa change after the 2007-2008 global financial crisis?

To find out, three researchers examined the performance of 83 banks from six countries in the period from 2008 to 2013. They employed the Panzar-Rosse model of firm competition, and found that the degree of competition among banks in sub-Saharan Africa increased. This increase is due to the effect of reform or liberalisation policies, largely initiated in the pre-crisis era. The success that followed as a result of the development of banking systems nonetheless moderated at the onset of the 2007-2008 financial crisis. System instabilities, which are characteristic of a post-crisis period, exposed deficiencies in regulation and asymmetric incentives for bank management. A significant recalibration of prudential policies followed as regulators sought to restore system stability, which again impacted the competitive conduct of banks.

Why does increasing competitiveness among banks matter? There are a number of reasons for this:

  • It promotes effective financial intermediation, and explains the structure, stability, efficiency and performance of the industry.
  • It lowers interest rates and improves the production, quality and distribution of banking products.
  • It explains the level of access to financial services and the extent of external financing at household and firm level.
  • It improves the effectiveness of monetary policy transmission, supports real economy production efficiency, and promotes overall growth and development.

However, competition can also lead to aggressive conduct or excessive risk-taking by banks, which can have negative implications. These include the creation of asset-price bubbles, artificial credit growth and proliferation of opaque financial products, the deterioration of asset quality, excess leverage, and the build-up of systemic risk to the financial architecture.

A significant recalibration of prudential policies followed as regulators sought to restore system stability, which again impacted the competitive conduct of banks

Why was this study undertaken?

The first motivating factor stemmed from the sheer diversity of economies in sub-Saharan Africa, and their influence on the competitiveness in banking systems. The region had an estimated total GDP of USD 1.60 trillion in 2013, with an estimated 650 banks.

Historically linked to World Bank and IMF reform, the structure and size of economies and their banking systems reflect the extent of the deregulation of markets and trade, the promotion of private enterprise and innovation, and the ease of entry for foreign participants.

The Nigerian and South African economies, for example, have large, diversified and competitive banking systems. Medium-sized economies such as Angola, Kenya and Ghana also have competitive banking systems with significant foreign participants, while smaller island economies such as Mauritius and the Seychelles have, by comparison, first-class banks and sophisticated financial products and services. As such, the diversity of economies and banking systems in sub-Saharan Africa triggered an investigation into the competitiveness and performance of banks.

The second motivating factor was a desire to investigate how the 2007-2008 financial crisis triggered the poor performance of banks. This led to increased systemic risk to the financial architecture and the exposure of structural weakness in supervision and prudential policies. As banks faced problems stemming from adverse selection and moral hazard in their lending activity, the risk to small depositors, for instance, increased in the wake of the financial crisis. This risk materialised in the form of sequential service constraints, which created an incentive for depositors to verify the solvency of banks. To protect depositors, global recalibration of prudential policies followed.

The third motivating factor was limited literature on bank competition in developing countries, thus presenting an opportunity to provide additional insights.

The objectives of this study were therefore to:

  • Measure banking competition: Examine changes in banking competition in sub-Saharan Africa during a period of significant banking and economic reform that coincided with the 2007-2008 global financial crisis. Also examine the pricing behaviour of banks by applying the Panzar-Rosse model to compute a continuous measure of a static H-statistic. The computed value would then suggest the extent of the contestability of markets.

Add insight to existing literature: Contribute new insight to the current debate on competition and its impact on financial sector development strategy.

… competition can also lead to aggressive conduct or excessive risk-taking by banks

Structural approach to measuring competition

Firms apply various pricing strategies that influence competitive behaviour. The structural approach assumes a causal relationship between market structure and performance, and consists of two competing hypotheses – the Structure-Conduct-Performance (SCP) paradigm and the Efficient Structure Hypothesis. The SCP paradigm posits that a high concentration in an industry weakens the degree of competition and encourages collusive behaviour by organisations. In turn, collusive behaviour leads to abnormal profit at the expense of efficiency. Popular empirical tests are the Herfindahl-Hirschman Index and firm concentration ratio.

The Efficient Structure Hypothesis (ESH) indicates that a larger market share for an individual bank that leads to high industry concentration is the result of efficiency and lower input costs, as opposed to a low degree of competition. The hypothesis further argues that the SCP paradigm ignores economic, legal, technological and other barriers to entry and exit in an industry. In addition, it argues that the SCP paradigm does not account for firm efficiency. Therefore, an efficient bank will, over time, increase market share and market power, and ultimately drive superior performance relative to competitors.

Non-structural approach to measuring competition

The non-structural approach, on the other hand, is a modern view. It suggests that changes in input costs influence pricing behaviour and the performance of banks. This leads to prices being set equal to marginal costs. In addition, the non-structural approach argues against the notion of a causal relationship between market structure and performance. Popular empirical tests are the Panzar-Rosse model and Bresnahan model.

As banks faced problems stemming from adverse selection and moral hazard in their lending activity, the risk to small depositors … increaseed

More about the Panzar-Rosse model

The Panzar-Rosse model, which was applied in this study, assumes that the conduct of competing banks influences the performance of any individual bank. The idea is that banks employ dissimilar pricing strategies as they respond to changes in factor input prices. Competitiveness, therefore, is the extent to which changes in input prices reflect in revenues in a state of equilibrium. Assumptions of the model include a single product output and profit maximisation, where marginal revenue is set equal to marginal cost.

Using data at firm level, the test derives a measure called an H-statistic, which is a summation of the elasticities of revenue with respect to changes in input prices. In other words, an H-statistic is a continuous measure of the level of competition. When an H-statistic is less than or equal to zero, it implies monopoly or oligopoly pricing behaviour. When it is equal to unity, which implies perfect competition. Results for an H-statistic between zero and unity imply varying degrees of monopolistic pricing behaviour.

Panzar and Rosse (1987) showed that for a profit-maximising monopolist, an H-statistic cannot be positive, since an increase in input raises marginal cost. This, they say, leads to an output restriction and therefore lower revenues. For perfect competition where an H-statistic is equal to unity, individual firms incur an increase in marginal and average costs without altering equilibrium output.

Developing two hypotheses

It has been indicated that the competitive structure of a banking system could change over time due to the process of reform/liberalisation and deregulation. From that view, a calculated H-statistic explains the pricing behaviour of firms. By measuring the sum of elasticities of revenue to factor input prices, an H-statistic equates to unity where there is perfect competition/contestability, implying that an increase in factor prices would not alter bank output. A calculated result, which is less than unity but above zero, would suggest an alternative view of monopolistic competition or partial contestability, which implies that changes in factor input prices affect bank pricing of output. Therefore, the hypothesis follows:

H1. There is a statistically significant positive association between unit factor input prices (market power) for a bank and the extent of competitive behaviour.

Following from the empirical theory on banking competition, the validity of the competition parameter is sufficient only when the banking system is observed in general market equilibrium. As such, an E-statistic, calculated to explain that general market equilibrium exists where the factor input prices of funds, labour and capital expenditure do not influence banking returns, is statistically equivalent to zero. The hypothesis therefore follows that:

H2. Market equilibrium exists where returns on bank assets are not associated with factor input prices.

How was the study conducted?

This study drew a sample of 83 banks from six countries which represented three sub-regions in sub-Saharan Africa: East Africa (Kenya and Uganda), Southern Africa (Mauritius and South Africa) and West Africa (Ghana and Nigeria). The selection criteria for the sample included data availability, economic and financial development, advanced legal frameworks, good corporate governance and disclosure, and the use of IFRS reporting standards. Data was mainly sourced from a public database called African Financials and from bank websites. Data on macroeconomic variables were sourced from the World Bank.

To protect depositors, global recalibration of prudential policies followed.

Dependent variables

In 2009, REV (ratio of interest income to total assets) increased to its highest level of 14.53% from 11.82% in 2008, intuitively suggesting that banks’ pricing behaviour altered to reflect increasing risk to lending activity in light of the financial crisis. Countries that experienced trade vulnerabilities, mainly due to declining commodity prices, would have likely reacted to a deterioration in loan quality by raising interest rates. As expected, bank performance was negatively affected by changes in the operating environment, resulting in a mean ROA of 1.41% for 2009, which was the lowest over the observed period, as some banks reported losses.

Independent variables

Not surprisingly, PF (unit price of funds or average cost of funds is the ratio of interest expense to total customer deposits) increased to its maximum of 10.74% in 2009, reflecting the rising cost of funds associated with the general loss of depositor confidence, capital flight, low liquidity and increased leverage. Years later, however, PF declined as regulators tightened prudential policy and directed banks to increase capitalisation levels. In the wake of the financial crisis, banks sought to improve the quality of risk management and general operations, which increased the wage rate as skilled talent was acquired. However, as alternative methods of distribution such as branchless banking evolved, pressure on the wage rate diminished. Banks, instead, focused on upgrading information technology infrastructure, driving PK to its highest levels in 2010.

Bank-specific control variables

Despite the negative effect of the financial crisis on asset quality in many banking systems in sub-Saharan Africa, a bank-specific control, RISKASS, did not rise significantly. The average was 3.41% in 2008, but declined to 1.89% in 2011. This implied that some banking systems where insulated from the impact of the crisis, or had sufficiently strong risk management infrastructure to avert a banking crisis. Other banking systems either wrote off or sold non-performing loans.

Interestingly, lending activity as measured by CREDIT remained relatively stable, with a mean of 50.60% over the observed period. The extent of financial intermediation in banking systems in sub-Saharan Africa pre- and post-crisis was constrained as a result of poor credit information, a lack of collateral and financial illiteracy, such that banks traditionally preferred to lend to larger and less-risky corporate customers or alternatively held cash and government securities. Therefore, and as expected, there was no significant level of deleveraging that occurred post-crisis.

However, in view of the crisis regulators took precaution by instigating a recapitalisation of banking systems. In essence, average EQUITY increased to 15.01% in 2010, and to 15.11% in 2013, as profitability of banks improved.

Country-specific control variables

GROWTH also followed a positive trend, from 4.24% in 2009 to 6.40% in 2011, due to a recovery in commodity prices, additional resource discoveries and exploitation, and rising domestic demand. However, growth rates tapered off in 2012 and 2013 as uncertainties over stability in the global economy increased, and risks of faltering demand from emerging economies such as China materialised. Average inflation did not indicate any trend, owing to differences in pass-through to domestic prices from associated local currency depreciation. In 2008, as commodity prices peaked, average inflation for the representative sample reached a high of 14.61%, but subsequently declined to 6.59% in 2010.

Analysis of the correlation matrix

The correlation matrix mainly indicates positive signs for the coefficients. There was a statistically significant positive association between REV and the main independent variables PF and PL, with correlation coefficients of 0.62 and 0.64 respectively. PK, on the other hand, had a negative sign, but the relationship with REV was statistically weak as the coefficient was only 0.10. RISKASS and CREDIT had similar correlation coefficients with REV, of approximately 0.40 respectively, indicating a positive relationship between lending activity and risk management in the determination of interest rates. The higher the risk associated with granting each loan, the higher the lending rate.

Likewise, the association of RISKASS and CREDIT to PF was relatively strong, indicating that the cost of funds played a role in determining the quantity of risk and extent of lending activity assumed by each bank. Further, the correlation coefficient between RISKASS and CREDIT was positive with a correlation coefficient of 0.60. Notably, the correlation coefficient between PL and RISKASS of 0.41 indicated that bank wage rates were partly influenced by the acquisition of specialised talent in risk management in the wake of the financial crisis. PL and INFL had a coefficient of 0.39, but the positive sign highlighted the effect of inflationary pressures on the wage rate.

Lastly, the relationship between ASSET and GROWTH had a correlation coefficient of 0.49. Significantly, the positive sign was associated with the notion of a causal link between financial sector development and economic growth.

In the wake of the financial crisis, banks sought to improve the quality of risk management and general operations, which increased the wage rate as skilled talent was acquired.

What did the study find?

Firstly, the outcome of testing for H2 indicated sufficient conditions of market equilibrium. Secondly, H1 was regressed and the conditions of monopolistic competition identified were consistent with previous studies.

Analysing the general market equilibrium

H2 was tested for a sample of 83 banks in sub-Saharan Africa to determine whether banking competition exists under conditions of general or long-run market equilibrium. Based on the literature, this could also be stated as ROA is not influenced by factor input prices in the long run, with a computed E-statistic equalling zero. The outcome was that the computed value of the E-statistic was 0.003, with a p-value of 0.407. Therefore, the null hypothesis that unit factor input prices were equivalent to zero, was not rejected. This implies that banking competition was observed in a state of general equilibrium.

The results of the empirical test for H2 were consistent with findings from previous studies, where, in the long run, factor input prices did not influence bank returns. These findings were also consistent with the theoretical literature, which states that, in equilibrium, the zero profit constraint holds constant at market level.

… policymakers should continue to draw up policies aimed at the development of financial intermediation and improved competitive conduct of banks in sub-Saharan Africa

Test of competition using the Panzar-Rosse approach

Having satisfied the conditions of general market equilibrium, H1 was tested for the same sample of 83 banks to determine whether there is a statistically significant relationship between changes in market conditions/power and the extent of competitive conduct. Specifically, a regression of the Panzar-Rosse model was used to compute a continuous measure of an H-statistic that had a value of 0.57. The results confirmed that the H-statistic was significantly different from both unity and zero at the 1% level of significance. The findings suggested that the banking system is characterised by monopolistic competition, as opposed to perfect competition or pure monopoly. Both null hypotheses were strongly rejected, allowing for heterogeneity among the banks.

Similarly, the results of monopolistic competition were consistent with outcomes of previous studies since changes in factor input prices (market power) incurred by a specific bank influenced changes to its revenue. Under conditions of perfect competition, on the one hand, an increase in input prices would have raised marginal costs and total revenue by the same amount, where an H-statistic is equal to unity. Under pure monopoly, on the other hand, marginal costs would have increased but equilibrium output would have declined, such that the H-statistic is less than zero.

What are the implications of this?

Consistent with the outcome of monopolistic competition, is has been suggested that reform/liberalisation and prudential policies would likely have influenced pricing behaviour of individual banks and market discipline. The findings, therefore, supported H1, namely that there is a statistically significant positive association between the effect of market conditions (banking reform) and the extent of competitive behaviour.

Unexpected, bank-specific control variables largely carried no statistical significance (RISKASS, ASSET and CREDIT), while RISKASS had a negative sign. EQUITY, however, had a strong statistical significance, with a positive sign on the coefficient, implying that higher capital levels led to strong pricing power. This was expected in view of the impact of prudential policies which followed the 2007-2008 financial crisis, where a significant number of banks in sub-Saharan Africa increased capital via mergers and acquisitions, initial public offerings and/or the capitalisation of reserves.

What are the policy implications of this?

The findings of this research impacted policy design in the financial sector. This was mainly due to the linkage between the extent of competition, technological advancement, efficiency of financial intermediation, access to financial services, performance and stability.

  • The impact of policies on revenue and cost: It is clear that reform/liberalisation and prudential policies impacted the revenue and cost functions of the banking systems. As such, market players would likely continue to alter their conduct to ensure profit maximisation. For example, interest rate liberalisation could increase the cost of funds as banks compete for market share of deposits. In turn, banks could increase lending rates to expand their net interest margin.
  • Recapitalisation leading to increased market power: The policy-driven recapitalisation of banks resulted in increased market power in the pricing of loan output.
  • Higher contestability of markets leading to increased risk taking: Higher contestability of markets, owing to unrestricted/universal banking approaches and the deregulation of formal barriers, drove excessive risk-taking by banks in order to defend or expand market share. For example, excessive risk-taking by banks in Nigeria, via the provision of ill-fated margin loans, triggered regulatory responses to the ensuing crisis.
  • The rise in foreign bank participation: Foreign bank entry impacted the contestability of markets, technological advancement, the recalibration of risk management frameworks and capital flow. In East Africa, for example, where formal regulatory barriers were largely withdrawn as a part of policy design, there were a number of implications. These included a rise in foreign bank participation, significant cross-border capital flows and strong technological innovation, which enhanced the competitive conduct of banks.
  • Increased access to finance: Policy implications on the provision of credit to the private sector indicated a trend towards promoting access to finance, enhancing competitive conduct and performance among banks. Although findings on lending activity were statistically insignificant, banks made progress in extending their markets to low-income households and SMEs.
  • More robust banking systems: The study found that policy helped to foster the development of banking systems and efficiency of financial intermediation in the real economy, which ultimately influenced economic growth.


  • The original article was published in 2018 the SPOUDAI Journal of Economics and Business, 68(1), 59-83. Find the link here.
  • Steve Motsi and Oluseye Samuel Ajuwon are involved with the Department of Development Finance at the University of Stellenbosch Business School.

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