Why Do African Banks Lend So Little?

Abstract

The authors put forward a plausible explanation of African banking sector under‐development in the form of a bad credit market equilibrium. Using an appropriately modified Industrial Organization model of banking, they show that the root of the problem could be unchecked moral hazard (strategic loan defaults) or adverse selection (a lack of good projects). Applying a dynamic panel estimator to a large sample of African banks, they show that loan defaults are a major factor inhibiting bank lending when institutional quality is low. They also find that once a threshold level of institutional quality has been reached, improvements in the default rate or institutional quality do not matter. This provides support for their theoretical predictions. This is an output from the ‘Politics, Finance and Growth’ Project