Diversification and banks’ funding costs in Africa: The role of financial regulations

Abstract

Background: The banking literature suggests that banks can reduce their funding costs by optimising their deposit mix to prioritise low-cost accounts, managing capital efficiently, and employing diversification strategies to attract more cost-effective funding sources. While the roles of deposit mix optimisation and capital management in lowering funding costs are well-documented, the impact of diversification remains relatively underexplored, particularly in developing countries.

Aim: This study examines the relationship between diversification, financial regulations and banks’ funding costs.

Setting: A sample of 563 banks operating across 53 African countries over the period 2007–2021 was selected based on the availability of data.

Method: This study employs fixed effects model as the main estimation approach, along with two-stage least squares (2SLS) and generalised method of moments (GMM) estimation technique for robustness test.

Results: The study’s results indicate that diversification significantly lowers banks’ cost of funds in Africa. The analysis also reveals that revenue diversification has a more pronounced impact on large and international banks. Furthermore, the study identifies an indirect effect of financial regulations on banks’ funding costs through revenue diversification.

Conclusion: The study highlights the need for bank managers, particularly those in large international banks, to proactively adopt diversification strategies to optimise their funding structures and reduce costs effectively.

Contribution: The study provides insights into the broader implications of the interactions between regulatory frameworks, bank diversification, and funding costs in Africa.