4.3. Analyses of Country Risk and Stability
Equations (3) and (4) were estimated using pooled mean group (PMG), mean group (MG), and dynamic fixed-effect (DFE) models. It presents the findings of the impact of country risk on bank stability in Africa. Model 1 was estimated using the PMG model. Model 2 was estimated using the MG model. Model 3 was estimated using the DFE model. The Hausman test applied between the three estimation techniques selected the PMG as a better estimator. Also, the PMG performed better than MG and DFE for significant impacts and provided the theoretical consistency of the results. Therefore, the results for the PMG were interpreted.
The result in
Table 6 shows that country risk has a negative and significant impact on the stability of African banks in the short run at the 1 percent level of significance. This implies that an increase in country risk ratings leads to a decrease in the stability of banks in Africa. Bank stability showed sensitivity to country risk in the short run. Npl_ta was negative and significant, implying that non-performing loans was one of the determinant factors affecting the stability of banks in Africa. An increase in non-performing loans poses a serious threat to any bank’s survival. The negative impact is consistent with the literature that non-performing loans weaken bank stability (
Soenen and Vander 2022). Africa has a high lending cost; therefore, the losses in bank loans can be high, which can adversely affect the stability of banks in Africa.
Finally, we noted that the Gdpgrowth was statistically insignificant. The insignificant impact of the Gdpgrowth implies that bank lending is too low in African banks to have any significant impact on bank stability. In the long run, a positive and significant relationship exists between the country risk and bank stability at the 1 percent significance level.
The fixed-effect result (see
Appendix A,
Table A2) suggests that country risk has a positive effect on bank stability. Hence, the use of the PMG is relevant to shed light on the short- and long-run impacts. Using the PMG, we can observe that country risk in Africa has a negative impact on bank stability in the short run, but a positive impact on bank stability in the long run.
The Implication of the positive long-run relationship of country risk on bank stability is that, as changes in the country risk ratings occur, the banks are unprepared, thus resulting in a negative impact in the short run. However, country risk can have an increasing effect as banks adjust their portfolios to the country risk rating changes. Hence, a positive long-run relationship is created.
The error correction term (ECT) in
Table 6 shows that there is a co-integration among the panel variables, indicating the existence of a stable and converging long-run relationship between the Zscore, CRS, Npl_ta, and Gdpgrowth.
While the negative effect of country risk level on bank stability in Africa was determined in the previous results, it was also important to analyze how this effect changed due to the influence of regulatory capital. This was assessed to determine whether country risk levels impacted banks differently under different Basel capital levels. The estimation result for Equation (4) is reported in
Table 7. It presents the findings of the effect of capital adequacy on the stability of the African bank sector. Equation (4) was estimated six times using different Basel capital ratios (CAPs) with the country risk score. Models 1, 3, and 5 included the Basel II capital ratio and non-performing loans with country risk scores. Models 2, 4, and 6 included the Basel III capital ratio and non-performing loans with country risk scores. Models 1–6 in
Table 7 include non-performing loans to explore whether non-performing loan influence the relationship between country risk and bank stability under different Basel capital levels. The results for the PMG (Models 1 and 2) are interpreted based on the Hausman selection of the PMG as the best estimator.
The results of the effects of country risk on bank stability show that when the Basel capital ratio is introduced into the models, the country risk impacts on bank stability are insignificant for Basel II and III compliant banks. However, the country risk impacts on African banks differ depending on their capital levels. For Basel II-compliant banks, country risk positively impacts bank stability, although not significantly. In comparison, country risk has a negative impact on bank stability on Basel III-compliant banks. The result shows the ability of capital to protect African banks against unexpected risks as country risk becomes insignificant when the Basel capital is introduced to the model. Our result is consistent with studies, such as
Anani and Owusu (
2023), which support the effectiveness of Basel capital adequacy to ensure bank stability.
For the capital adequacy of African banks, the results show a persistent positive and significant relationship between Basel capital ratios and bank stability for Basel II and III-compliant banks in the short run. The positive impact implies that the compliance with Basel capital regulations reduces the probability of bank distress in Africa. From the empirical literature, Basel III-compliant banks are deemed to have an adequate capital to continue lending in periods of high country risk levels relative to normal times, while less adequately capitalized banks restrict their lending activities (
Huang and Lin 2021). But, for African banks, compliance to at least the Basel II capital improves bank stability, regardless of the country risk effects in the short run.
In the long run, Basel II and III capitals negatively and significantly impact bank stability at a 1 percent significance level. Theoretically, adequate capitalized banks have the resources to withstand long stress periods. Also, an adequate capital can stabilize the effects of country risk changes, especially downgrades. However, the evidence from African banks shows that they may be vulnerable to country risk effects in the long run.
African banks operate in a volatile macroeconomic environment with high country risk levels. Our result suggests that being adequately capitalized may not alone be a sufficient tool to protect banks if high country risks persist into the foreseeable future.
On the other hand, the negative impact of capital on bank stability may also imply that African banks comply with bank regulations just to pass the routine banking supervision from their relevant regulatory authorities. Following this, the banks revert back to their normal activities. Therefore, there is no structured compliance with Basel regulations. Thus, African banks may practice selective compliance to Basel requirements. In this regard, African banks need to be monitored regularly by regulatory authorities. In addition, even though the African banks included in the sample were Basel II or III compliant, many operated below the minimum Basel capital requirements. Thus, the composition and quality of the capital may not protect African banks in the long run.
Non-performing loans (Npl_ta) have a positive and significant relationship with bank stability for Basel II and III-compliant banks. The result suggests that an increase in non-performing loans increases the probability of bank distress in Africa. Non-performing loans and country risk continue to be important for bank stability in African countries.
The error correction term (ECT) in
Table 7 shows a co-integration among the panel variables, indicating a stable and converging long-run relationship between the Zscore, CRS, Npl_ta, and Basel capital ratios. The result provides strong evidence of the co-integrational relationship among the Zscore, CRS, Npl_ta, BII_capratio, and BIII_capratio.