Country Risk and Financial Stability: A Focus on Commercial Banks in Africa

Abstract

This paper employs dynamic panel models to investigate the impact of country risk on the financial stability of banks in Africa. Using country risk and bank specific data for 10 African countries over the period of 2000 and 2021, the results reveal that African countries have a high country risk exposure. The country risk negatively and significantly affects African bank stability. The study findings suggest that compliance with at least Basel II capital requirements is needed to protect African banks from the negative effects of country risk on their stability in the short run. However, the adverse effects of prolonged country risk are mitigated by the compliance with higher Basel capital requirements in the long run. The results further show that an efficient legal and regulatory framework is essential to complement the capital buffer against country risk. Policies must be introduced to reduce country risk to enable African banks to adequately support the African economy in good and challenging times. Overall, country risk remains a threatening factor for bank stability, and consequently, banks need adequate capital to reduce the impact of country risk on bank stability in Africa.