Does hoarding liquidity really mitigate African banks’ financial fragility?

Abstract

Purpose African banks often hoard substantial precautionary liquidity buffers to safeguard against liquidity and credit risks. This study investigates whether this practice effectively mitigates their financial fragility or, conversely, exacerbates it. Design/methodology/approach The study employs a panel fixed-effects model on a comprehensive dataset of 484 commercial banks from 50 African countries, covering the period from 2011 to 2020, to explore the relationship between liquidity hoarding and financial fragility. For robustness, two-step system generalized method of moments and quasi-maximum likelihood estimators are used to account for the dynamic nature of financial fragility. Findings The results reveal that liquidity hoarding significantly contributes to financial fragility, with a more pronounced detrimental effect observed in larger pan-African bank groups than smaller banks. This suggests that liquidity hoarding exacerbates financial instability rather than alleviating it. Originality/value This study provides novel insights into the adverse effects of liquidity hoarding on the financial stability of African banks. It underscores the need for regulatory policies that incentivize banks towards liquidity creation, highlighting that liquidity hoarding not only impedes economic output but also heightens financial instability.