Financial market structure and capital controls in Sub-Saharan Africa

Abstract

PurposeThis study investigates the influence of capital controls on financial market structure in Sub-Saharan Africa (SSA). This is especially relevant as the former restrictions are relatively common on the sub-continent. At the same time, the sub-region’s financial markets are highly bank-based and focused on the short term, with stock markets being illiquid and stunted.Design/methodology/approachTo achieve its research objectives, the study posits an original model and uses comparative statics to analyze the relation between the aforestated phenomena in a representative SSA economy. Key hypothesized conclusions derived therefrom are tested using panel econometrics.FindingsThe comparative static analysis illustrates that capital controls favor banks, making them monopolistic and inefficient. This is confirmed by the empirical investigation, as the said market restriction skews financial market structure towards a bank-dominated system.Research limitations/implicationsThe study limits itself to capital controls and their effects on financial market structure. It does not particularly investigate the influence of different types of these restrictions. Specifically, it dichotomizes the influence of the examined controls on bank and stock markets.Practical implicationsThe dissimilar influence of capital controls on banks relative to stock markets is critical for decision and policymakers. This paper highlights that capital controls may have unintended adverse effects on domestic financial markets. Also, they may not be the most appropriate policy to deepen markets and enhance domestic resource retention. There is, consequently, a need to determine fitting policies that attract rather than repel financial flows. Furthermore, capital controls may engender rather than address macroeconomic misalignment.Social implicationsAs a social imperative, it is necessary to analyze SSA’s framework of capital restrictions to better understand how they distort market incentives and mechanisms. This would help identify adverse effects that retard social development.Originality/valueThis study extends existing literature by developing a novel analytical framework incorporating key characteristics of SSA economies. This helps to better understand the nature of the capital controls–financial market structure relation in imperfect market conditions.