Trends and Determinants of Bank Profitability: Empirical Evidence from Commercial Banks of Bangladesh

Abstract

The study presents the trends and determinants of bank profitability with the empirical evidence from commercial banks of Bangladesh. The banking sector is the prime driving force and pillar for accelerating economic growth of modern economics. But, it is less stable in developing countries than in developed countries. A sound banking sector provides a base for stabilizing financial system to accomplish earnings for developing economy. To maintain financial stability in an economy and to defend any negative shocks, it is badly needed to identify the significant determinants which have mostly influence on bank profitability. Profitability can be defined as the capability to generate profit. It is the primary goal of all business venture. In bank business assessing present and past profitability and projecting upcoming profitability is very important. Some commercial banks are renowned for their profitability but some other banks deteriorated, this poses queries about some factors that will be dominated by the bank management to determine their profitability. At the same time we need to know about the extent of common determinants of bank profitability of Bangladesh. Almost 96% of total assets of the monetary sector are accounted in the banking industry in Bangladesh. Banks functioning in a concentrated market have some market control and might be more cautious in risk-taking which may enhance profits, either by higher interest rate or less loan loss provision. The traditional SCP theory advises that market structure influences the competitive conduct of banks which further affects the bank profitability. This is because extremely concentrated banking structure encourages banks to plan with each other to produce more profit. Types of bank, efficiency and ownership structure also have an important issue against the inclination of bank profitability. Credit and liquidity risk management, efficiency of the personnel, business diversification, market concentration/competition, good governance and the economic growth may have impact on bank profitability. Global deregulation and technological progression made an indention of challenge in bank business. Now a days, banks are engaged in diversified trading activities such as transfer of fund, credit mechanisms etc. which may have an impact on its profitability. As a service oriented business, banks are also highly regulated by the supervisory authority in an economy. We consider driving determinants of bank profitability in Bangladesh, assessing the impact of competition and concentration on banking profit and the effect of capital conservation buffer on bank profitability based on the panel evidence from commercial banks in Bangladesh. We studied the impact of capital conservation buffer because banks in Bangladesh are practicing Basel III accord where additional capital conservation buffer was enacted. Another theoretical motivation to investigate the impact of competition and concentration on profitability, as new banks are coming and we found bank market is moderately concentrated with low level of competetion. Therefore we are inquisitive to study the scope for rising competitiveness by averting disproportionate concentration which have an impact on bank profitability. In chapter one, we confer the motivation and the extensive review of literature concerning our research. As the profitability of bank business in Bangladesh is not static and it is a lion share of the Bangladesh economy, it inspired us to investigate the determinants of bank profitability. Banks are trying to earn more profit to get a place in the financial market. Adequate level of profit is required to absorb any shocks and to conquer firmness of the financial system. With the vision of testing the economic theories concerning to the bank profitability theoretically encourages us to perform the present study with some empirical evidence in Bangladesh. In chapter two, we empirically analyzed the impact of managerial and macroeconomic issues which drive profitability of 57 commercial banks in Bangladesh from 2007 to 2017 by the use of GMM estimator. We considered bank-specific, industry specific and macroeconomics factors to determine the significant determinants of bank profitability. Profitability of banks is proxied by return on asset (ROA), return on equity (ROE) and net interest margin (NIM). Our empirical result shows that cost efficiency has significant impact on the measures of profitability which can be improved by dropping undesirable working expenses. Total loan to deposit ratio is positively and significantly associated with profitability (ROA and ROE), suggesting that efficient fund management including investment and assessed expenditure should be emphasized. Liquidity and profitability are significantly negatively correlated while profitability measured in terms of ROA. Bank size has significant negative influence on all the measures of profitability, indicating that growth in bank size is significantly negative impact on profitability due to monopolistic competition. Credit risk significantly positively affects ROE meaning that, due to economical uptrend, financially insolvent borrowers are taking loan for investment which will motivate them to honor debt. As a result, profitability will increase from speeding up net interest margin. Again, positive association with NIM indicates core business activity which influences profitability of banks in Bangladesh. Among macroeconomic variables, inflation affects negatively and economic growth rate has positive influence on ROA and significant positive impact on NIM but inverse relationship is found with ROE. Bank spread has positive relationship with the profitability measured in ROA and NIM but significantly negative with ROE of Banks in Bangladesh.

In chapter three we studied the impact of competition and concentration on the profitability of commercial banks in Bangladesh for a period of 2007 to 2017 by the use of panel data of 57 commercial banks functioning in Bangladesh. In traditional structure conduct performance (SCP) hypothesis, market structure influences the competitive behavior of the market participants which promote the profitability of banks. This study supported SCP hypothesis and found that profitability in the banking arena in Bangladesh is moderately concentrated. We assessed competition and concentration by Herfindahl-Hirschman Index (HHI) which has a positive relationship with bank profitability. It reveals that concentration drops the cost of collusion between banks and generates greater profit for all market participants.We found evedence that employee productivity have significant positive association to banking profits, whereas expense management, liquidity position, bank size and marginal costs are significantly negatively affect bank profitability. Profit variable i.e. ROA responds positively to GDP growth and bank spread, but inversely associated with inflation. In chapter four we examined the co-movement of buffer capital contemplating the Basel III accord and profitability in the banking industry in Bangladesh.. We cosidered bank-specific, industry specific and macroeconomic issues of 57 commercial banks for the period of 2007-2018. To improve the quality of regulatory capital, significant improvement in financial stability and proper treatment of liquidity risk Basel III accord emerged in 2010 with new capital and liquidity regulations to safeguard the banking sector both in stressed situation and profitable situation. In our study, profitability was porxied by return on assets (ROA), return on equity (ROE) and net interest margin (NIM). We observed procyclical behavior of buffer capital in relative term with ROA, and significant counter cyclical influence of regulatory buffer capital on ROE and NIM. Internal capital generation rate has a strong significant impact on the proxy variables of profitability measured by NIM. Bank size has a significant positive influence on ROE due to employ monopolistic power to generate profit. Tier I leverage is positively related with ROE and NIM. Our present study on the driving determinants of the bank profitability, impact of competition and concentration on banking profit and the impact of capital conservation buffer considering the Basel III accord on bank profitability will provide an early prediction of the growth and profitability of banks in Bangladesh. This study make an arrangement to implement urgent measures while its threat is not yet full-fledged. Our findings also provide a scope to raise competitiveness by averting disproportionate concentration as well as enrich the literature with direct inferences for community strategy towards banking-structure and principles. Comparative study can be performed in different dimensions by the forthcoming researchers like between private banks and state owned banks comparison, traditional banks and Islamic banks comparison etc. Other explanatory variables like corporate governance, corporate social responsibility(CSR), corporate tax rate, and deposit insurance can be considered to accelerate the model. Extended time adjustment analysis can be accomplished to magnify the profitability of banks in Bangladesh by the future researchers.