Size, efficiency, market power, and economies of scale in the African banking sector

Simplice A Asongu,Nicholas M Odhiambo

doi:10.1186/s40854-019-0120-x

Simplice A Asongu, Nicholas M Odhiambo

Open Access

https://doi.org/10.1186/s40854-019-0120-x

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Abstract

There is a growing body of evidence that interest rate spreads in Africa are higher for big banks compared to small banks. One concern is that big banks might be using their market power to charge higher lending rates as they become larger, more efficient, and unchallenged. In contrast, several studies found that when bank size increases beyond certain thresholds, diseconomies of scale are introduced that lead to inefficiency. In that case, we also would expect to see widened interest margins. This study examines the connection between bank size and efficiency to understand whether that relationship is influenced by exploitation of market power or economies of scale. Using a panel of 162 African banks for 2001–2011, we analyzed the empirical data using instrumental variables and fixed effects regressions, with overlapping and non-overlapping thresholds for bank size. We found two key results. First, bank size increases bank interest rate margins with an inverted U-shaped nexus. Second, market power and economies of scale do not increase or decrease the interest rate margins significantly. The main policy implication is that interest rate margins cannot be elucidated by either market power or economies of scale. Other implications are discussed.

Highlights

Over the decade since the 2008 financial crisis, the literature on banking and finance has seen renewed interest in a number of areas, including the nexus between loan growth, regulation, diversification, and competition, and the development indicators for risk, capital management, and efficiency of banks (Kashif et al 2016; Bokpin 2016; Fanta 2016; Zheng et al 2017; Ozili 2017; Khraisha and Arthur 2018)
Existing research maintains that some big banks might abuse their market power instead of leveraging economies of scale to increase their efficiency in financial intermediation
In the light of the above, the problem to be addressed can be stated as follows: “Is the relationship between bank size and efficiency influenced by exploitation of market power or economies of scale?” To the best of our knowledge, the existing literature regarding African financial development has not focused on this underlying question for banks

Summary

Introduction

Over the decade since the 2008 financial crisis, the literature on banking and finance has seen renewed interest in a number of areas, including the nexus between loan growth, regulation, diversification, and competition, and the development indicators for risk, capital management, and efficiency of banks (Kashif et al 2016; Bokpin 2016; Fanta 2016; Zheng et al 2017; Ozili 2017; Khraisha and Arthur 2018). Existing research maintains that some big banks might abuse their market power instead of leveraging economies of scale to increase their efficiency in financial intermediation. In the light of the above, the problem to be addressed can be stated as follows: “Is the relationship between bank size and efficiency influenced by exploitation of market power or economies of scale?” To the best of our knowledge, the existing literature regarding African financial development has not focused on this underlying question for banks.. This paper contributes to the literature by providing a deep examination of the connection between bank size and efficiency in Africa, with the concurrent goal of determining whether that association is influenced by abuse of market power or economies of scale. Cost efficiency section provides our conclusion, including the implications of our findings and suggestions for future research

Literature review and clarification of concepts

Methodology and data