Determinants of Bank Profitability: The Case of Commercial Banks Listed on the Vietnam s Stock Exchange

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1 Determinants of Bank Profitability: The Case of Commercial Banks Listed on the Vietnam s Stock Exchange Le Thanh TAM 1, Pham Xuan TRANG 2 National Economics University, Hanoi Le Nhat HANH University of Economics, Hochiminh City 3 Abstract Using panel data collected from 9 Vietnamese commercial banks listed in the HNX and HOSE in period data, this paper found out that: (1) profitability level of these banks is higher than minimum requirements of CAMELS, that is, when compared to the average levels of international standards - although some banks got low profitability in certain years; (2) the profitability of these banks are determined by several internal and external factors. The key significant internal factors are: bank size - the smaller banks have higher profit; total assets a total assets growth rate the higher the profit; interest rates higher interest rate level bring better benefit to banks than deposit customers. To improve the bank profitability, management should consider carefully the appropriate bank size, manage the cost structure well, implement the rational interest rate policy, and manage the credit risks and other risks prudentially. Bank returns are also strongly affected by macroeconomic variables, suggesting that macroeconomic policies to promote low inflation and high GDP growth rate to have good impacts on bank profitability and development. Keywords: Capital, Commercial bank, Determinant, Macroeconomic factors, Profitability, Risk. Address Correspondence to: Le Thanh Tam, Ph.D. School of Banking & Finance, National Economics University, Hanoi, Vietnam. tamlt@neu.edu.vn Journal of Business Sciences (JBS) Volume 1, Issue 2, pp (P-ISSN: ; E-ISSN: ) December 2017 Author: Le Thanh Tam, Pham Xuan Trang & Le Nhat Hanh 1

2 1. Introduction Banks play a central function in the economy. They keep the savings of the public and finance the development of business and trade (Casu et al, 2006; Rose et al, 2013). Several studies, summarized and survey by Levine (1996) shown that the bank efficiency can also affect economic growth via net return to savings and gross return for the investment. Several research studies on factors affecting bank performance have been conducted extensively for US commercial banks and, to a lesser extent, for financial institutions in Europe and in large emerging markets. The respective empirical studies have focused their analysis either on cross-country evidence or on the banking system of individual countries in Germany, France, United Kingdom, and the United States. The studies by Molyneux and Thornton (1992), Demirguc-Kunt and Huizinga (1999), Staikouras and Wood (2004), Goddard, Molyneux, and Wilson (2004), Pasiouras and Kosmidou (2007), and Flamini et al. (2009) investigated the bank profitability using panel data set in one country. However, relatively little is known about determinants of bank performance among banks in other developing countries particularly in Vietnam. Thus, this paper attempts to empirically analyse the determinants of profitability of 9 commercial banks listed on HOSE and HNX in the period from 2007 to 2013 by using panel data analysis. 2. Literature Review on determinants of bank profitability. There are some mutual elements to categorise the determinants of banking profitability, focusing on internal factors and external factors. Huizinga (1999) in his research used Regression Analysis to determine the relationship between some bank ratios and measure of profitability. According to the data of banks for 80 countries, they found that differences in interest margins and bank profitability reflect various determinants: macroeconomic conditions, bank characteristics, regulation for insurance of deposit and general financial system. Regarding their research, they found that the bank ratio of concentration also influences to the bank profitability, as bigger banks tend to have a bigger profit. Aburime & Toni (2008) researched on 154 banks over the period. However, it should be noted that the majority of their work was focused on the analysis of external factors. According to their results, they show that the inflation, real interest rates, the exchange rate and monetary policy are significant macroeconomic indexes of bank performance in Nigeria. In this work, they showed that there is a strong relationship between macroeconomic performance and profitability of the bank. But they also reported that stock market development, banking sector development, and financial structure are not statistically significant; and the relationship between bank profitability and tax policy in Nigeria is inconclusive. Regarding studies from the Middle East, a few studies have shed some light on the bank profitability. Khrawish (2011) accessed the Jordanian commercial bank profitability from 2000 through 2010 and categorised the factors affecting profitability into internal and external factors. The author found that there is significant and positive relationship between return on assets (ROA) JOURNAL OF BUSINESS SCIENCES (JBS) 2

3 and the bank size, total liabilities/ total assets, total equity/ total assets, net interest margin and exchange rate of the commercial banks and that there is significant and negative relationship between ROA of the commercial banks and annual growth rate of gross domestic product and inflation rate. In the South Eastern European Region, the impact of many variables on bank profitability have been reported, according to nature and the purpose of each study. Athanasoglou et al. (2008) point out that the determinants of bank profitability are usually discussed as a function of internal and external variables. The internal variables are a proxy of microeconomics or bank-specific determinants such as size, asset quality, capital adequacy, liquidity ratios, operation ratios, and leverage, while the external determinants reflect macroeconomic indicators such as inflation, GDP, and interest rates. Flamini et al. (2009) investigated the bank profitability using panel data set of 389 banks in 44 Sub-Saharan African countries. The findings were: these banks had high profit compared to other regions; apart from credit, higher ROA was associated with larger bank size, activity diversification, and private ownership. Macroeconomic variables such as low inflation and stable economic growth also affect bank returns. However, higher returns do not immediately result in the higher capital requirements. It implies that to strengthen financial stability, policymakers should impose higher capital requirements. The bulk of literature shows that: the profitability of banks can be assessed by either three variables: return on assets (ROA), return on equity (ROE), and net interest margin (NIM). The internal factors affecting bank profitability could be bank size (total asset could be the proxy for this factor), the growth of total assets, credit risk (with a proxy of provision for loan losses), risk (ratio of loans to bank s equity), management expenses, the capital. The external factors which have been assessed in several countries are inflation, GDP growth rate, population growth, interest rate. 3. Data analysis for the case of Vietnam Variables and models Our panel data covers the period of 7 years ( ) of 9 commercial banks operating in Vietnam 4. All the data has been extracted from the financial statements of the commercial banks listed on HOSE or HNX. The data on internal factors of commercial banks collected from their financial statements. Regarding data on external factors, we collected from official websites of General Statistics Office of Vietnam (GSO) and The State Bank of Vietnam (SBV). To facilitate the analysis, the symbols of the variables in the research model are presented in the following table: Table 1: Variables and Abbreviations Variable Abbreviations Variable type Return on average assets ROA Dependent Return on average equity ROE Dependent Net interest margin NIM Dependent 4 These banks are: ACB (HNX), BIDV (HOSE), Vietinbank (CTG HOSE), Eximbank (EIB HOSE), Military Bank (MBB-HOSE), National Citizen Bank (NVB-HNX), SHB (HNX), Sacombank (STB HOSE), Vietcombank (VCB HOSE). Source: National Securities Commission (2014). Author: Le Thanh Tam, Pham Xuan Trang & Le Nhat Hanh 3

4 Bank Size BS Independent and internal Growth of total assets GTA Independent and internal Credit risk CR Independent and internal Risks R Independent and internal Management Expenses ME Independent and internal Capital C Independent and internal Inflation I Independent and external GDP Growth GDP Independent and external Population growth PG Independent and external Interest rate IR Independent and external Based on the literature review above, the three econometric models will be used for analyzing the profile presented in the following sections: Model 1: ROAit = α0 + α1bsit + α2gtait + α3crit + α4rit + α5emit + α6cit + α7iit + α8gdpit + α9pgit + α10irit + εit Model 2: ROEit = β0 + β1bsit + β2gtait + β3crit + β4rit + β5emit + β6cit + β7iit + β8gdpit + β9pgit + β10irit + εit Model 3: NIMit = λ0 + λ1bsit + λ2gtait + λ3crit + λ4rit + λ5emit + λ6cit + λ7iit + λ8gdpit + λ9pgit + λ10irit + εit Subscripts i and t index banks and time in years, respectively; α, β, and λ are coefficients while εit is the error term. Based on the theoretical framework, empirical researches and Vietnam conditions, the research hypotheses of the paper are presented as below: Table 2: The expected impact of independent variables on bank profitability Dependent variable: ROA Dependent variable: ROE Dependent variable: NIM Independent Variables Expected Signal Independent Variables Expected Signal Independent Variables Expected Signal BS - BS - BS - GTA + GTA + GTA + CR + CR + CR + R + R + R + ME + ME + ME + C + C + C + I + I + I + GDP + GDP + GDP + PG + PG + PG + IR + IR + IR + These expected signals will be rejected or accepted according to regression results of three models which presented above. JOURNAL OF BUSINESS SCIENCES (JBS) 4

5 3.2.Descriptive statistics result of the variables Following are the descriptive analysis of the 9 commercial banks listed on the stock exchange of Vietnam. Table 3: Descriptive statistics of the variables Variable Obs Mean Std. Dev. Min Max Median ME BS GTA R NIM ROE ROA CR I GDP PG IR C Source: Stata outputs based on financial statement reports of 9 banks listed on stock exchange Most of the mean and median value of variables are in stable range, with low standard deviation. This implies that there is very low variation in the data set and the distribution of data is fairly 1symmetric. Two exceptional cases of the BS (bank size) and GTA (growth of total assets) due to the fact that we have taken the various size of banks, and there was a large variation in the GTA between banks during that period. The mean levels of ROA (1.26%) and ROE (15.21%) are higher than minimum levels as required by CAMELS and with bank scope database 5 (ROA = 1%, ROE = 15%), showing that on average, these banks had the acceptable profitability levels compared to international standards. These banks are also having better performance among 39 commercial banks in Vietnam, as they have the capacity to be officially listed on the stock exchange. However, the high standard deviation and low in value represent the fact that not all of these 9 banks reach the standard profitability. The Correlation analysis was carried out to show connections between all the variables. Table 2 below presents the results of the correlation analysis for the study in order to determine the level of association among the variables. Table 4: Correlation between variables ME 1 ME BS GTA R NIM ROE ROA CR I GDP PG IR C BS GTA R NIM Author: Le Thanh Tam, Pham Xuan Trang & Le Nhat Hanh 5

6 ROE ROA CR I GDP PG IR C Source: Stata outputs based on financial statement reports of 9 banks listed on stock exchange Overall, with the correlation relationships between the independent variables in the range below 0.6, it would indicate that multicollinearity was not an issue in these estimations, as no two variables were highly correlated. All profitability indicators (ROE, ROA, and NIM) of banks is inversely correlated with ME. It means that management expenses ratio will decrease with changes in profitability ratios. It seems that the increase in costs leads a decrease in profitability. However, GTA of banks is positively correlated to ROE, NIM, and ROA which is consistent with Pasiouras & Kosmidou (2007) and Smirlock (1985). Besides, risk (R) is positively related with the NIM, which is consistent with Abreu and Mendens (2002). This implies that positive relationships between risk, a growth of total assets and profitability indicators can be observed in regression results Regression results and Hausman test for selecting the suitable model In this part, we explore how the changes in explanatory variables influence the dependent variables. Estimation was firstly done by applying the Fixed Effect Model (FEM) and Random Effects model (REM). Because our panel data is unbalanced, econometricians recommend the REM method as an efficient estimator for unbalanced panel data (Baltagi, 2005). This was confirmed by the Hausman specification test which evaluated the efficiency between the REM and FEM estimators for the panel regressions. The results of the Hausman test performed to select between FEM or REM indicate that the REM is more suitable than the FEM because all values of Prob > Chi2 are larger than 5%. 6 These results of Hausman test are consistent with the theory that random effects estimator is expected to generate more efficient results after controlling for possible endogeneity and autocorrelation effects associated with dynamic models (Blundell and Bond (1998). The REM coefficients of the regressions indicate how much ROA, ROE, and NIM (dependent variables) change when there is a change in internal and external variables (independent variables): 6 The Hausman test for models: Test HO: Difference in coefficients not systematic Model 1: Chi2 (10) = Prob>chi2 = Model 2: Chi2 (10) = Prob>chi2 = Model 3: Chi2 (9) = Prob>chi2 = JOURNAL OF BUSINESS SCIENCES (JBS) 6

7 Table 5: REM regression for ROA, ROE, and NIM Model 1 (ROA) Model 2 (ROE) Model 3 (NIM) VARIABLES FEM REM FEM REM FEM REM ME ** * * *** *** (0.192) (0.164) (2.519) (2.135) (0.791) (0.697) BS ** ** * *** ** * (0.299) (0.141) (3.913) (1.806) (1.229) (0.594) GTA * * * * ** ** ( ) ( ) (0.0411) (0.0366) (0.0129) (0.0119) R * ** 0.652** 0.785* 0.292* 0.288** (0.0428) (0.0343) (0.560) (0.444) (0.176) (0.145) CR * * ** 98.98* (14.20) (12.16) (185.9) (157.8) (58.36) (51.53) I * * 0.301*** 0.324*** (0.0132) (0.0117) (0.173) (0.153) (0.0542) (0.0498) GDP ** 26.22* 20.47** (1.104) (0.745) (14.45) (9.662) (4.538) (3.157) PG * * (1.431) (1.333) (18.73) (17.39) (5.880) (5.661) IR ** *** * * (0.221) (0.190) (2.886) (2.469) (0.906) (0.804) C * 0.514** 0.684** * ** (0.0283) (0.0230) (0.371) (0.299) (0.116) (0.0976) Constant * (5.989) (5.477) (78.39) (71.34) (24.61) (23.24) Observations R-squared Number of code1 Standard errors in parentheses *** p<0.01, ** p<0.05, * p<0.1 It is clear that the relationship between profitability indicators (ROA, ROE, and NIM) and capital (C) is positive and statistically significant. The banks with larger capital are able to diversify their business operations by strengthening their ability to assume the risk and get funds at low cost, which will enhance their liquidity position. The overall effect will be an improvement of their lending, with a positive effect on profitability. As Athanasoglou et al. (2005) pointed out, a bank with a sound capital position is able to pursue business opportunities more effectively and has more time and flexibility to deal with problems arising from unexpected losses, thus achieving Author: Le Thanh Tam, Pham Xuan Trang & Le Nhat Hanh 7

8 increased profitability. These results are also confirmed by the studies by Bourke (1989), Flamini et al. (2009). Bank size (BS) has a negative and statistically significant effect on banks profitability indicators (ROA, ROE, and NIM). Therefore, this result does not provide evidence for the economies of scale theory. This conclusion is in line with Athanasoglou et al. (2008), Dietrich & Wanzenried (2009) and Staikouras & Wood (2004). The negative relationship could be that, as the banks are becoming extremely large, the bureaucratic procedures have negatively affected their performances. For instance, the mergers and acquisitions of banks in Vietnam during that period, where the number of banks was reduced, could have caused the returns of the banks to decline (SBV, 2013). In line with expectations, the management expenses (ME) variable has a negative and significant effect on banks profitability indicators (ROA, ROE, and NIM). This result also implies that efficient management of banks expenses, by reducing the cost of operations, improves the performance of the banks. The most important policy lesson to the banks is that reducing the cost of operations reduces the incidence of failure of the banks and hence strengthens the confidence of the shareholders and the public through improved "financial performance of the banks. Thus, as stated by Efficiency Structure (ES) hypothesis, an efficiently managed bank will earn higher profits than the less efficient ones. This signal is consistent with research findings of Huizinga (1999) and Pasiouras & Kosmidou (2007). Interest rate variable (IR) has a positive and significant effect on banks profitability indicators (ROA, ROE, and NIM) as expected. Most banks charge a higher rate of interest on loans and advances because of their perceived risk of doing business than paying deposit interest rates to depositors. Borrowers have no readily available alternative sources of borrowing to finance their investments, the availability doctrine, rather than the cost doctrine, has been the only option. They are ready, at whatever cost, to obtain loans from the banks as far the loans are available. The higher interest rates benefit the banks in terms of higher profits but at the expense of the overall economic development of the country. Expectedly, the GDP variable has the positive and statistically significant relationship with profitability. The positive effect is an indication that higher GDP represents improved business opportunities, which ultimately leads to higher profitability for Vietnamese Commercial Banks from 2007 to The result is consistent with theory as documented in the study by Dietrich & Wanzenrid (2009). With regard to the population growth rate (PG), the impact of this variable on the profitability of commercial banks is not clear. In addition, all the regression coefficient of this variable is not statistically significant. It may come from the fact that these banks do not cover outreach to all the regions. They still focus on urban customers because of the huge market potential here. Table 6: Conclusion on the determinants of Vietnamese commercial banks profitability JOURNAL OF BUSINESS SCIENCES (JBS) 8

9 Independent Variables Expected Signal Actual signal Hypothesis accepted/rejected BS - - Accepted GTA + + Accepted + on ROA/ROE Accepted CR + - on NIM R + + Accepted ME + - Rejected C + + Accepted + on ROE/NIM Accepted I + - on ROA (insignificant) GDP + + Accepted PG + Unclear No conclusion IR + + Accepted Source: Author calculation basing on REM & FEM regressions result The coefficient of the variable representing credit risk (CR) indicates that CR has a negative and significant on ROE and ROA but not on NIM. The higher the interest rate margins, the higher the profits and banks are able to shield themselves against hazards of credit risk resulting from adverse selection and moral hazard. This is consistent with findings of Athanasoglou et al. (2008) & Flamini et al. (2009). For the minus correlation with NIM, it shows that the other incomes are higher than costs to cover the loss in the net interest margin, and the unused of provision for loan losses which have been returned. These banks have saved provision for loan losses because of the efficient credit risk solving. For inflation variable (I), the coefficient is positive and significant, in NIM and ROE but negative and insignificant in ROA. That bank management may anticipate the rate of inflation and react accordingly. Consequently, banks in Vietnam tend to be more profitable in inflationary environments. If predictions become correct, such adjustments in interest rates could be incorporated in inflation expectations, to achieve higher profits. If the forecast is incorrect, the effect of inflation on bank's profitability could be negative or less significant. This is consistent with the finding by Goddard et al. (2004b) that the effect of inflation on bank profitability depends on the ability of inflation forecast by the bank's management. 4. Major findings & conclusion This research contributes to the basic ratiocinate the case of Vietnam, and to shows concurrently what management should determine to develop their bank's profits effectively. It points out that if the bank decides to expand bank size, they could face the reducing profits. Besides, Management Expense (ME) also has a negative relationship with the profitability of banks. Concurrently, the research has found out that IR variable, Capital, and GDP has a positive impact on the index reflecting the bank's profits. The differences in the expected signals of two independent variables (credit risk and growth of population) in Vietnam case with literature reviews show that (i) these banks have reserved more provision for loan losses than actual uses, which means they have good credit risks solutions; and (ii) these banks still operate in urban areas, not yet reaching the rural areas. Author: Le Thanh Tam, Pham Xuan Trang & Le Nhat Hanh 9

10 The policy implications for improving bank profitability are: First, choosing the appropriate bank size level, as small size may bring better benefits. Bank managers should be more careful when deciding to scale up development as if they want to increase profits, it requires them to adjust banking activities in the most appropriate way. The large-size banks or the banks who want to increase their size by M&A, by shares issued should consider their decision carefully. Second, the cost of management should be considered and checked carefully, as the more expenses on them, the less the profitability. Banks should be cost-effective in selecting the good management model. Third, the interest rate policy should be rational and should be one of key competition policies of banks. Customers pay very much attention to the borrowing and deposit prices in the medium-rank market. In calculating the lending interest rates, risk premium should always be one of the key factors. Fourth, credit risk and other risks should be managed in a cost-effective way. Using provision for loan losses and other prevention methods are prioritized. Banks may have to spend more costs for risk prevention, but it is more efficient and spent fewer opportunity costs than to solve the risks which are already occurred. Solving non-performing loans effectively by different measures, including reviewing the lending process, applying the standard internal credit scoring system, selling to the market or to asset management company (VAMC) to clear up their balance sheets. Fifth, market segments and financial services should be diversified more. The urban market is good, but the rural market is also very potential + a huge customer base and less risky. Banks should also enhance and improve quality of traditional and new services to bring more customers, including retailer and wholesale customers in the emerging market of more than 90 million people of Vietnam. The limits of this research are: (i) relying mostly on secondary data; (ii) number of banks in the sample are still small; (iii) A similar study should also be carried out on the relationship between financial performance of commercial banks incorporating more financial and accounting variables and also taking into account the prevailing macroeconomic situation (such as monetary policies, tax structure) and the microeconomic situation (like capital structure) in the country. REFERENCES Aburime, M. & H. Toni (2008), The effect of internal variables on the profitability of commercial banks in Kenya, Accounting Review, (10), pp Athanasoglou, P.P., S.N. Brissimis & M.D. Delis (2008), Bank-specific, industry-specific and macroeconomic determinants of bank profitability, International Financial Markets, Institutions, and Money, 18, JOURNAL OF BUSINESS SCIENCES (JBS) 10

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12 National Securities Commission (2014), List of commercial banks on Hanoi Stock Exchanges (HNX) and Hochiminh City Stock Exchange (HOSE). Pasiouras, F. & K. Kosmidou, (2007), "Factors influencing the profitability of domestic and foreign commercial banks in the European Union, Research in International Business and Finance 21, Research and analysis of Vietcombank Securities. (2013) Updated report of Banking. VCBS. 7 th October. [Online]. Available from: [Accessed: 10 th September 2014] Rose, P. S. and S. C. Hudgins (2013) Bank Management and Financial Services, 9th Edition. London: McGraw Hill. Staikouras, C. & G. Wood (2003), The determinants of bank profitability in Europe, European Applied Business Research Conference Proceedings, Venice. SBV (State Bank of Viet Nam) (2014), Annual Statistics [Online]. Available from: ment?_adf.ctrl-state=14s0la308y_4&_afrloop= [Accessed: 10 th September 2014]. JOURNAL OF BUSINESS SCIENCES (JBS) 12