bank portfolio allocation

139 Pages·2013·1.91 MB·English

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BANK PORTFOLIO ALLOCATION: EVIDENCE FROM
SIERRA LEONE

BY
BAIMBA AUGUSTINE BOCKARIE
(10297268)

THIS THESIS IS SUBMITTED TO THE UNIVERSITY OF
GHANA, LEGON IN PARTIAL FULFILLMENT OF THE
REQUIREMENT FOR THE AWARD OF MPHIL
ECONOMICS DEGREE

JUNE, 2012.
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DECLARATION
This is to certify that this thesis is the result of a research undertaken by Baimba
Augustine Bockarie towards the award of a Master of Philosophy degree in the
Department of Economics, University of Ghana.

-----------------------------------------------------
BAIMBA AUGUSTINE BOCKARIE

------------------------------------------------- --------------------------------------------------
DR. S. K. K. AKOENA DR. E. OSEI-ASSIBEY
(SUPERVISOR) (SUPERVISOR)

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ABSTRACT
Bank portfolio allocation is an important determinant of the efficacy of monetary policy
through the bank lending channel of monetary policy transmission mechanism. This
study generally investigates the factors that influence banks‟ portfolio allocation in Sierra
Leone. Specifically, the study looks into the effects of risk premium, leverage ratio, and
credit risk on banks‟ earning asset portfolio allocation in Sierra Leone between 2002 and
2011.
Using annual bank level data on an unbalanced panel of thirteen commercial banks for
the study period, and employing time and bank specific fixed effects model for
estimation, it is confirmed that risk premium, the share of non-performing loans in the
banks‟ loan portfolio, tier 1 capital ratio (leverage ratio), and local currency deposit levels
positively and significantly affect the share of loan supply to the private sector in banks‟
earning assets. On the other hand the loan-deposit ratios (or advance-deposit ratio) and
bank size has significant negative effects on the share of loans in banks‟ earning assets.
The study also finds bank type (state, private domestic, and foreign) and the growth rate
of real Gross Domestic Product - a control variable for economic activities and hence,
loan demand - to be important determinants of the share of loans in banks‟ earning assets.
Based on these results, the study makes a number of recommendations including the
following:
 Action should be taken to increase risk premium to banks, for example, through
exercising stronger fiscal discipline so as to bring down the yield on government
securities.
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 The Central Bank of Sierra Leone should play a parental role in strengthening the
depth of the Interbank Market operations as a secondary market. This will have
the effect of increasing access of banks to short term liquidity The availability of
more funding sources other than client deposits reduces the risk of adverse
deposits shocks.
 Banks should be encouraged to have capital in excess of the minimum paid up
capital (Capital buffers) so as have more room to absorb the inherent risk in the
business of banking.

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DEDICATION
This work is dedicated to my daughters (Ayisha and Anisah Bockarie) and my parents
(Mrs Jinnah-Watta Bockarie and Mr Mohamed Bockarie).

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ACKNOWLEDGEMENTS
I thank God for making it possible for me to particularly undertake this entire study. Very
special thanks to Mr and Mrs Mohamed Bockarie for bringing me to this world and
painfully ensuring that I get some formal education.
I wish to register my profound gratitude to the African Economic Research Consortium
(AERC) for sponsorship. I offer my sincerest gratitude to my supervisors, Dr S. K. K.
Akoena and Dr E.Osei-Assibey, who supported me throughout my thesis write-up with
their patience, thoughtful suggestions and the invaluable and constructive comments on
every chapter of this work. I am indebted to Dr and Mrs Abu Bakar Tarawalie for their
motivations and supports to me, Dr Afred Barimah and Dr Edward Nketiah-Amponsah
for sharing my student troubles with me, and every member of staff in the Department of
Economics, especially those through whose hands I have passed, including the workers in
the General Office and the office of the Head of Department.
I am extraordinarily thankful to Miss. Betty Annan and the Edward Annan Family for
making me feel at home away from home. Your good deeds will always linger in my
mind. Verily, I cannot be more grateful to Miss. Mahawa Bayoh and Mr Mohamed Foday
of the Banking Supervision Department of BSL for providing me with the data for this
research. Equal thanks go to all of my mates (especially Innocent Abgelie, Christopher
Nyarko and Murtala Yusuf). Special thanks to my brother, Dr Mohamed Sheku for his
care and love. I cannot thank Mrs Hawah Bockarie more for her continuous support. I
appreciate all those whose names I could not mention here. Finally, any ambiguities and
shortcomings in this thesis are solely my responsibility.
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TABLE OF CONTENTS
TITLE PAGE
Declaration ----------------------------------------------------------------------------------- i
Abstract --------------------------------------------------------------------------------------- ii
Dedication ------------------------------------------------------------------------------------ iv
Acknowledgements-------------------------------------------------------------------------- v
Table of Contents---------------------------------------------------------------------------- vi
List of Tables -------------------------------------------------------------------------------- x
List of Figures ------------------------------------------------------------------------------- xii
List of Acronyms and Abbreviations ----------------------------------------------------- xiv

CHAPTER 1: BACKGROUND OF THE STUDY -------------------------------- 1
1.1 Introduction ------------------------------------------------------------------------------ 1
1.2 Statement of the Research Problem -------------------------------------------------- 7
1.3 Research Objectives -------------------------------------------------------------------- 9
1.4 Research Hypotheses ------------------------------------------------------------------- 10
1.5 Significance of the Study -------------------------------------------------------------- 10
1.6 Organisation of the Study ------------------------------------------------------------- 11

CHAPTER2: OVERVIEW OF THE COMMERCIAL BANKING
SYSTEMOF SIERRA LEONE--------------------------------------------------------- 13
2.1 Introduction ------------------------------------------------------------------------------ 13
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2.2 Evolution of Commercial Banking in Sierra Leone ------------------------------- 13
2.3 Branch Networks ----------------------------------------------------------------------- 15
2.4 Analysis of the Industry Balance Sheet---------------------------------------------- 17
2.5 Market Trends--------------------------------------------------------------------------- 19
2.6 Market Shares --------------------------------------------------------------------------- 25
2.7 Some Commercial Banking Regulations in Sierra Leone------------------------- 27
2.8Sectoral Allocation of Bank Loans--------------------------------------------------- 30

CHAPTER 3: LITERATURE REVIEW -------------------------------------------- 32
3.1 Introduction ------------------------------------------------------------------------------ 32
3.2 Theoretical Literature Review -------------------------------------------------------- 32
3.2.1 The Markowitz Portfolio Selection Model ---------------------------------------- 32
3.2.2 The Accommodation Principle ----------------------------------------------------- 34
3.2.3 The Profit Maximising Principle --------------------------------------------------- 35
3.2.4 Bank Attitude Toward Risk --------------------------------------------------------- 36
3.2.5 The Risks of Banking Business ---------------------------------------------------- 38
3.2.5.1 Interest Rate Risk ------------------------------------------------------------------ 39
3.2.5.2Measuring Interest Rate Risk ---------------------------------------------------- 40
3.2.5.2.1 The Repricing (Funding Gap) Model ---------------------------------------- 40
3.2.5.2.2 The Macauley‟s Duration Model --------------------------------------------- 43
3.2.5.2.3 The Risk Matrics Model------------------------------------------------------- 47
3.2.5.2.4 Historic (Back) Simulation Model -------------------------------------------- 49
3.2.5.3 Credit Risk -------------------------------------------------------------------------- 49
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3.2.5.4 Measuring Credit Risk ------------------------------------------------------------- 50
3.2.5.4.1 Reputation ---------------------------------------------------------------------- 50
3.2.5.4.2 Leverage ------------------------------------------------------------------------- 50
3.2.5.4.3 Volatility of Earnings---------------------------------------------------------- 51
3.2.5.4.4 Collateral ------------------------------------------------------------------------ 51
3.2.5.4.5 Business Cycle ----------------------------------------------------------------- 52
3.2.5.4.6 The Level of Interest Rates --------------------------------------------------- 52
3.2.5.4.7 Credit Scoring Model --------------------------------------------------------- 53
3.2.5.4.8 Capital Adequacy -------------------------------------------------------------- 56
3.2.5.4.9 The Leverage Ratio ------------------------------------------------------------ 56
3.2.5.4.10 Risk Based Capital Ratio ------------------------------------------------------ 57
3.2 Empirical Literature Review ---------------------------------------------------------- 59

CHAPTER 4: METHODOLOGY ----------------------------------------------------- 73
4.1 Introduction ------------------------------------------------------------------------------ 73
4.2 Theoretical Framework and Model Specification---------------------------------- 73
4.3Expected Signs of the Parameter Estimates ---------------------------------------- 77
4.4Estimation Technique ------------------------------------------------------------------ 79
4.5Definition of Variables ----------------------------------------------------------------- 84
4.6Data Type and Source ------------------------------------------------------------------ 86

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CHAPTER 5: EMPIRICAL RESULTS AND DISCUSSIONS ------------------ 87
5.1 Introduction ------------------------------------------------------------------------------ 87
5.2 Diagnostic Tests ------------------------------------------------------------------------ 87
5.2.1 Test for Endogeneity ----------------------------------------------------------------- 87
5.2.2 Test for Consistencies of OLS, Random and Fixed Effects Estimators ------- 88
5.2.3 The Hausman (1978) Specification Test ---------------------------------------- 89
5.2.4 Test for Groupwise Heteroskedasticity -------------------------------------------- 90
5.2.5 Test for Time Specific Fixed Effects ---------------------------------------------- 91
5.3 Descriptive Statistics ------------------------------------------------------------------- 91
5.4 Regression Results and Analysis ----------------------------------------------------- 92

CHAPTER 6: CONCLUSION AND POLICY RECOMMENDATIONS---- 100
6.1 Conclusion ------------------------------------------------------------------------------- 100
6.2 Policy Recommendation --------------------------------------------------------------- 102
6.3 Research Limitations ------------------------------------------------------------------- 105
6.4 Areas for Further Research ----------------------------------------------------------- 105

References------------------------------------------------------------------------------ 160
Appendix A Minimum Variance Frontier of Risky Assets-------------------------- 114
Appendix B: Banking Activities and Market Shares --------------------------------- 115
Appendix C:Outputs of STATA Version 11 ------------------------------------------ 120

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