The Effects of Bank Regulations, Competition and Financial Reforms on MENA Banks’ Profitability

Abstract

In this paper, we examine the influence of bank regulations, concentration, financial and institutional development on commercial bank margin and profitability across a broad menu of Middle East and North Africa (MENA) countries. We cover the 1989-2005 period and control for a wide array of macroeconomic, , financial and bank characteristics. The empirical results find that bank specific characteristics, in particular bank capitalization and credit risk, have positive and significant impact on banks’ net interest margin, cost efficiency and profitability. As for the impact of macroeconomic and financial development indicators on bank performance, we conclude that these variables have no significant impact on net interest margin, except for inflation. However, inflation shocks seem to be passed mainly through the deposit rates — which means that banks bear the entire negative cost of inflation. Also, the results suggest that banks lower their operating costs in a well-developed banking sector environment (as confirmed by the negative and statically significant coefficient of the bank development variable in the cost efficient regression models). Furthermore, the stock market development variable is always positive and significant in all specifications, suggesting that banks that operate in a well-developed stock market environment tend to have greater profit opportunities. The regulatory and institutional variables seem to have an impact on bank performance as the results suggest that corruption increases the cost efficiency and net interest margins while an improvement in the law and order variable decreases the cost of efficiency without affecting performance. The analysis has a clear set of policy implications for the MENA countries. It is evident that enhancing competition through easing entry of foreign banks should be accommodated since it could reduce interest margins by intensifying competition. Additionally, the development of capital markets is encouraged to improve banks’ transparency and provide for better screening and monitoring of bank activities. Governments should also improve governance at the macro level — with implementing initiatives for fighting corruption and enforcing law and order as they have a positive impact on banks performance. Last, states are encouraged to speed up bank privatization activities that allow for changing ownership and control from the state to the private sector, so increasing competition, transparency and performance of banks.

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