Determinants of banks’ profitability using a model

DEPENDENT VARIABLE
This thesis attempts to define the determinants of banks’ profitability using a model in which the dependent variable is estimated by using different independent variables. Hence, profitability is the dependent variable of the model and can be estimated using different metrics. Academic research addresses several measures of banks’ profitability, categorized into two classes; accounting based measures and economic based measures.
 
 TRADITIONAL ACCOUNTING MEASURES OF PROFITABILITY
The traditional accounting based measures are simple proxies of banks’ profitability, obtainable from public disclosed information. Prior academic research propose different accounting based measures for banks’ profitability, e.g. the return on equity (ROE) (Goddard et al., 2004) and return on assets (ROA) (Athanasoglou et al., 2008) either by using average values in the denominator (Pasiouras and Kosmidou, 2007 and Dietrich and Wanzenried, 2011). Among others, Demirgüç-Kunt and Huizinga (1999) uses the net interest margin (NIM) as proxy for banks’ profitability. The usage of the mentioned proxies of banks’ profitability is to some extent controversial because the measures have some drawbacks, examined below.
 
Following Golin’s study, as cited in Pasiouras and Kosmidou (2007), return on assets or return on average assets (ROAA), is the key ratio and most common measure of banks’ profitability in today’s banking literature. ROA is an indicator of efficiency and operational performance by presenting the return on each euro of invested assets (Pasiouras and Kosmidou, 2007). Nevertheless, ROA has a major drawback since it is distorted by banks’ off balance sheet (OBS) activities. Returns generated by OBS activities are incorporated in banks’ net income while the accompanying assets of OBS are not incorporated into banks’ assets, reflected by the denominator of the ROA ratio. Hence, the ROA ratio is biased upwards due to an exclusion of OBS assets. Empirical research proposes to use the net interest margin, calculated as net interest income divided by total assets, to overcome the OBS bias. In contrary to ROA, NIM does not include all the profits resulting from off balance sheet activities and other non-core banking activities in the numerator only some interest revenues and expenses relating to OBS activities. Nevertheless, neglecting non-core banking returns is improper since these activities have become increasingly important contributors to banks’ earnings Goddard et al. (2004).
 
Furthermore, ROE is also not affected by OBS activities since it only measures the return on owners’ equity. Traditionally, ROE is the most practiced measure of profitability both for the banking sector as for the non-banking sector (European Central Bank, 2010). However, the ROE ratio has a major drawback because it disregards financial leverage and the impact of regulation on financial leverage (Athanasoglou et al., 2008) and Dietrich and Wanzenried, 2011). Profits generated with debt financing distort the ROE measure since these returns are incorporated in the numerator while the sources of funding are not incorporated in the denominator of the ratio. Banks that rely more on debt financing perform better than banks with a more equity orientated capital structure, ceteris paribus[i]. Hence, according to the European Central Bank (2010) a high ROE may either reflect healthy profitability or reflect low capital adequacy. In this context, the European Central Bank (2010) state that ROE is a useful measure of banks’ profitability during prosperity but appears to be a weak measure of profitability in an environment with substantial higher volatility[ii].
 
[i] The distortion of debt financing is graphically represented by equation (ii); the first two fractions reflects the return on assets (net profit margin and asset turnover) while the latter fraction, the equity multiplier, captures the financial leverage effect. The equity multiplier implies that a higher financial leverage, represented by a lower equity denominator, will lead to a higher ROE, ceteris paribus. Thus, financial leverage distorts ROE as profitability measure because an overleveraged balance sheet will likely give a higher ROE ratio.
 
(ii)
 
[ii] According to the European Central Bank (2010) ROE is an inadequate measure of profitability during times of high volatility. Banks with high ROE ratios performed particularly poor during the financial crisis (a period of high volatility) due to the need for rapid leverage adjustments. Banks with high ROE ratios tend to have a low equity base, which is highly unfavorable in times of uncertainty when losses appear. According to the European Central Bank (2010) the financial crisis indicated that ROE failed to separate profitable banks from non-performing banks; thus, ROE is only a short-term measure by estimating the profitability at a particular moment in time.

Get Professional Assignment Help Cheaply

.
Whichever your reason may is, it is valid! You can get professional academic help from our service at affordable rates. We have a team of professional academic writers who can handle all your assignments.
Our essay writers are graduates with diplomas, bachelor’s, masters, Ph.D., and doctorate degrees in various subjects. The minimum requirement to be an essay writer with our essay writing service is to have a college diploma. When assigning your order, we match the paper subject with the area of specialization of the writer.
Why Choose Our Academic Writing Service?

Plagiarism free papers
Timely delivery
Any deadline
Skilled, Experienced Native English Writers
Subject-relevant academic writer
Adherence to paper instructions
Ability to tackle bulk assignments
Reasonable prices
24/7 Customer Support
Get superb grades consistently

How It Works
1.      Place an order
You fill all the paper instructions in the order form. Make sure you include all the helpful materials so that our academic writers can deliver the perfect paper. It will also help to eliminate unnecessary revisions.
2.      Pay for the order
Proceed to pay for the paper so that it can be assigned to one of our expert academic writers. The paper subject is matched with the writer’s area of specialization.
3.      Track the progress
. Receive a paper.
4.      Download the paper
The paper is sent to your email and uploaded to your personal account. You also get a plagiarism report attached to your paper.
 
PLACE THIS ORDER OR A SIMILAR ORDER WITH 24/7 ESSAY WRITERS TODAY AND GET AN AMAZING DISCOUNT