Dynamic interactions between stock markets and banks in South Africa : testing for market disciplining of banks

Abstract

Literature on the significance of vibrant financial system is vast and conclusive, more so on the need for strong banking system for sustainable inclusive growth. This study take cognisant of such literature and explores the possible links between stock markets and banking system, with emphasis on testing the presence of market disciplining of banks. The study analysed South African individual bank panel data for the period 1994-2014. The study makes the following contributions: testing of market discipline of banks by stock markets in a developing economy, albeit this new strand in banking sector research has been fairly a preserve for developed countries across literature; testing stock market channel of monetary policy transmission in South Africa; exploring robust estimations to mitigate downfalls with short and unbalanced panels; controlling for financial crisis as well as covering a period of Basel II & III which emphasizes market discipline as a third pillar. The role of stock market discipline in aiding regulators and supervisors in ensuring efficiency and stability of the banking system is phenomenal internationally as seen by the recognition in Basel II & III, however its effectiveness has not been empirically tested in developing countries like South Africa. Diverse panel data estimation techniques producing robust/ corrected standard errors have been employed on the data making use of STATA 13. The study also made use on Pooled Mean Group estimates as well as dynamic fixed effects for robustness checks. The empirical results indicate that indeed stock market indicators are omitted variables in the traditional bank lending channel model and that the specified stock market channel model has no omitted variables. The presence of a stock market channel of monetary policy transmission in South Africa is established and thus vindicating the appropriate intermediate target for the central bank to be price level (inflation), with price stability being the ultimate goal. Furthermore the results point to the ability of stock markets to monitor and influence the banks (market discipline of banks) as indeed stock markets have been found to be significantly linked to banks’ operations as being information aggregator and provider. The results have varied implications for policy and further research.