Regulatory and Legal Determinants of Banking Stability: Evidence from Chad Using a Vector Autoregression Analysis (VAR) Approach

Abstract

Background: Banking stability is a pivotal aspect of financial sector health, with non-performing loans (NPLs) serving as a key indicator of potential vulnerabilities. In Chad, the banking sector's stability is particularly crucial given the country's economic challenges and development goals. Aim: This study investigates the interplay among regulatory framework, legal framework, and banking stability in Chad, using annual data from 2002 to 2022. Methodology: Data on the Non-Performing Loans Ratio, which measures banking stability, were obtained from the Bank of Central African States (BEAC), complemented by the World Bank's Global Financial Development Database (GFDD). The Regulatory Quality Index (RQ), measuring the effectiveness of the regulatory framework, and the Rule of Law Index (RL), assessing the strength of the legal framework, were sourced from the Worldwide Governance Indicators (WGI) database. In order to analyze the relationships among these variables, the study employs a Vector Autoregression (VAR) model, complemented by Granger causality analyses and impulse response function (IRF) insights. Banking stability is measured by the Non-Performing Loans Ratio (NPLR), regulatory framework by the Regulatory Quality Index, and legal framework by the Rule of Law Index. Results: The results indicate that improvements in regulatory quality significantly reduce non-performing loans, thereby enhancing banking stability. Conversely, enhancements in the rule of law initially increase non-performing loans due to stricter enforcement and recognition of bad loans, but this is crucial for long-term stability as it fosters a more transparent and accountable banking environment. The interplay between regulatory and legal frameworks reveals that improvements in one might initially challenge the other, emphasizing the need for harmonized reforms. Conclusion: The study concludes that both regulatory and legal frameworks are essential for banking stability in Chad, and recommends harmonized reforms, continuous monitoring, and capacity building for regulatory and legal institutions to ensure sustainable banking stability. Future studies could explore the long-term effects of regulatory and legal changes on banking stability, and incorporate additional variables such as economic growth, political stability, and international financial influences to provide a more comprehensive understanding of the factors affecting the banking sector.