Freedom, competition and bank efficiency in Sub-Saharan Africa

Abstract

PurposeThis study aims to consider the effect of financial (banking) freedom and competition on bank efficiency.Design/methodology/approachWith data from 11 Sub-Saharan African countries over the period 2006-2012, the study estimates both competition (market power) and bank cost efficiency using the same stochastic frontier framework. Subsequently, Tobit models, including instrumental variable Tobit regression, are used to assess how financial freedom affects the relationship between competition and bank efficiency.FindingsThe results show that increase in market power (less competition) leads to greater bank cost efficiency, but the effect is weaker with higher levels of financial freedom. This is not consistent with the quiet life hypothesis.Practical implicationsPolicymakers usually take the view that opening up banking markets to greater competition may lead to higher efficiency. However, the results have shown that allowing banks to maintain some level of market power may be necessary to ensure banking system efficiency.Originality/valueThis study deepens the understanding of the inconsistent relationship between competition and bank efficiency, by using the same framework to measure both competition and efficiency, and by providing new empirical evidence on how the level of financial freedom affects this relationship.