The Impact of Public Sector Lending on Financial Stability in Central Africa

Abstract

Investments by the private and public sectors have formed the basis for economic growth in developing economies. The creation of goods and services for consumption hinges on the ability of market actors to lend from financial institutions. The process of credit creation is, therefore, central to economic activity, output, employment, productivity, and wage growth. Nevertheless, it is not clear that crowding out of investment occurs via lending to state entities, whose ability to repay credit is contingent on oil prices and domestic economic activity. This paper finds that the impact of the public sector on per capita GDP is weaker (1.6%), while the impact of private credit is significantly larger (2.6%). Greater linkages between commercial banks and the public sector increase financial stability risks as weaker oil prices affect the ability of the public sector to repay its loans to Cameroon’s commercial banks. In other to bolster financial stability, commercial banks should make targeted investments in high-growth and scalable sectors that will reduce the uncertainty on their profits stemming from uncertain oil prices and late repayments by state-owned entities. Not only will a climate-centric and diversified portfolio insulate bank profits over the medium-long run, they will also reduce the exposure of their asset and liquidity positions to uncertain commodity prices.