Overview of the National Banking Sectors in North Africa
Banking regulations on the acceptable standards have become a central point of discussion in most developed nations especially due to the recent financial crisis. A program or scheme that enforces the channeling of resources into more investments would boost the financial stability of the economies of most developing nations. A study of the regulations in the banking industry on the economic growth can reveal a lot concerning the economic growth in some specific South Mediterranean countries (Algeria, Tunisia, Morocco and Egypt). The banking efficiency and its proximity to internationally acceptable standards are measured using convergence methodologies such as β-convergence, Meta Frontier analysis, data envelopment analysis and α-convergence.
This first chapter provides an in-depth study of the banking sector in the four countries. The banking sectors of the four countries have shown some common changes in the recent past. The governing authorities in these countries have implemented major policy changes so as have modern banking systems. In an effort to increase efficiency, the governing authorities have implemented the following procedures: privatization of public banks, implementation of risk management programs and enhancement of the supervisory role of the government. In countries such as Egypt and Morocco, credit information has been made more accessible through sharing of this information.
Underdevelopment of the banking sector in most of the South Mediterranean countries is due suppression of the private sector by the public sector. This may be through the public debt and loans which balance sheets of most banks or state ownership of banks. The presence of the state in the banking sector has also crippled the quality of credit. However, efforts to improve the quality of credit through privatization improvements of loan information systems have led to better figures in the balance sheets. However, compared to other regions these countries still lag as pertains to credit quality.
Convergence of Banking Sector Regulations
Seven areas can be identified for assessing the different aspects of regulatory adequacy. These include: licensing requirements, independence and power of the supervisor, safety nets, capital requirements, and availability of credit information. Most of the information was obtained through the Bank Regulation and Supervision Surveys (BRSS) due the relative similarity in the questionnaires over the years. Interviews were also carried out by four country experts- one for each country. Some of the key areas covered in the seven main indices included: scope restrictions, credit and information laws, entry obstacles, deposit insurance, capital requirements, private monitoring and supervisory authority.
Results from a study of the scope restrictions showed that regulators imposed strict restrictions on insurance activities. However, these have been on a decline over the years. Entry obstacles are implemented by the regulators of the banking sectors usually through legal licensing requirements or setting limits on ownership of banks, especially by foreign investors. Government ownership gives undue advantage to incumbent banks while limiting entry incentives. This has caused the level of entry obstacles to fall below the EU-MED standards. Deposit insurance concerns the presence of an exclusive scheme and mitigation of moral hazards. The implicit insurance and adverse incentives have resulted in deposit insurance levels falling below the EU- MED standards. Capital requirements in most of these countries showed an increasing disparity from the practically acceptable standards due to risk insensitivity.
Private monitoring concerns the accessibility of reliable and timely information to potential investors. Political interference has undermined the role of supervisory authority and enforcement of government direct control of the banking sector. The four South Mediterranean countries have poor accounting practices. This has led to a disparity in the private monitoring from internationally acceptable standards. Credit information and laws facilitate lending since legal and information systems are accessible. However, in most of these countries this information is not readily available. This is below the EU- MED standards.
Analysis of Efficiency and Convergence
The banking efficiency and its proximity to internationally acceptable standards are measured using convergence methodologies such as β-convergence, Meta frontier analysis, data envelopment analysis and α-convergence. Data Envelopment Analysis (DEA) is a mathematical linear programming method that identifies the efficient frontier from a linear combination of units or observations. Meta-frontier analysis is an approach used to accommodate for variation of available banking technology and technical competencies in the four countries. The meta-frontier production function is a function that includes all the frontiers of individual groups or countries.
Modeling convergence involves the convergence of bank efficiency levels by employing β-convergence and α-convergence.
The results of the analysis indicate improvements in efficiency levels of the banking sector. The improvement was especially notable in Algerian and Morocco. Results in α-convergence implied an increase in the speed of convergence. Similarly, estimation of β-convergence indicates the convergence in efficiency scores. There are two main approaches used in the definition and determination of the inputs and outputs of financial institutions: the production approach and the intermediation approach. Intermediation approach was used to conduct this specific study. The approach views financial institutions as the link between the demand and supply of funds. Consequently, deposits are considered inputs while interest on deposits considered as a part of the total cost, such as labor and capital. Due to the variation of accounting practices across the four countries, a broad definition of the input and output variables presented by Bankscope was selected. Total costs (interest expenses plus overheads) were used as inputs while the total loans and other earning assets of the banks were used as the outputs. In most of these countries, there was a marked increase in total cost possibly due to the steady growth in bank loans. Morocco showed a remarkable increase in other earning assets and this can be linked to the possible entry of foreign banks into their financial market. According to the region’s average efficiency score of about 63.5%, it can be concluded that Mediterranean banks could reduce costs (inputs) by up to 36.5% and still produce the same outputs. There has also been a marked improvement in the overall efficiency of the banks in all countries, especially since 2005 to date. This can be attributed to general improvements in best practice.
Impact of Bank Regulations on Efficiency
Results of the study of the impact of bank regulations on efficiency indicate that the banks are more efficient in countries where there exists a sound regulatory structure. Cost efficiencies in banks are enhanced by the availability of credit information, private monitoring, and the presence of deposit insurance programs. Supervisory independence had little correlation to cost efficiency. This can be attributed to the offsetting effect of increased risks due to intense political power. The suitability and adequacy of the banking regulations and standards should take into account subsidiary effects. Cost efficiencies may, for example, improve at the expense of a decline in profits thus affecting the system stability.
There are four variables that are used to control for market size and power, capital strength and liquidity as pertains to the banking sector in each of the four countries. The bank asset variable shows the size of the bank. Size can be an indicator of possible costs, assuming increasing returns to scale. The bank market share is used to measure the market power. The bank market share refers to the proportion of a bank’s asset in proportion to the total banking assets for a particular year. However, it is highly likely that the banks with large market share will not concern themselves with cost reduction or efficiency improvement. Therefore, there exists a negative relation between bank efficiency and the bank market share.
A ratio of the demand and time deposits maintained in other banks to the customer deposits provides a measure of the bank liquidity. The proportion of the bank equity in the total assets acts as an indicator of the capital strength. Highly liquid banks which are well capitalized experience lower funding costs due to the minimized default risks. A study of three main country variables: inflation, institutional quality and economic growth reveals a lot on the banking sector.
Inflation increases instabilities and hence decreases bank efficiencies. It undermines the ability of interest rates to act as indicators of the underlying market conditions. Although inflation increases bank transactions, it increases operational costs that arise due to excessive branching and increased competition. Economic growth is usually read from the GDP values and it acts as a guide on the current state of business cycles. Institutional quality is an aggregate of smaller variables, each with a specific effect on banking efficiency. These variables include political competitiveness, voice and accountability, executive competitiveness, and control of corruption.
Impact of Bank Regulations on Growth
The impact of bank regulations on growth was measured using three financial variables: bank efficiency, private credit and stock turnover. Regulatory variables such as capital requirements stringency, deposit insurance and credit information are also included. Results of the study indicate that some country variables have no significant effect on the growth. For example, inflation does not significantly affect growth. Lack of corruption has a consistent and positive effect on growth. Government ownership has a consistent but weak impact on growth. Regulatory factors such as private monitoring have a strong effect on growth. Scope restrictions have a negative effect on growth, when bank efficiency is considered. Capital requirement stringency has little or negligible effect on growth, considering stock market turnover.
Financial regulations have a relatively limited direct effect on growth. Of the seven aspects under consideration, government ownership is the only one with a consistent negative impact on growth. As per the results of the study, there is little or no correlation between financial and economic development. Despite the fact that stock market turnover and efficiency have a positive impact on per capital growth, private credit still impacts negatively on growth. It can be concluded that regulatory factors have an indirect impact on growth. This effect is through the way these factors affect financial development. It is also quite evident that corruption level must be maintained at a minimum if growth in the banking sector is to be attained.
Shortcomings of the Study
Technical problems encountered while carrying out the study include sampling biases due to generation of similarities between the countries. Differences in the various factors across the four countries are not specifically highlighted due to consideration of similarities while carrying out the analysis. This means strong indicators in specific countries were not highlighted.
Ayadi, R., Arbak, E., Naceur, S.B., & Casu, B. 2011. Convergence of bank regulations on
international norms in the southern Mediterranean: impact on bank performance and growth. Brussels, Belgium: Centre for European Policy Studies.
