Institutional quality and banking sector deepening in East Africa

Abstract

Access to formal financial institutions remains a challenge in East Africa. Yet these institutions provide finance, vital for promoting investment. Banks, which dominate the financial sector and provide various financial products, have minimal presence in various regions. Therefore, access to financial products remain persistent in East Africa for various macroeconomic actors, for example businesses and individuals. Who often lack access to banks or are charged high interest rates due to the risk factor. Furthermore, existing institutions which play a leverage role in the economy have not aided in addressing this issue. The paper stresses that while financial access is essential, it must be supported by strong institutional reforms to achieve sustainable financial deepening. This study investigates the effect of institutional quality on banking sector deepening in five East African countries: Kenya, Uganda, Tanzania, Rwanda, and Burundi, over the period from 2002 to 2021 with data sourced from the World Bank database. Utilizing a fixed effects econometric model, the findings indicate that weak institutional environments obstruct financial deepening and efficient resource allocation. The study advocates for improvement in governance by establishing independent oversight bodies and implementing regular audits to support contract enforcement and enhance the security of financial transactions. Additionally, promoting deposits through incentives like tax benefits can widen the loanable base facilitating banking sector deepening.