Derivatives use and the risk-taking behaviour of African banks

Strong criticisms have repeatedly been voiced, and sporadic evidence presented, that banks typically maintain derivatives positions that exacerbate their risk. This paper expands on the existing knowledge about the risks of derivatives activities in the context of developing countries specifically 14 African economies, referring to their impact on the risk-taking impulse of 147 banks at 'idiosyncratic' levels. At the same time, the risk-taking impulse resulting from the banks' business lending efficiency is examined. Using the standard return on assets (ROA)- and return on equity (ROE)-based idiosyncratic risk metrics, the two-stage least squares (2SLS) regression was implemented following linear and nonlinear specifications. Generally, banking stability appears to be unsustainable from the onset, as shown by the reported Z-scores. The results further hint at the adverse implications of using derivatives on bank risk-taking whereas the reported efficiency-led banking stability cannot be maintained, which may increase risk-taking and bank instability. The banks exhibit hazardous behaviour in the current climate of rapid transformation of the banking systems, calling for regulatory vigilance in order to limit imprudent actions.