Economic Freedom and Bank Stability in the Rich African Economies

Abstract

This study empirically examines the nexus between economic freedom and bank stability in rich African economies, seeking to uncover the underlying causes of the recent wave of bank failures in these countries. It employs the Heritage Foundation’s Economic Freedom Index, utilizing its four main pillars to offer a more holistic approach compared to existing studies on the continent. Static panel regression analysis is applied to bank-level, economic freedom, and macroeconomic data from ten countries over the period 2013–2022 to test the hypotheses. The results largely support a positive relationship between bank stability and economic freedom, though at a lower intensity, as indicated by the insignificant positive coefficients of the overall economic freedom index. Specifically, the findings show insignificant positive coefficients for the rule of law (RLW) and government size (GVSZ), alongside significantly positive and negative coefficients for regulatory efficiency (REGE) and the open market system (OPM), respectively. These results highlight weaknesses in the OPM’s components, including trade, investment, and financial freedom, despite their average level. The study also points to a need for improving the components of RLW, given its low mean score, which signals insufficient judicial effectiveness, government integrity, and property rights protection – factors essential for attracting business and fostering banking sector growth. While regulatory efficiency is seen as a key factor in enhancing bank solvency in the future, the study emphasizes that significant behavioral and policy changes are needed for other pillars to contribute meaningfully to bank stability in the rich African economies. The findings provide insights into how banks, especially those from wealthier African nations, can maintain global recognition and financial viability through economic liberalization. At the same time, the study’s limited access to bank-specific data presents an opportunity for future research to further build on these findings.