SOVEREIGN CREDIT RATINGS, FUNDING COSTS AND PROFITABILTY: EVIDENCE FROM BANKS IN AFRICA

ABSTRACT This study set out to examine the effect of sovereign rating on funding cost and profitability of banks in Africa. Using over 300 banks operating in Africa from 2006 to 2012, the study investigates sovereign ratings‟ impact on bank profitability and funding cost. The long term domestic sovereign ratings announced by Fitch and Standard & Poor‟s during the period under study were used. The regressions were estimated using Prais-Winsten and the Generalized Method of Moments estimation approach. The findings of the study indicate that sovereign ratings upgrades have an inverse and statistically significant relationship with funding costs. Also, the regression results show that bank profitability is positively and significantly related to sovereign credit rating. The findings suggest that sovereign rating upgrades makes it easier for banks to access funds from the capital and global market at a cheaper cost compared to rating downgrades. The accessibility of funds at a cheaper cost translates to growth in profitability of banks. It is evidenced that markets are sensitive to rating changes and therefore react more to changes in sovereign rating. The study gives some important policy recommendations. It is recommended that governments should actively pursue actions to improve credit ratings for instance payment of debt on time reduces the rate of default and this brings about rating upgrades. From the results sovereign credit rating upgrade is one of the major means to attract funds into the country at a cheaper cost. In addition, the study recommends that in making investment and funding decisions, sovereign rating should be considered since the evidence suggests that it can reduce bank risk and improve profitability.