The Profitability Determinants of Private Commercial Banks in - - PowerPoint PPT Presentation

The Profitability Determinants of Private Commercial Banks in Bangladesh

Presented by

• Md. Sohel Saklain
• Md. Sohel Saklain

Examination Committee: Dr. Sundar Venkatesh (Chairperson)

• Dr. Juthathip Jongwanich
• Dr. Yousre Badir

Professional Master’s in Banking and Finance

1

Agenda

• 1. Overview of the Banking Sector in Bangladesh
• 2. Analysis of Profitability: The Case of One

Commercial Bank

• 3. Problem Statement & Objectives of The

Research Study Research Study

• 4. Research Methodology
• 5. Analysis of The Profitability Determinants of

Private Commercial Banks in Bangladesh

• 6. Conclusion and Recommendations for Policy

Implications

2

Bangladesh Financial System of Bangladesh

Central Bank (Bangladesh Bank) State Owned Commercial Banks (SCBs) Private Commercial Banks (PCBs) Controller of Insurance (under the ministry of commerce) Life Insurance Rural Development and Cooperative Division ( RDCD ) Co-operative Banks Micro Credit Regulatory Authority Micro finance Institutions Securities and Exchange Commission (SEC) Dhaka Stock Exchange Banks (PCBs) Foreign Banks (FCBs) Government

• owned

Specialized Banks (DFIs) Non-Bank Financial Institution (NBFIs) General Insurance Chittagong Stock Exchange

3

• The Financial sector of Bangladesh, like most in

developing countries, is dominated by banking industry.

• 1. Overview of the Banking Sector in Bangladesh

6 6 4 4 4 4 4 4 2 2 2 3 5 5 5 4 8 10 13 27 30 30 4 6 7 7 9 13 9 9 5 10 15 20 25 30 35 Number of Banks in Bangladesh (by Type) from 1975 to 2010 Nationalised banks Specialised banks Private banks

4

4 4 4 4 4 4 2 2 2 3 5 5 5 4 4 5 1975 1980 1985 1990 1995 2000 2005 2010 Year Private banks Foreign banks

• In 1982 license to few Private Commercial Banks (PCBs) were given for the first

time.

• First Generation- License in early 1980s, Second Generation- license in late 1980s

and early 1990s , Third Generation- license in Late 1990s and onward

• 1. Overview of the Banking Sector in Bangladesh Cont..

4 4 30 9 10 20 30 40 SCBs DFIs PCBs FCBs Bank Type Number of Scheduled Banks (by Type) in Bangladesh (as on June, 2010) SCBs 29% FCBs 7% Share of Industry Assets by Type(as on June, 2010)

5

Bank Type 3394 1366 2427 59 1000 2000 3000 4000 SCBs DFIs PCBs FCBs Bank Type Number of Bank Branches by Type(as

• n June, 2010)

DFIs 7% PCBs 57%

• 1. Overview of the Banking Sector in Bangladesh Cont..

89.45 70.89 62.43 62.07 55.22 40.52 27.83 26.06 27.85 31.47 46.47 60.81 40 50 60 70 80 90 100 %

Deposit of Scheduled Banks by Types

SCBs DFIs

6

• The higher interest rate on deposit may be the probable reason for rising

trend of PCBs deposit.

27.83 4.34 4.4 4.37 4.9 5.98 5.97 5.1 18.34 26.06 27.85 31.47 6.21 6.37 7.14 5.18 7.04 7.04 6.26 10 20 30 40 1980 1985 1990 1995 2000 2005 2010 Year PCBs FCBs

• 1. Overview of the Banking Sector in Bangladesh Cont..

80.2 58.26 52.78 52.36 47.17 35.25 31.13 49.02 65.39 40 50 60 70 80 90 %

Advances of Scheduled Banks by Types

SCBs DFIs

7

• One of the probable reason of increasing trend of advances for PCBs is

the quicker and easier loan processing .

21.8 16.16 22.94 20.42 17.18 16.16 9.18 6.95 13.51 21.05 25.13 31.13 3.65 5.29 5.75 5.32 5.54 6.55 5.86 10 20 30 40 1980 1985 1990 1995 2000 2005 2010 Year DFIs PCBs FCBs

• 1. Overview of the Banking Sector in Bangladesh Cont..

9440.30 36555.90 0.00 10000.00 20000.00 30000.00 40000.00 50000.00 Million Taka

Trend of Net Profit of Scheduled Banks by Type

SCBs FCBs

8

• 44159.20
• 50000.00
• 40000.00
• 30000.00
• 20000.00
• 10000.00

0.00 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009(p) Taka Year PCBs DFIs

• From the year 2006 the profit of PCBs begun to rise in the rocket

high rate and it ended with 36,555.90 million taka in the year 2009.

• 1. Overview of the Banking Sector in Bangladesh Cont….

0.70 0.96 0.74 0.80 0.70 1.20 1.10 1.10 1.30 1.40 1.55 2.00 2.40 2.60 3.20 3.10 2.20 3.10 2.90 3.18 2.87 1.00 1.50 2.00 2.50 3.00 3.50 %

Trend of ROA of Scheduled Banks by Type

SCBs DFIs

9

0.10 0.10

• 0.10
• 0.10

0.00 0.00 0.70 0.74 0.30 0.00

• 0.20
• 0.10
• 0.20
• 0.30
• 0.60

0.37 0.22 0.80 0.70

• 1.00
• 0.50

0.00 0.50 1.00 Year DFIs PCBs FCBs

• PCBs always maintained the second level of ROA in the industry for the

entire period.

• From the year 2009 to 2010 the ROA of PCBs rose remarkably.

• 2. Analysis of Profitability: The Case of AB Bank Ltd.

162.45 532.19 1,903.49 2,300.62 3,417.19 3,989.52

• 500.00

1,000.00 1,500.00 2,000.00 2,500.00 3,000.00 3,500.00 4,000.00 4,500.00 Taka (million)

Net Profit of AB Bank Ltd.

33,065.40 47,989.34 63,549.86 84,053.61 107,093.0 1 134,003.8 8

• 20,000.00

40,000.00 60,000.00 80,000.00 100,000.00 120,000.00 140,000.00 160,000.00

Total Assets of AB Bank Ltd.

10

• 2005

2006 2007 2008 2009 2010 Year Net Profit

• Net Profit of ABBL was only 162.45 million in the year 2005 but it became

3,989.52 million in the year 2010 which is almost 25 times increment.

• 2005

2006 2007 2008 2009 2010 Year Total Asset

• 2. Analysis of Profitability: The Case of AB Bank Ltd. Cont..

1.1% 3.0% 2.7% 3.2% 3.0% 1.1% 1.10% 1.30% 1.40% 1.55% 2.00% 1.2% 1.4% 1.6% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% %

Comparative Trend of ROA

ABBL PCBs

11

0.5% 0.6% 0.8% 0.9% 1.2% 1.4% 0.0% 0.5% 1.0% 2005 2006 2007 2008 2009 2010* Year Banking Industry

• After 2006 AB Bank Ltd. maintained a much higher level of

ROA than the banking industry and even the PCBs.

10.6% 20.6% 42.2% 34.2% 33.2% 28.2% 18.1% 15.2% 16.7% 16.4% 21.0% 24.3% 15.6% 21.7% 22.9% 15.0% 20.0% 25.0% 30.0% 35.0% 40.0% 45.0% %

Comparative Trend of ROE

ABBL PCBs

• 2. Analysis of Profitability: The Case of AB Bank Ltd. Cont..

10.6% 12.4% 14.1% 13.8% 15.6% 0.0% 5.0% 10.0% 2005 2006 2007 2008 2009 2010* Year Banking Industry

12

• The ROE of ABBL reached its peak in the year 2007. In that year the

ROE of ABBL was 42.2%. The reason might be the surge in Net Profit

• f ABBL and lower equity in this year.
• In the subsequent years the ROE of ABBL declined continuously but

it remained above the ROE of banking industry and PCBs.

2.09% 1.28% 2.26% 2.42% 2.77% 3.05% 2.68% 4.24% 5.06% 4.90% 5.05% 5.91% 0.14% 1.64% 2.34% 1.81% 1.77% 2.90% 1.00% 2.00% 3.00% 4.00% 5.00% 6.00% 7.00%

Income Mix of ABBL

NIM NII IIOSBD

• 2. Analysis of Profitability: The Case of AB Bank Ltd. Cont..

1.28% 0.14% 0.00% 1.00% 2005 2006 2007 2008 2009 2010 Year

13

• NII (Non Interest Income/Total Assets) line always stayed above the NIM line.
• The Investment Income from the Investment in Shares, Bonds and Debenture

(IIOSBD= Investment Income from the Investment in Shares, Bonds and Debenture/Total Assets) also occupied a significant proportion of the non interest income.

• The IIOSBD line has the same shape as NII line which indicates that the IIOSBD

had a great influence on the NII.

• 3. Problem Statement
• Private

commercial banks in Bangladesh are continuously making a huge chunk of profit.

• The profit growth seems to be astonishingly high.
• Good

sign for an economy but question

• f

sustainability arises. sustainability arises.

• Banks are involved in the wide array of other non

traditional banking activities. Some of these profit seeking activities may lead banks to take very high exposures to the risk.

14

• 3. Objective of the Study

This research study only tries to focus on the Private Commercial Banks (PCB) category because of its hefty profit growth. So the main objectives are: So the main objectives are:

• To identify the major determinants of the

profitability of Private Commercial Banks in Bangladesh in recent years.

• To address some policy implications and

suggest directions for further study.

15

• 4. Research Methodology

Data:

– Annual data for all the 30 Private Commercial Banks of Bangladesh for the years 2009 and 2010. – Source of data: annual report of each bank. – To capture the recent year’s profitability determinants-

• nly two years’ data has been considered.
• nly two years’ data has been considered.

– No sampling has been made to select the banks.

Research Method:

– One dependent and nine explanatory variables have been taken that may influence the profitability of a bank. – Two multiple regression analyses have been run for the year 2009 and 2010.

16

• 4. Research Methodology Cont..

Example of variables in few literatures

Literature Dependant Variables Independent Variables

• F. Sufian & M. S.

Habibullah (2009) ROA Asset Size, Capital Adequacy, Loans, Deposit, Loan Loss Provision, NII, GDP, Inflation, Supply

• f money
• N. Jahangir, S. Shill, &
• M. A. J. Haque (2007)

ROE Asset Size, loan and deposit

• D. Alpher & A. Anbar

ROA, ROE Asset Size, Capital Adequacy, Asset Quality,

17

• D. Alpher & A. Anbar

(2011) ROA, ROE Asset Size, Capital Adequacy, Asset Quality, Liquidity, Deposits, NIM, NII, GDP, Inflation, Interest Rate

• M. Pervan, I. Pervan,

& A. Guadagnino. (2010) ROA, ROE, NIM Asset Size, Market Share, Solvency risk(capital adequacy), Credit risk, Liquidity risk, Operating

• Exp. Mgt., Fees Income, HHI Index,

Concentration Index, Inflation, GDP

• S. S. Debashis, & N. C.

Shil (2011) Net Profit Spread, NII, Credit Deposit Ratio, Non Performing Assets to Net Advances, Provision & Contingencies, Operating Exp., Business Per Employee, Profit per Employee

• 4. Research Methodology Cont..

Dependent Variable:

– Return on Assets (ROA) and Return on Equity (ROE) are most commonly used – ROA has been used in this study

Bank Specific Independent Variables:

– Bank specific financial ratios representing capital adequacy, cost

Variable Selection

– Bank specific financial ratios representing capital adequacy, cost efficiency, Income Expenditure mix, asset quality, and size are mostly used internal variables. Some of these variables have been used in the study. – Based on the case study of AB bank Ltd. we also considered the investment activities in our variable selection.

Macro Economic Independent Variables:

– GDP, inflation, market interest rates etc. are commonly treated as external determinants that affect bank profitability. This study has not covered any external variables.

18

Definitions and Notation of the Variables

Variable Measure Notation Dependent Variables Profitability Return on Assets (ROA) = Net Profit/Total Assets ROA Asset Size Natural Logarithm of Total Assets logA Capital Adequacy Equity / Total Assets CA Asset Quality Loans / Total Assets Non-Performing Loans / Total Loans LA NPL Deposit Deposits/Total Assets DP

19

Independent Variables Deposit Deposits/Total Assets DP Income-Expenditure Structure Net Interest Margin = Net Interest Income/ Total Assets Non-Interest Income = Non-Interest Income /Total Assets NIM NII Investment Activities Investment in Govt. securities/Total Assets Other Investment/Total Assets IGSEC OI

So our profitability model would be as follows: ROA = β0 + β1LogA + β2CA + β3LA + β4NPL + β5DP + β6NIM + β7NII + β8IGSEC+ β9OI + ε

Hypotheses of the Study

The previous discussion in the overview of the banking sector of Bangladesh and the case study of AB bank Ltd. sections lead us to predict the following hypothesized relationships with respect to the profitability:

• Hypothesis H1a: Asset size measured by natural logarithm of total
• 4. Research Methodology Cont..
• Hypothesis H1a: Asset size measured by natural logarithm of total

assets (logA) has a significant positive impact on ROA

• Hypothesis H2a: Net Interest Margin (NIM) has a significant

positive impact on ROA

• Hypothesis H3a: Banks with more diversified income measured by

Non-Interest Income (NII) tend to be more profitable

• Hypothesis H4a: Investment activities mainly in quoted and

unquoted shares and debentures of private sectors measured by Other Investment (OI) have a significant positive impact on ROA

20

• 5. Analysis of The Profitability Determinants

Descriptive Statistics Year ROA Log A CA LA NPL DP NIM NII IGSEC OI 2009 Mean 1.27% 24.96 8.10% 69.03% 6.42% 82.18% 2.39% 3.13% 10.86% 1.40% Max 3.19% 26.35 23.36% 82.35% 80.99% 89.41% 3.99% 5.05% 31.06% 6.25% Min

• 10.85%

23.67 -6.36% 54.83% 0.94% 68.66% 1.25% 0.54% 1.87% 0.00%

• Std. Dev.

2.35% 0.47 4.17% 6.87% 14.54% 4.93% 0.61% 1.10% 6.10% 1.52%

21

• Average ROA of 2010 is higher than that of 2009.
• Average NII were higher than the NIM for both the year.
• The percentage of other investment is not so high for both the year.

2010 Mean 1.86% 25.21 8.21% 71.68% 5.13% 79.76% 2.75% 3.70% 8.99% 2.12% Max 5.10% 26.52 14.86% 83.75% 61.60% 88.57% 4.19% 6.72% 22.63% 7.40% Min

• 7.29%

23.65-31.14% 53.08% 1.14% 68.02% 1.36% 0.42% 0.02% 0.05%

• Std. Dev.

1.93% 0.48 7.81% 6.11% 10.88% 5.76% 0.70% 1.36% 4.68% 1.59%

• 5. Analysis of The Profitability Determinants cont..

Correlation Matrix among Independent Variables

Log A CA LA NPL DP NIM NII IGSEC OI Log A 1 CA

• 0.3717

1 LA 0.0046 0.2166 1 NPL

• 0.4868

0.5290

• 0.0696

1 DP 0.3612

• 0.5227

0.1807

• 0.5012

1 NIM 0.4200

• 0.0270

0.0978

• 0.2761
• 0.1599

1 NII 0.3241

• 0.1218
• 0.3255
• 0.4217

0.0347 0.0154 1

2009

22

NII 0.3241

• 0.1218
• 0.3255
• 0.4217

0.0347 0.0154 1 IGSEC 0.1151

• 0.2025
• 0.5984
• 0.1426

0.1240

• 0.2921

0.6073 1 OI 0.0981 0.0324

• 0.0340
• 0.1762
• 0.0513

0.1661 0.3159

• 0.1398

1 Log A CA LA NPL DP NIM NII IGSEC OI Log A 1 CA 0.6172 1 LA 0.0195

• 0.1567

1 NPL

• 0.5994
• 0.9245
• 0.0598

1 DP 0.0669 0.0348 0.4133

• 0.2797

1 NIM 0.3247 0.1383 0.0737

• 0.1456
• 0.1585

1 NII 0.2360 0.5665

• 0.2162
• 0.4488
• 0.3031

0.1568 1 IGSEC 0.1545 0.3870

• 0.5135
• 0.3128

0.1042

• 0.0580

0.4293 1 OI 0.1606 0.3405

• 0.1891
• 0.2250
• 0.2494

0.4684 0.5737 0.0979 1

2010

There is no prima facie evidence of multicollinearity for both the year.

• 5. Analysis of The Profitability Determinants cont..

Regression Statistics 2009 2010 Multiple R 0.9885 0.9855 R Square 0.9772 0.9711 Adjusted R Square 0.9669 0.9581 Standard Error 0.0043 0.0039 Observations 30 30

23

F 95.1505 74.7313 Significance F 0.0000 0.0000

• The value of R Square is 0.9772 (0.9711) in the year 2009 (2010) which

reflects that the regression model explains 97.72% (97.11%) of the variation in ROA.

• F-statistic is very much significant. Significance F≈0.000 at 95 percent

confidence interval suggesting that both the model are useful to determine the determinants of ROA..

• 5. Analysis of The Profitability Determinants cont..

Regression Statistics 2009 2010 Coefficients t Stat P-value Coefficients t Stat P-value Intercept

• 0.0191
• 0.3554

0.7260

• 0.0488
• 0.8944

0.3817 Log A 0.0015 0.6225 0.5406

• 0.0004
• 0.1684

0.8679 CA

• 0.1704
• 6.2757

0.0000 0.1305 3.4777 0.0024 LA 0.0471 2.7490 0.0124 0.0167 0.8786 0.3901

24

LA 0.0471 2.7490 0.0124 0.0167 0.8786 0.3901 NPL

• 0.1113
• 12.5910

0.0000

• 0.0406
• 1.5478

0.1373 DP

• 0.0471
• 1.9188

0.0694 0.0447 2.0676 0.0519 NIM 0.1751 0.9814 0.3381 0.1245 0.9062 0.3756 NII 0.4152 3.2677 0.0039 0.4540 4.7546 0.0001 IGSEC 0.0309 1.2741 0.2172

• 0.0323
• 1.2864

0.2130 OI 0.1373 2.1722 0.0420 0.1331 1.8856 0.0740

• The coefficient of NII is the highest for both the year.

• 5. Analysis of The Profitability Determinants cont..
• Hypothesis H1a: Asset size measured by natural logarithm of total

assets (logA) has a significant positive impact on ROA

• Coefficient = 0.0015 and -0.0004

t= 0.6225 and -0.1684 p= 0.5406 and 0.8679

Hypothesis Test

p= 0.5406 and 0.8679 Result: Rejected

• Hypothesis H2a: Net Interest Margin (NIM) has a significant

positive impact on ROA Coefficient =0.1751 and 0.1245 t= 0.9814 and 0.9062 p= 0.3381 and 0.3756 Result: Accepted

25

• 5. Analysis of The Profitability Determinants cont..
• Hypothesis H3a Banks with more diversified income measured by Non-

Interest Income (NII) tend to be more profitable Coefficient = 0.4152 and 0.4540 t= 3.2677 and 4.7546 p = 0.0039 and 0.0001 Result: Accepted

Hypothesis Test

Result: Accepted

• Hypothesis H4a: Investment activities mainly in quoted and unquoted

shares and debentures of private sectors measured by Other Investment (OI) have a significant positive impact on ROA Coefficient = 0.1373 and 0.1331 t= 2.1722 and 1.8856 p= 0.0420 and 0.0740 Result: Accepted

26

• 6. Conclusion and Recommendations

Asset size:

– No significant effect on profitability – It suggests that to achieve a higher level of ROA it is not always necessary to be a larger bank

Interest income:

– It is always considered to be the main source of income and found to have positive impact on profitability

Non-interest income: Major Findings Non-interest income:

– The most significant variable which affects the profitability – This indicates that greater diversification in banking activities positively influence profitability

Investment activities:

– Other Investment- mainly in shares and debentures (quoted and unquoted) of private sectors have a significant positive impact on ROA – It suggests that banks which are more exposed to the capital market or invest higher proportion of funds in unquoted shares and debenture may achieve higher profitability

27

• 6. Conclusion and Recommendations Cont..
• Diversified banking activities- bring more new and innovative

products and services - can have argument whether it should be welcomed or not

• Diversification reduces risks, but if the earning includes volatile

trading activity in higher proportion the risk may become higher.

• More exposure in the capital market may bring more risk – when

Policy Relevance

• More exposure in the capital market may bring more risk – when

speculation rather than the real financial indicators is dominant.

• New and Innovative products- create more complexity- customers

can be exploited by higher fees and commission. Non-traditional activates of banks (other than deposit taking and lending) may lead banks to higher exposure to the risk. So, from the regulatory perspective, risk management should be the key focus.

28

• 6. Conclusion and Recommendations

The policy direction should be directed in such a way which will enhance the resilience and efficiency of the financial institutions with the aim of intensifying the robustness as well as stability of the banking sector.

• Capital adequacy should be emphasized so that banks are able

to withstand any negative shock

Recommendations

to withstand any negative shock

• Ring-fencing traditional banking from investment banking

activities

• Putting limit on the exposure to risk taking investment

activities can be one of the way to minimize the risk

• The risk taking investment activities also should be monitored

very closely by the supervisor

• Fees and commission should be monitored and managed so

that a customer is not deceived

29

Future Research Direction

• Inclusion of macroeconomic variables such as

GDP growth rate, inflation rate (INF) and real interest rate (RI).

• 6. Conclusion and Recommendations Cont..

interest rate (RI).

• Use of Panel Data Set.
• To analyze the linkage between the bank’s

profitability and their exposure to the capital market more intensively

30

31