Effect of Institutional Quality on Stability of Banks in Sub-saharan Africa

Abstract

The study investigated the relationship between institutional quality and stability of banks in Sub-Saharan Africa using unbalanced panel data from 48 countries from 2007 to 2017. Two proxies were used for bank stability, namely Z-score (insolvency risk) and NPL (credit risk), and institutional quality was the main variable of interest. The study used five control variables, and the analysis relied on secondary data collected from 2002 to 2017. The fixed and random effects estimations were used for objectives one and two, while the panel Granger causality test was used for objective three. The study revealed a negative effect of institutional quality on bank stability. The quality of public and civil service, as well as its independence from political pressures, as well as the quality of policy formulation and implementation, have all been compromised, which has a negative impact on the financial system and reduces the stability of banks in Sub-Saharan Africa. Furthermore, good institutions play a vital role in ensuring that loan default rates are minimized, which reduces credit or portfolio risk for the financial system in Sub-Saharan Africa. It was established that causalities between stability and institutions were established, which suggests that the level of regulations and institutional laws are basically due to the level of accompanying risk. The study recommended that regulatory authorities should take into consideration the impact of various governance mechanisms on the risk profile of financial institutions in Sub-Saharan Africa