7th Call - Professor Yindenaba Abor

Project Title: How Do Corporate Governance Structures Affect the Funding Strategy of Banks in   Sub- Saharan Africa?

Principal Investigator: Prof. Joshua Yindenaba Abor (Department of Finance, UGBS)

Email Address: joshabor@ug.edu.gh

Award Amount: GHC 24,995.00

Project Status: On-going

Summary:

Banks across the world run their operations using various business models. These business models vary based on factors such as economic development, social factors, and regulatory quality. Indeed there are various forms of banks such as commercial banks, cooperative banks, development banks, investment banks, merchant banks, real estate and mortgage banks and savings banks to mention a few. The mode of funding across these different bank types vary because their focus in the market place also tend to differ. The recent trend around the world has been towards universal banking wherein banks can offer a variety of services to their clientele base. Banks are relationship based financial institutions and gather various forms of information on their clientele base to reduce information asymmetry. Reducing information asymmetry reduces the hazards associated with lending and therefore reduces the probability of a bank going bankrupt. The trend towards universal banking therefore allows banks to use information gathered in making loan choice decisions to sell other financial services to their clients such as investment services and advice at a profit. Funding structure in essence represents how a bank raises finance to fund its operations and assets. A bank may fund its operations using deposits, non-deposit funding sources and internal capital. Deposit and non-deposit funding usually represent debt financing whereas internal capital represents an equity funding mode. Most banks finance their operations with deposits since these are relatively cheap and are more reliable compared to non-deposit funding (see for example Ianotta et al. 2007; Dinger and von Hagen 2005; Gilkeson et al. 1999). In recent times, the share of non-deposit funding in the overall bank funding mix seems to have increased (see Norden and Weber, 2010). The funding mode adopted by a bank is likely to have implications for its risk and return. Substituting deposit funds with non-deposit funds are likely to reduce a bank’s profitability because these funds are likely to be more costly (see Norden and Weber, 2010 and Demurguc-Kunt and Huizinga, 2010). Further, Hackethal (2004) asserts that the structurally declining role of deposits represents a future critical issue for banks in Germany. Even though non-deposit funding may be more costly compared to deposits, it may aid a bank overcome constraints in the supply of deposits and to finance unexpected retail withdrawals (Goodfriend & King, 1998). In terms of risk, due to higher sums committed, and the absence of non-deposit insurance, providers of non-deposit funds usually have a higher incentive to monitor the activities of a bank. Thus, the use of non-deposit funding may lead to a safer banking system. Conversely, higher non-deposit funding may lead to a riskier banking system. Anectodal and recent empirical evidence suggests that the use of large non-deposit sources of finance may have been a prime culprit in the 2007 financial crisis (see for example Demurguc-Kunt and Huizinga, 2010 and Ratnovski and Huang, 2009). Indeed, previous studies show that the probability for a bank to invest in riskier projects increases with its costs of funds (see for example Allen and Gale 2000 & 2004; Craig and Dinger, 2013). In addition to influencing risk and return, Amidu (2013) shows that banks with a higher non-interest income ratio (these banks usually tend to also rely on non-traditional sources of funding) have higher market power. The study therefore seeks to examine what determines the funding choice of banks in Sub-Saharan Africa (SSA). In particular, we are interested in uncovering how corporate governance structures influence the funding choice of banks in SSA. In terms of corporate governance, we examine issues such as who chairs the board of directors, the number of non- executive directors, the size of the BOD, and the level of institutional share ownership. We argue that these corporate board characteristics should influence the funding choice of a bank.