The Effect of Institutional Factors on Financial Deepening: Evidence from 50 African Countries

This paper investigates the impact of institutional factors on financial deepening and its implications on bank credit in Africa. The paper employs different panel econometric models to examine the heterogeneity of 50 African countries from 2000 to 2019. The estimators include panel corrected standard errors, system generalized method of moments, quantile and threshold regressions. The results show that rule of law, regulatory quality, government effectiveness, voice and accountability, control of corruption, and political stability significantly influence financial deepening in Africa. However, government effectiveness has a higher effect on middle- and high-income countries, while other indicators have a high impact on low-income countries. All institutional indicators have stronger effects, almost double, at higher financial levels than for countries with lower levels. Government effectiveness and regulatory quality impact financial deepening more for countries with strong institutions than weak ones. Thus, the relationship between institutional qualities and credit provided by banks is non-monotonic. The findings suggest that strengthening appropriate institutional factors based on country heterogeneity may effectively stimulate debt financing in Africa, the primary source of financing for small and medium-sized enterprises and entrepreneurs. The novelty of this paper is that previous studies did not sufficiently scrutinize the heterogeneity of the structure of African economies – i.e. differences in institution, credit and income levels.