Confronting the Global Financial Crisis: Bank Efficiency, Profitability and Banking System in Africa

The current global financial crisis that originated in the collapse in the market for sub-prime mortgages in the United States in 2007 initially did not hit Africa directly. The crisis also had little impact on the Sub-Saharan African financial systems because the financial sector in Africa remains shallow, uncompetitive and weakly integrated into the global markets. Despite the fact that money, currencies, and capital markets had the significant pressures by the crisis, they have continued to function normally, and financial institutions in most countries have been stable without emergency support from monetary authorities. Nevertheless, due to pressures intensified by the crisis, Sub-Saharan African countries are being hit hard as the global crisis has continued to deepen. The spiraling effects of a depressed world economy and the increased risk aversion of investors pose growing risks for Sub-Saharan African financial systems. As a matter of fact, frontier and emerging market countries such as South Africa, Nigeria, Ghana, and Kenya were hit first, suffering falling equity markets, capital flow reversals, and pressures on exchange rates. Most African economies have a high degree of foreign bank penetration. The large share of foreign-owned banks across Africa has brought stability over the past years but also exposes the region to additional contagion risk. Also, the boosting of domestic banks' efficiency is mainly attributable to raising the number of foreign banks. Central bankers in the Southern African Development Community (SADC) recognize that efficiency in the banking sector is a key contributor to macroeconomic stability (Ngalande, 2003). It is also a precondition for economic growth and important for the effectiveness of monetary policy (Hartmann, 2004). In the late 1980s and early 1990s, a number of African countries began to restructure their financial sectors in order to boost banking efficiency (Brownbridge and Harvey, 1998). Thus, it is crucial to conduct research on bank efficiency in Africa. Some researchers have already studied about the efficiency of African banks. At the same time, it is also important to assess pre-effects of the ongoing financial crisis on the banking efficiency as well as banking system in Africa. At present, it is likely to be difficult to entirely analyze the impact of the current crisis on the African banking sector because of the limited availability of 2008 bank-level data. Thus, the paper mainly tries to answer the following questions. a) How were the pre-crisis performance and profitability of commercial banks in Sub-Saharan Africa? b) During the pre-crisis period, how was the relationship between bank efficiency and financial indicators? c) Whether the African banking sector may be exposed to contagion effects of the current financial crisis.The rest of this paper is structured as follows. Section 2 reviews the current financial crisis and gives a brief survey of impact of the crisis on the Africa's banking system. Section 3 discusses banking sector in Sub-Saharan Africa through comparative analysis of bank performance and profitability. This is followed by a description of methodology and data used in the study. The cost and alternative profit functions are used to measure domestic and foreign banks' cost and profit efficiency by using a stochastic frontier approach. Then, the paper assesses the links between bank efficiency and financial indicators such as operation, capital, liquidity, and asset quality ratios though the instrumental variable estimation in the form of two-stage least squares technique. The paper concludes with a brief assessment of the pre-effects of the crisis by pointing out the issues on Africa's banking system and by suggesting policy implications,download.