The Profitability Determinants of Private Commercial Banks in Bangladesh Presented by 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 4. Research Methodology 5. Analysis of The Profitability Determinants of Private Commercial Banks in Bangladesh 6. Conclusion and Recommendations for Policy Implications 2
Financial System of Bangladesh Central Bank (Bangladesh Bank) State Owned Commercial Banks (SCBs) Private Commercial Banks (PCBs) Foreign Banks (FCBs) Controller of Insurance (under the ministry of commerce) Life Insurance General 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 Chittagong Stock Exchange Government -owned Specialized Banks (DFIs) Non-Bank Financial Institution (NBFIs) The Financial sector of Bangladesh, like most in developing countries, is dominated by banking industry. 3
1. Overview of the Banking Sector in Bangladesh 35 30 25 20 15 10 5 0 Number of Banks in Bangladesh (by Type) from 1975 to 2010 30 30 27 Nationalised banks 13 13 10 8 9 9 9 Specialised banks 6 6 7 7 4 4 4 54 54 54 2 2 2 3 4 Private banks Foreign banks 1975 1980 1985 1990 1995 2000 2005 2010 Year In 1982license 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 4
1. Overview of the Banking Sector in Bangladesh Cont.. 40 30 20 10 0 Number of Scheduled Banks (by Type) in Bangladesh (as on June, 2010) 4 4 30 SCBs DFIs PCBs FCBs Bank Type 9 Share of Industry Assets by Type(as on June, 2010) FCBs 7% SCBs 29% 4000 3000 2000 1000 0 Number of Bank Branches by Type(as on June, 2010) 3394 1366 2427 59 SCBs DFIs PCBs FCBs Bank Type PCBs 57% DFIs 7% 5
1. Overview of the Banking Sector in Bangladesh Cont.. Deposit of Scheduled Banks by Types % 100 90 80 70 60 50 40 30 20 10 0 89.45 70.89 62.43 62.07 55.22 60.81 46.47 40.52 26.06 27.85 31.47 27.83 18.34 4.34 6.21 0 6.37 4.4 4.37 7.14 5.18 4.9 7.04 5.98 7.04 5.97 6.26 5.1 SCBs DFIs PCBs FCBs 1980 1985 1990 1995 2000 2005 2010 Year The higher interest rate on deposit may be the probable reason for rising trend of PCBs deposit. 6
1. Overview of the Banking Sector in Bangladesh Cont.. Advances of Scheduled Banks by Types % 90 80 70 60 50 40 30 20 10 0 80.2 65.39 58.26 52.78 52.36 47.17 49.02 35.25 31.13 22.94 20.42 21.05 25.13 21.8 16.16 13.51 17.18 16.16 9.18 3.65 5.29 5.75 5.32 5.54 6.55 5.86 6.95 0 SCBs DFIs PCBs FCBs 1980 1985 1990 1995 2000 2005 2010 Year One of the probable reason of increasing trend of advances for PCBs is the quicker and easier loan processing. 7
1. Overview of the Banking Sector in Bangladesh Cont.. Million Taka 50000.00 40000.00 30000.00 20000.00 10000.00 Trend of Net Profit of Scheduled Banks by Type 0.00-10000.00-20000.00-30000.00-40000.00-50000.00-44159.20 36555.90 9440.30 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009(p) Year SCBs FCBs PCBs DFIs From the year 2006 the profit of PCBs begun to rise in the rocket highrateanditendedwith36,555.90milliontakaintheyear2009. 8
1. Overview of the Banking Sector in Bangladesh Cont. Trend of ROA of Scheduled Banks by Type % 3.50 3.00 2.50 2.00 1.50 1.00 0.50 0.00-0.50-1.00 2.40 2.60 0.80 0.70 0.30 0.10 0.10 0.00 3.20 3.10 3.10 3.18 2.90 2.87 2.20 2.00 1.20 1.10 1.10 1.30 1.40 1.55 0.96 0.70 0.74 0.37-0.10-0.10 0.00 0.00 0.22-0.20-0.20-0.30-0.60 SCBs DFIs PCBs FCBs Year PCBs always maintained the second level of ROA in the industry for the entire period. Fromtheyear2009to2010theROAofPCBsroseremarkably. 9
2. Analysis of Profitability: The Case of AB Bank Ltd. Taka (million) Net Profit of AB Bank Ltd. 4,500.00 4,000.00 3,500.00 3,000.00 2,500.00 2,000.00 1,500.00 1,000.00 500.00-532.19 162.45 2,300.62 1,903.49 3,989.52 3,417.19 160,000.00 140,000.00 120,000.00 100,000.00 80,000.00 60,000.00 40,000.00 20,000.00 - Total Assets of AB Bank Ltd. 84,053.61 63,549.86 47,989.34 33,065.40 134,003.8 107,093.0 8 1 2005 2006 2007 2008 2009 2010 2005 2006 2007 2008 2009 2010 Year Year Net Profit Total Asset 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. 10
2. Analysis of Profitability: The Case of AB Bank Ltd. Cont.. Comparative Trend of ROA 3.5% 3.0% 3.0% 2.7% 3.2% 3.0% % 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% 1.1% 1.30% 1.40% 1.1% 1.10% 0.5% 1.2% 0.8% 0.9% 0.6% 1.55% 1.4% 2.00% 1.6% ABBL PCBs Banking Industry 2005 2006 2007 2008 2009 2010* Year After 2006 AB Bank Ltd. maintained a much higher level of ROAthanthebankingindustryandeventhePCBs. 11
2. Analysis of Profitability: The Case of AB Bank Ltd. Cont.. % 45.0% 40.0% 35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% Comparative Trend of ROE 42.2% 34.2% 33.2% 28.2% 20.6% 21.0% 24.3% 18.1% 15.2% 16.7% 16.4% 21.7% 10.6% 22.9% 12.4% 14.1% 13.8% 15.6% 2005 2006 2007 2008 2009 2010* Year ABBL PCBs Banking Industry 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 ofabblandlowerequityinthisyear. In the subsequent years the ROE of ABBL declined continuously but it remained above the ROE of banking industry and PCBs. 12
2. Analysis of Profitability: The Case of AB Bank Ltd. Cont.. 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% 0.14% 4.24% 2.68% 2.09% 1.64% 1.28% Income Mix of ABBL 5.06% 4.90% 5.05% 2.26% 2.42% 2.34% 2.77% 1.81% 1.77% 5.91% 3.05% 2.90% 2005 2006 2007 2008 2009 2010 Year NIM NII IIOSBD 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 hadagreatinfluence onthenii. 13
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 of 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: 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
Data: 4. Research Methodology Annual data for all the 30 Private Commercial Banks of Bangladesh for the years 2009 and 2010. Sourceofdata:annualreportofeachbank. To capture the recent year s profitability determinants- only two years data has been considered. Nosamplinghasbeenmadetoselectthebanks. 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
Literature F. Sufian& M. S. Habibullah (2009) N. Jahangir, S. Shill, & M. A. J. Haque (2007) 4. Research Methodology Cont.. Example of variables in few literatures Dependant Variables ROA ROE Independent Variables AssetSize, Capital Adequacy, Loans, Deposit, Loan Loss Provision, NII, GDP, Inflation, Supply of money Asset Size, loan and deposit D. Alpher& A. Anbar ROA, ROE Asset Size, Capital Adequacy, Asset Quality, (2011) Liquidity, Deposits, NIM, NII, GDP, Inflation, Interest Rate M. Pervan, I. Pervan, & A. Guadagnino. (2010) S. S. Debashis, & N. C. Shil(2011) ROA, ROE, NIM Net Profit AssetSize, Market Share, Solvency risk(capital adequacy), Credit risk, Liquidity risk, Operating Exp. Mgt., Fees Income, HHIIndex, Concentration Index, Inflation, GDP Spread,NII, Credit Deposit Ratio, Non Performing Assets to Net Advances, Provision & Contingencies, Operating Exp., Business Per Employee, Profit per Employee 17
Dependent Variable: 4. Research Methodology Cont.. Variable Selection Return on Assets (ROA) and Return on Equity (ROE) are most commonly used ROAhasbeenusedinthisstudy Bank Specific Independent Variables: 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
Dependent Variables Independent Variables Definitions and Notation of the Variables Variable Measure Notation Profitability Return on Assets (ROA) = ROA Net Profit/Total Assets Asset Size Natural Logarithm of Total Assets loga Capital Adequacy Equity / Total Assets CA Asset Quality Loans / Total Assets Non-Performing Loans LA NPL / Total Loans Deposit Deposits/Total Assets DP Income-Expenditure Net Interest Margin = Net NIM Structure Interest Income/ Total Assets NII Non-Interest Income = Non-Interest Income /Total Assets Investment Activities Investment in Govt. securities/total IGSEC Assets OI Other Investment/Total Assets So our profitability model would be as follows: ROA = β 0 + β 1 LogA + β 2 CA + β 3 LA + β 4 NPL + β 5 DP + β 6 NIM + β 7 NII + β 8 IGSEC+ β 9 OI + ε 19
4. Research Methodology Cont.. 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 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 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% 2009 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% 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% 2010 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% Average ROAof 2010 is higher than that of 2009. Average NIIwere higher than the NIMfor both the year. The percentage of other investment is not so high for both the year. 21
5. Analysis of The Profitability Determinants cont.. Correlation Matrix among Independent Variables 2009 2010 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 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 There is no prima facie evidence of multicollinearityfor both the year. 22
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 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.. 23
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 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 NIIis the highest for both the year. 24
5. Analysis of The Profitability Determinants cont.. Hypothesis Test 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 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 Test 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 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 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.. Policy Relevance 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 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 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 Ring-fencing traditional banking from investment banking activities Putting limit on the exposure to risk taking investment activitiescanbeoneofthewaytominimize therisk 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
6. Conclusion and Recommendations Cont.. Future Research Direction Inclusion of macroeconomic variables such as GDP growth rate, inflation rate (INF) and real interest rate(ri). UseofPanelDataSet. To analyze the linkage between the bank s profitability and their exposure to the capital market more intensively 30
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