Bank-led finance slows growth in Africa, but stock markets show positive impact

A newly published study, titled “Financial Development and Economic Growth in Sub-Saharan Africa Revisited: Disentangling the Role of Banks and Stock Markets”, presents striking evidence that the structure of financial systems in sub-Saharan African countries may be hindering, rather than helping, long-term economic growth. The paper, published in the International Journal of Financial Studies, revisits the longstanding debate over whether banks or stock markets better fuel economic expansion in developing economies.

Through a robust econometric framework using panel data from seven sub-Saharan countries between 1995 and 2015, the study finds that bank-led financial development has a statistically significant negative effect on economic growth, while stock market development exerts a modest but positive influence. These findings challenge prevailing assumptions about the universal benefits of bank-centric financial expansion and suggest a policy reorientation may be required.

What is the relative impact of banks and stock markets on growth?

The authors applied a dynamic fixed effect (DFE) estimation approach, grounded in the augmented Solow growth model, to examine the independent contributions of banking systems and stock markets to economic development. They drew on multiple financial indicators, such as private credit to GDP, deposit bank assets, market capitalization, and equity market turnover, to capture the depth, activity, and efficiency of financial sectors.

Results revealed that a 1% increase in banking assets relative to GDP was associated with a decrease in economic growth of up to 0.10%. Similarly, an increase in private credit led to a reduction in growth by 0.09%, undermining the notion that credit expansion inherently promotes development. On the other hand, stock market activity, particularly the value of equities traded, showed a modest but statistically significant positive effect on growth. Neither market capitalization nor turnover ratio, however, demonstrated meaningful individual impacts.

This discrepancy suggests that while African banks might be expanding in size, they may not be efficiently allocating resources to the most productive sectors. Potential factors contributing to this misalignment include high concentration, limited access to credit for SMEs, and outdated risk assessment models.

Do banks and stock markets complement each other?

To determine whether the two financial structures act in synergy or operate as substitutes, the study employed two synthetic indicators: the “activity–structure” ratio (market capitalization over bank assets) and the “activity–finance” aggregate (the sum of market capitalization and total bank assets). This dual-measure framework allowed the researchers to assess not only the individual roles of banks and markets but also the structure and scale of financial development as a whole.

The results were revealing. The activity–structure ratio had a positive association with growth, suggesting that economies where financial markets hold a greater relative share compared to banks tend to grow faster. In contrast, the activity–finance aggregate exerted a negative effect, implying that a simultaneous expansion of both sectors, without regard to structural balance, may dilute financial effectiveness.

These findings hint at the importance of striking a strategic balance between bank and market-based financing. When stock markets grow faster relative to banks, capital allocation appears more efficient and supportive of economic productivity. Conversely, a blind expansion of financial assets, irrespective of structure, can lead to inefficiencies and growth drags.

What are the policy implications for Sub-Saharan Africa?

The study offers a sobering takeaway: expanding the banking sector in its current form may not yield the intended benefits for economic growth in sub-Saharan Africa. While banks continue to dominate financial intermediation, their apparent inefficiencies, misaligned incentives, and high costs of credit limit their developmental impact. Meanwhile, stock markets, though underdeveloped and often volatile, seem better positioned to channel capital into long-term, productivity-enhancing investments.

Policy recommendations from the authors emphasize a pivot toward developing robust equity markets. This could include improving regulatory frameworks, enhancing investor protections, incentivizing private listings, and introducing modern trading infrastructure. They also stress the importance of revisiting the operational model of banks to strengthen their role in supporting SMEs and innovation-driven sectors.

Furthermore, the research acknowledges broader macroeconomic dynamics, such as the 2008 financial crisis, the emergence of BRICS, and the rise of ESG investing, as variables that may influence the finance–growth nexus. Notably, the study refrains from attributing causality in an overly simplistic manner, instead encouraging more nuanced and context-sensitive financial policy formulation.