Economic role of derivatives on bank lending, firm value and economic growth : evidence of South Africa

Abstract

The South African financial system has had substantive growth in the derivative market from 1996 up to the present day. The instruments are growing at an astonishing rate, although the economic growth of South Africa was unstainable. It is growing at a slow rate that cannot be matched to the rate of derivatives growth. However, the causal analysis of derivatives markets and economic growth in developed market economies revealed that the variables tend to move together over time. What remains thorny to researchers is the question as to why such a relationship exists. Is it a pure coincidence, wealth effect, or is the derivative market a mirror or a leading indicator of the economy, or does the derivatives market drive the economy or reverse? The present study wishes to find out the answers to such questions regarding South Africa through examine the impact of derivatives on bank lending and firm's value and consequently economic growth. This study is predominantly quantitative, and it followed financial development-growth nexus studies to establish its methodology. The adoption of the methodology followed that derivatives are regarded as part of financial development instruments among stocks, bonds, bank loans, and other financial instruments. In terms of the estimation technique, the system generalised method of moments (GMM) was deemed appropriate due to its wellacknowledged ability to account for endogeneity prone with panel data set and growth-related models. This study revealed that derivatives, irrespective of type, positively influenced lending in the banking industry. Thus, the evidence shows that loan portfolios of banks that participate in derivative instruments increase. In addition, the analysis shows that derivatives permit banks to lend more to the private sector; there is a positive statistical relationship at 1 percent significance. Listed non-financial firms on the Johannesburg Stock Exchange use derivatives to manage foreign exchange, market, price, and interest rate risks during their operations. The results obtained suggested that the use of derivatives generates value for non-financial firms. There is a significant hedging premium for South African non-financial firms that use derivatives. Derivatives permit more significant extension of credit to the private and public sectors, which impacts the economic growth of South Africa; that is, if there is a 1% change in the loan portfolio growth, the real GDP of South Africa expanded by 1.52%, as estimated by the research findings. Also, derivatives allow non-financial firms to undertake capital investments, increasing the yearly South African real GDP by 1.15% if there is a 1% change in the firm value. It is observed that economic growth pinned its roots in the efficiency of the banking sector. Banks effectively provide funding through lending to the private sector to secure credit and interest rate risks with derivatives. Thus, it is availing liquidity in an economy that is essential for the firms to capitalise, finance capital projects, and invest in opportunities to derive economic activities. Thus, economic growth increases the production of quality goods and services through the private and public sectors. The research findings documented in this study supported policies to inspire the development of derivative markets as part of financial development. This can help deepen the financial sector in South Africa, which will help stimulate economic growth. Therefore, it is recommended that policymakers adopt strategies that reinforce the development of derivative markets in the country through fiscal or monetary interventions.