Determinants of Private Bank Profitabliy

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Determinants of Private Banks’
Profitability in Ethiopia: Panel Data
Yigremachew Benti
Addis Ababa
March 2008
Using the standard static as well as dynamic models, the study tries to find systematic evidence on the determining factors for the corporate profitability of private commercial banks in Ethiopia. The study utilizes data on balance sheet as well as income statement account items of all the domestic private banks, which have at least been operational since 1999/00 fiscal year. In effect six private commercial banks have been included in this survey. Regarding the estimation methodology, I employed a static panel data model. However, in order to correct for parameter endogenouty resulting from the likely presence of unobserved bank specific effect and also to address the dynamic relationship, I use the augmented generalized method of moments (GMM) estimator developed by Arellano and Bond (1991) and further developed by Blundell and Bond (1998). As to the econometric software, I make use of STATA to obtain estimates of the static as well as dynamic panel models. All in all, the study results indicate that interest and non-interest incomes and interest expense are the main determining factor for the profitability of private banks in Ethiopia both in static and dynamic conditions. Increase exposure to credit risks has also strong negative impact on profit. The empirical result evident that there is persistence in profitability and speed of adjustment to industry average (equilibrium) is about 16%. On the contrary, market concentration has no significant role on private banks’ profitability. The contribution of other bank level variables (like fixed asset investment, capital adequacy ratio and employees’ productivity) has considerable positive impact on profit. Macroeconomic conditions such as inflation and tax have significant unfavorable impact on operational performances of private banks. In contrast, improvement in foreign sector or overall economy has significant positive effect on corporate profitability.

1. Introduction
1.1 Background
The financial sector, which is congeries of financial institutions, has multifaceted roles in serving the needs of the economy. The service is rendered through providing three major functions, such as intermediation or allocation, operational and payment systems. Operational and allocative functions are the provisions of financial resources to meet borrowing needs of individuals and other economic agents. The main microeconomic function of financial intermediaries is the provision of facilities to collect and invest saving funds. Provision of a sound payment mechanism is also the other expected service from financial institutions. Hence the performance of a financial institution is perhaps measured in terms of the above major roles of the banking business. The performance of a bank mainly relies on the provision of these functions. Thus, addressing the impacts of internal and external factors on these functions is meant for identifying the inherent effect on the overall operational performances of a particular bank or the financial sector in general. It is instrumental for management decisions through indicating the critical operational variables, existing problems or opportunities and also answering key policy questions. However, evaluating a bank performance is a complex process that involves assessing interaction between the environment, internal and external activities. No consensus has yet emerged on a set of indicators, which is more relevant to assessing financial soundness or building effective early warning systems. Hence, this study intends to systematically measure or closely examine the static as well as dynamic relationship between profitability and those internal and external competitive factors using eight years longitudinal data. 1.2 Objectives of the Study

The main objective of the study is to find...
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