Financial intermediation spread and stability of the banking system in the Southern Africa Customs Union

Abstract

Purpose

Asymmetric information impedes the efficiency of financial intermediation by widening the gap between lending and deposit rates. The cost of information gathering is high and often translates into high borrowing costs. Consequently, high borrowing costs may make it hard for borrowers to repay loans and increase the volume of non-performing loans – a recipe for financial instability. This study first compares the application of the simple GARCH (1,1) and BGARCH (1,1,1) models in the estimation of macroeconomic volatility and finds that the latter is more suitable for this purpose. Moreover, the choice of BGARCH (1,1,1) over the simple GARCH (1,1) implies different outcomes for Granger causality tests. This finding implies that the BGARCH (1,1,1) model minimises loss of important information when estimating macroeconomic volatility in developing countries. Second, the study uses bootstrap panel Granger causality to test the hypothesis that there is a causal relationship between financial instability and the financial intermediation spread in Southern African Customs Union (SACU). The findings support this hypothesis and underscore the importance of implementing sound macroeconomic policies for high and stable growth as well as effective monetary policy to attain and maintain low and stable prices in order to narrow the financial intermediation spread in SACU. The paper aims to discuss these issues.

Design/methodology/approach

This study uses bootstrap panel Granger causality to test the hypothesis that there is a causal relationship between financial instability and the financial intermediation spread in SACU.

Findings

The findings support this hypothesis and underscore the importance of implementing sound macroeconomic policies for high and stable growth as well as effective monetary policy to attain and maintain low and stable prices in order to narrow the financial intermediation spread in SACU.

Originality/value

Application of panel bootstrap Granger causality test to test for a casual relationship between financial intermediation spread and financial stability in the context of SACU.

Citation

I. Motelle, S. and Biekpe, N. (2014), "Financial intermediation spread and stability of the banking system in the Southern Africa Customs Union", Managerial Finance, Vol. 40 No. 3, pp. 276-299. https://doi.org/10.1108/MF-06-2013-0147