International Business and Economics Research Journal

Topics: Bank, Commercial bank, Retail banking Pages: 39 (8360 words) Published: December 10, 2012
International Business & Economics Research Journal

Volume 3, Number 6

The Determinants
Of European Bank Profitability
Christos K. Staikouras, (E-mail:, Athens University of Economics and Business, Greece Geoffrey E. Wood, (E-mail:, City University Business School, United Kingdom

The rate of return earned by a financial institution is affected by numerous factors. These factors include elements internal to each financial institution and several important external forces shaping earnings performance. The type of explanation would d etermine possible policy implications and ought to be taken seriously. This paper reviews the literature on bank performance studies and classifies the bank profitability determinants. The second part of the paper quantifies how internal determinants (“wit hin effects” changes) and external factors (“dynamic reallocation” effects) contribute to the performance of the EU banking industry as a whole in 1994 -1998. We construct OLS and fixed effects models, and the results provide a new perspective for understan ding the impact of changes in competition on the performance of the EU banking industry. The estimation results suggest that the profitability of European banks is influenced not only by factors related to their management decisions but also to changes in the external macroeconomic environment. The results are in contrast to studies that have examined the structure-performance relationship for European banking and find a positive effect of the concentration and/or market share variables on bank profitabilit y.

1. Introduction


number of studies have examined bank performance in an effort to isolate the factors that account for interbank differences in profitability. These studies fall generally into several categories. One group has focused broadly on the tie between bank earnings and various aspects of bank operating performance. A second set of studies has focused on the relationship between bank earnings performance and balance sheet structure. Another body of literature has examined the impact of s ome regulatory, macroeconomic or structural factors on overall bank performance. The term bank structure is frequently used when referring to the characteristics of individual institutions. Individual bank characteristics such as the portfolio compositio n, and the scale and scope of operations, can affect the costs at which banks produce financial services. Market structure, measured by the relative size and number of firms, can influence the degree of local competition, and, by extension, the quality, quantity, and price of financial services ultimately available to bank customers. 2. Literature Review

Determinants of bank profitability can be split between those that are internal and those that are external. Internal determinants of bank profitabilit y can be defined as those factors that are influenced by the bank‟s management decisions and policy objectives. Management effects are the results of differences in bank management objectives, policies, decisions, and actions reflected in differences in ba nk operating results, including profitability. Zimmerman (1996) found that management decisions, especially regarding loan portfolio concentration, were an important contributing factor in bank performance. Researchers frequently attribute good bank performance to quality management. Management quality is assessed in terms of senior officers‟ awareness and control of the bank‟s policies and performance. Haslem (1968, 1969) computed balance sheet and income statement ratios for all the member banks of the US Federal Reserve System in a two -year study. His results indicated that most of the ratios were significantly related to profitability, particularly capital ratios, interest paid and received, salaries and wages. He also stated that a guide for improved management should first emphasise expense management, fund source 57...
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