Influence of Bank Specific and Macroeconomic Factors On Profitability of Commercial Banks (The case study of different countries) By Tabby-Monsoon Influence of Bank Specific and Macroeconomic Factors On Profitability of Commercial Banks (The case study of different countries) Tabby Monsoon Master in business administration Department of management sciences University Of Gujarat, Gujarat, Pakistan E-mail: Tabby. [email protected] Com Abstracts Purpose- The purpose of this paper is to identify the influence of bank specific and macroeconomic factors on profitability of commercial banks over the period of 2006 o 2012.
Methodology- In order to achieve the study objective and to answer the question, return on assets and return on equity as dependent variable Further Bank specific and macro economic determinant are used. The employing descriptive statistics, correlation and regression analysis are used. Finding – The study results signify that banks with larger assets size and with efficient management lead to greater return on assets. Originality – The paper shows that management efficiency regarding operating expenses positively and significantly affects the banks’ profitability.
Key words- Return on Assets, Return on Equity, Inflation, capital adequacy, Bank specific determinant, profitability. Type of paper – The type of this paper is Research paper. 1 . Illumination: In economy the banking sector plays important role. The financial sector of economy may perform many functions. The financial institutions are the main source challenges. The economy growth rate is also influenced by the financial institution. In addition, insolvencies of bank can lead to crisis as a whole economy.
The banking sector profitability contributes in economies and some time this profitability nutrient positively and some time it is negative that affect our economy (Ethanol’s et al. , 2005). For that reason, understanding of profitability determinants is important. The main purpose of commercial banks is attaining of better profit through the increase in commercial banks owners wealth by achieving of higher return on investment. This is not only the object of the owners, but the object of depositors also.
Subsequently, this study will able to answer the given question, what are bank- specific and macro-economic determinants that affect the commercial banks profitability? The study purpose is to discover the aspects that influence the commercial banks profitability, with main focus of bank-specific determinants. These key aspects help commercial banks to obtain better profitability through factors that influence it. For that cause, the study is very critical because of the term increasing important and demand of commercial banks.
The factors recognition is very vital that affect positively and negatively and to maximize the owners wealth and funds of depositors of commercial banks. This study is an addition to the literature and complement that analyses the factors affects the commercial banks profitability. Banking is a quickly increasing industry. Every bank is trying to improve overall performance plus profits to occupy a better position in financial system. This study will recognize the key essentials that have crash on the performance of banks.
The aim of this research is to determine and observe bank specific or internal as well as macroeconomic or external determinants of profitability and degree to which they influence the profitability of commercial banks of different countries for a period of 2006 to 2012. Objectives of study The main objective of this study is to give the answers of following questions. 1) What are the main bank specific internal factors that affect the profitability of commercial banks from 2006 to 2012? 2) What are the main macroeconomic external factors that affect the profitability of commercial banks from 2006 to 2012? These studies are valuable for stakeholders such as public, government and other financial institutions. This wide study of determinants of profitability of commercial banks is most important from point of view of managerial together with regulatory views. From the managerial view it is significant to inspect the determinants related with success to figure out the performance that can push up the performance of banks.
Regulators of banks are concerned in protection along with reliability of the banking system and they are protecting the confidence of public. Other stakeholder can also get benefit from this study to know that how banks are performing. Whether they should place their money in banks or invest in other business and what factors that can influence performance of banks. Next Section will explain the literature review of data and research methodology while section 4 reveals the results & discussions and sat sections explain the conclusion and recommendations.
Model developed by author. 2. Literature Review: This section presents the review of the previous studies that determine the factors to affect the performance of the banks in a specific country or in a group of the countries. Most of the researcher used internal and external variables in their studies. All, Farman, and Safari (2011) examined bank and economic factors that affects the profitability of the commercial banks in Pakistan. ROE and ROAR is used by to measure the profitability of banks. They used the statistical analysis e. G. Regression.
They show that return on assets has a clear relationship with size, total deposits [total assets ratio and operating revenues / total assets ratio, on the other side ROAR has harmful impact with capital and credit risks. ROE is positively relating with capital, operating income/total assets, deposit/assets ratios. GAP is the factor has major influence on the banks profitability. Lapel and Unbar (2011) carryout a study to discover factors that influence the profitability of turkey banks during the period of 2002 to 2010. They used panel data analysis. They discover that ROAR absolutely influenced by Asset size.
Non interest income/assets and real interest rate, whereas ROAR harmfully affected by loan/assets. Other factors like capital ratio, deposits/assets, net interest margin, GAP and inflation are not much linked with banks profit. Annum and Judos (2012) analyses the factors of the profitability of the banks by using data from 2005 to 2009 on the basis of quarters. The used the regression method to observe the outcome. They establish that inside factors like credit risk, interest income and advances have important effect on the profitability of banks. Bank has insignificant effect on the profits.
They learning show no outside factors form import, export, discount rate and inflation greatly connected with bank profits. Dyad and Bookmobile (2012) they discuss in their learning the profitability factors of Tunisian sector of banking from 1995 to 2005. They establish that Bank size importantly and credit risk and liquidity importantly relate with the profits of Tunisian banks. Outside factors GAP and Inflation have harmful relationship with profitability of banks. Share, Shawnee, and Salem (2011) conducted their learning in Middle East region to examine the factors that have prejudiced on the reference of the banks.
They inferred the factor analysis techniques (PICA). They planned that bank features (Bank size, size & duration of deposits & duration of loans, concentrations in lending activity, Net charge off loan ,bank capital and bank operating cost) has important effect on the profitability of banks. Safari and Gums (2012) they investigate to find out the inside and outside factors influencing the Azerbaijan banking sector. CAMELS’ model was used to appraise the functioning and Panel data regression analysis was used to decide the determinants of profitability.
They done that Inflation and GAP has harmful relationship with the banks performance. The Jordan Islamic banks for the period of 50th 2009. Multiple Linear regression model was used in this study and remarked that ROE has major relation with total equity/total asset and total income/total asset while has harmful linked with bank size, total liability/total assets, GAP, inflation and exchange rate. Useful and Argali (2008) started their research in Philippines to examine the aspect related profitability of banks from the period 1990 to 2005. In this research they used Multivariate regression model.
Their research illustrate that profitability of banks has harmfully connected with bank size, credit risk and expenses management on the other side having a definite connection with non-interest income, capitalization and inflation. Whereas the other macroeconomic factors like Money supply, stock market capitalization has minor impact on the performance of banks. Asana (2011) examine the relationship of bank specific and economics variable with profitability of US banking industry for the period of 1995 to 2007 with the help of GEM system estimator.
He finished that only one factor capital ratio has harmful inconsiderable relationship with performance of banks. Bank size due to discomposes of scale has instructive relationship with profitability of banks. Gin and Pastors (2012) started their study on Tanzania sector of banking from 2000 to 2009 by using regression model and find that liquidity and assets quality has sure relationship whereas non performing loan and capital adequacy has harmful relation with the banks performance.
Balloon and Abidjan (2012) observe the aspects influencing the performance of banks in Nigeria. Three decomposed models with aggregate model were used . This duty portray the answer in two ways as in short run Capital adequacy ratio while in long run size of bank has important effect on the performance of banks. By using NOVA test they found that there is no main difference among the commercial banks of Nigeria. Taft, Shuffles, and Razz (2012) observe the factors of profitability of Islamic banks in Pakistan.
They used five variable inflation, GAP, industrial production rate, unemployment and interest rate in their study. By using regression analysis they exposed that only interest rate is the factor that has certain effect on Return on assets and Return on equity. Scam and Squid (2012) examine the profitability of foreign & domestic banks in Pakistan. They found that foreign banks are additional profitable as compared to domestic banks in Pakistan and also found that inflation and GAP further affected the domestic banks as contrast to foreign banks.
Leniency, and Mamba (2009) used the capital adequacy, liquidity management, assets quality and income diversification as inside issue whereas foreign ownership and market concentration used as market or outside factors that influenced the banking all inside factors have certain effect on banks profit whereas no market factor effect he performance of banks. Java, Near, Zamia and Gaffer (2011) observe the factors that have great impact on the profitability of banks in Pakistan from 2004 to 2012.
They employed Pooled ordinary least square method to find the result by using Equity, loans, deposits as independent and ROAR as dependent variable. They found that equity and deposits have sure influence on ROAR. Loans have minor but constructive relation with ROAR. Gull, Richards and Zamia (2011) examined the bank specific and macroeconomic factors that influenced the profitability of banks in Pakistan for the period of 2005 to 2009. They apply assets, equity, loans and deposits as independent variables while ROAR, ROE and MIM as dependent variables.
By employing pooled ordinary least square method they estimate that banks with higher assets, deposits, loans and equity has higher profitability. Bilabial, ASPI, Mark All and Toques investigated the influence of bank specific and macroeconomic factors on profitability of commercial banks in Pakistan over the period of 2007 to 2011. They measured the profitability by using return on assets (ROAR) and return on equity (ROE). From the regression models, it is seen that BBS, presented the natural log of assets of banks, is found to have positive significant impact on the profitability.
Nonperforming loans represent the credit management having a negative insignificant impact on the ROAR but negative significant affect on ROE. Now one thing is clear from this literature review that there are a lot of internal and external factors that can affect the profitability of commercial banks . So in this study researchers will try to find out the major factors that have significant impact on the profitability of commercial banks in Pakistan from 2006 to 2012. 3. Data and Methodology: 1. Data: 1. Population: From a population of more thank banks selected sample has used to determine profitability of commercial banks. 1. 2 Sample: The population data has used for this purpose and the selected sample has based on 50 commercial banks from 18 countries. The sample banks are from different regions such as North Asian countries, East Asian Countries, Europe, North American Countries and South American Countries also from West & Central Asian countries. 1. 3 Data source: From year 2006 to 2012 available data has used in this study.
The countries have hoses from different regions to determine the profitability of commercial banks of bank-specific variables. The data has been collected from the annual reports of each bank available at banks legal website. On the other hand macro-economic variables, the data on economic activity (GAP) and annual inflation rate are obtained from: trading economy and World Bank. In this study Researcher used the E-view software to implement the statistical techniques. Researchers used three techniques. 1. 1st is descriptive statistics to calculate mean, median and standard deviation of all the variables. . Correlation analysis to check the relationship of independent variables and there dependence on each other. 3. The regression analysis used to check the significant or insignificant impact of independent variables on the dependent variable. 2. Variables: The 9 variables have used in the study to analyses the profitability determinants of commercial banks. The two variables are used as dependent variables and the rest of variables are considered as independent variables. The bank-specific variables have categorized as internal management and macro- economic determinants of profitability of commercial bank.
Notation and the variable of commercial banks profitability variables Measures Notation Determinants independent variable Profitability Return on assets ?net profit/total assets Return on equity = net profit/equity ROE ROAR Bank-specific Assets management Operating income total assets POP Capital adequacy Equity/ total assets CA Operating efficiency ratio Operating expenses otal assets TOE Financial Risk Total liability/ Total assets TLA Assets size Natural logarithm of total assets Macro Economic Economic Activity Annual GAP growth rate GAP Inflation Annual inflation rate INFO 2. 1 Dependent variables: .
Return on equity: It is (ROE) defined as net profit to total equity and is shown in percent. It shows the rate of return which bank receives by investing the money of stockholder in creative projects. This also shows the risk of banks for capitalizing its assets and how much relying on the finances of shareholders. 2. Return on assets: It is (ROAR) shown in percent and measure as net profit to total assets. This show the actual success connected with management in order to use the overall asset and overlook the return. This shows the actual earning from the asset. 2. 2 Independent variable:
Independent variables are categorized in these two sub-groups: (1) bank-specific variables. (2) macro-economic variables. 1 . Assets size. It is measured by taking the logarithm of overall total assets of a bank. The asset size variable is mostly used in the literature of finance. The total assets of bank are used to represent the bank size. It may affect the profitability of the banks and usually calculated positive (Shamrock, 1985). 2. Capital adequacy. It is finding by the total equity to total assets. Higher of its ratio show less need of external fund and increase the bank profitability.
There is some costive relationship between this ratio and performance of bank. Because the banks with high capital face low chance of bankrupt that lower their risks costs and financial support (Berger, 1995; Hosannas and Basher, 2003). 3. Assets management. It is represented by total operating income to total assets. High assets management ratio is favorable for banks. The positive link exhibited between ratio and profitability of Islamic banks (Chicer, 2003; Miller and Annual, 1997). 4. Operating efficiency. It is presented by total operating expense to total assets. Operating efficiency shows the management ability of the banks.
The lower operating efficiency leads to the good management efficiency. 5. Financial Risk. In this research we used total liability to total assets to find the financial risk. Financial risk show low capital or high loan. Some positive relation is between ROAR and risk. So risk has inverse relation with banks profitability. Macro-Economic variables. 6. Inflation. Inflation shows the change in the prices of goods in economy due to decrease in the value of money. Inflation is a factor that affects the banks profitability. Inflation and profitability may have both relationships positive and active.
But previous research examines positive link between inflation and profitability (Molybdenum and Thornton, 1992; Commodious, 2006). 7. Gross domestic product. High GAP is beneficial for a country because it attracts new and more investors like this low GAP attract less investor which affects bank profitability. Some demand and supply related banking factors may affect due to GAP. The previous research represents the positive relationship between GAP growth and profitability of banks (Demurring-Junk and Hazing, 1999; Biker and Huh, 2002). Empirical model: Return on Assets:
AS+џ_2 CA+џ_3 POP+џ_4 TOE+џ_5 INFO+џ_6 GAP+џ_7 LLC+џ_8 TLA+џ_9 Return on Equity: AS+џ_2 CA+џ_3 POP+џ_4 TOE+џ_5 INFO+џ_6 GAP+џ_7 LLC+џ_8 TLA+џ_9 4. Empirical result: The descriptive statistics is calculated to measure the profitability of commercial banks. The table shows the mean and standard deviation (SD) value for the variables. Mean represent the average value, standard deviation shows deviation of value from mean. The descriptive statistics shows the average of (ROE) in selected sample is 4. 8 percent and (ROE) standard deviation is 1. 7 percent. The return on assets (ROAR) average is 95 percent and deviation sis’s percent.
Assets size (AS) mean is 684 percent and deviation is 16 percent. Capital adequacy (CA) mean is 10 percent and deviation is 15 percent. The total liability to total assets ratio (TLA) and operating income to total assets (POP) average is 9. 7 and 1. 1 percent. Total operating expense to total assets (TOE) mean is 8. 9 percent and deviation is 41 percent. The inflation rate (INFO) mean is 6. 7 percent and deviation is 5. 2 percent of the selected sample. The gross domestic product mean is 3. 6 percent and deviation is 3. 8 percent. Table 0. 04860 1. 42582 CA . 97637 0. 90084 TOE 0. 06737 0. 038144 Mean 0. 95803 0. 6566 AS 0. 10069 1. 33897 POP 0. 08997 0. 052501 GAP Stand-deviation 2. 57797 ROE 6. 84200 0. 15725 TLA 0. 11974 0. 41124 INFO 0. 03697 Relationship between independent variables Table presents the relationship between independent variables (what is the strength of one variable affecting the other variable). As shows that there is correlation among the independent variables is very low. The low correlation coefficients explain that there is no multi-correlation exists. -0. 05 -0. 04 0. 01 0. 12 0. 29 0. 14 0. 09 TLA POP -0. 01 GAP TOE 0. 94 INFO 0. 08 -0. 04 -0. 03 GAP AS -0. 14 0. 01 Correlation -0. 001 1 TOE 1 INFO 0. 5 0. 30 0. 00 0. 22 0. 13 Empirical results from panel data analysis Determinants of return on equity (ROE). That all the explanatory variables explain return on equity 16. 67 percent. The value of F-statistic results from a standard statistical test used in NOVA and regression analysis to determine if variances between means of two populations are significantly different. The value of F-statistics is 9. 77 and p-value is O showing that the whole model is fit for the analysis. In this study, shows the positive and significant allegations with assets size (AS) and return on assets (ROE) at 10 percent significance level.
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