Bank Intermediation and Risk-taking in Africa: Does Protection of Creditor Rights Matter?

Tianshu Zhao, University of Stirling, Victor Murinde, University of Birmingham and Kupukile Mlambo, AfDB

This paper seeks to identify and quantify specific mechanisms through which the institutional setting for protection of creditor rights impacts on the development of the credit market. An integrated analytical model is specified to show how banks’ asset-allocation decisions, between loans and other competing stock of earning assets, depend on: risk and return; bank-specific elasticity of supply; and operating costs. The model is augmented with metrics on the institutional setting for protection of creditor rights, and is then estimated and tested on an unbalanced panel dataset of commercial banks in 20 African countries during the period 1995-2008. It is found that three metrics of institutional setting induce banks to allocate a significantly higher proportion of their earning assets to loans: higher level legal codes for creditors; better enforceability of legal rights; and availability of information sharing among banks. However, the three metrics appear to work through different channels. The enforceability of legal rights works not only through mitigating the credit risks banks take, but also through a composite effect of market competition and lowering costs of information acquisition and contract enforcement. The legal codes metric and information sharing metric exclusively rely on the composite effect.