Impact on Indian banks’ profitability indicators – an empirical study

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The aim of the present research is to determine the impact of the external and internal factors of bank performance on the profitability indicators of the Indian commercial banks in the period from 2006 to 2014.

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INTERNATIONAL JOURNAL OF MANAGEMENT (IJM) ISSN 0976-6502 (Print) ISSN 0976-6510 (Online) IJM Volume 7, Issue 2, February (2016), pp. 285-290 http://www.iaeme.com/ijm/index.asp ©IAEME Journal Impact Factor (2016): 8.1920 (Calculated by GISI) www.jifactor.com IMPACT ON INDIAN BANKS’ PROFITABILITY INDICATORS – AN EMPIRICAL STUDY G. Rathika Assistant Professor, Shrimati Indira Gandhi College, Trichy-620006 ABSTRACT The Indian banking system consists of 26 public sector banks, 20 private sector banks, 43 foreign banks, 56 regional rural banks, 1,589 urban cooperative banks and 93,550 rural cooperative banks, in addition to cooperative credit institutions. The Indian banking sector’s assets reached US$ 1.8 trillion in FY14 from US$ 1.3 trillion in FY10, with 70 per cent of it being accounted by the public sector. Indian banks are increasingly focusing on adopting integrated approach to risk management. Banks have already embraced the international banking supervision accord of Basel II. According to RBI, majority of the banks already meet capital requirements of Basel III, which has a deadline of March 31, 2019. Most of the banks have put in place the framework for asset-liability match, credit and derivatives risk management. The aim of the present research is to determine the impact of the external and internal factors of bank performance on the profitability indicators of the Indian commercial banks in the period from 2006 to 2014. On the basis of research conducted abroad on bank and macroeconomic profitability indicators, in order to obtain research results return on assets (ROA) and return on equity (ROE) indicators were analyzed using descriptive methods. On the basis of the obtained results, the profitability has had a significant effect on Net interest margin credit risk and portfolio composition and management. With regard to macroeconomic indicators, inflation has negative impact on exchange rate of USD/INR has a positive impact on profitability as measured by ROA and ROE. Considering the changes in macroeconomic indicators, the banks should be able to anticipate potential crises in order to avoid negative consequences for the bank-specific indicators. Key words: Return on Assets, Net Interest Margin, Return on Equity, Profitability Cite this Article: G. Rathika. Impact on Indian Banks’ Profitability Indicators – An Empirical Study. International Journal of Management, 7(2), 2016, pp. 285-290. http://www.iaeme.com/ijm/index.asp 1. INTRODUCTION The Indian banking system consists of 26 public sector banks, 20 private sector banks, 43 foreign banks, 56 regional rural banks, 1,589 urban cooperative banks and 93,550 rural cooperative banks, in addition to cooperative credit institutions. The Indian banking sector’s assets reached US$ 1.8 trillion in FY14 from US$ 1.3 trillion in FY10, with 70 per cent of it being accounted by the public sector. Indian banks are increasingly focusing on adopting integrated approach to risk management. Banks have already embraced the international banking supervision accord of Basel II. According to RBI, majority of the banks already meet capital requirements of Basel III, which has a deadline of March 31, 285 G. Rathika, “Impact on Indian Banks’ Profitability Indicators – An Empirical Study” – (ICAM 2016)
International Journal of Management (IJM), ISSN 0976 – 6502(Print), ISSN 0976 - 6510(Online), Volume 7, Issue 2, February (2016), pp. 285-290 © IAEME Publication 2019. Most of the banks have put in place the framework for asset-liability match, credit and derivatives risk management. Total lending and deposits increased at a compound annual growth rate (CAGR) of 20.7 per cent and 19.7 per cent, respectively, during FY07-14 and are further poised for growth, backed by demand for housing and personal finance. Total asset size of banking sector assets is expected to increase to US$ 28.5 trillion by FY25. Deposits have grown at a CAGR of 13.6 per cent during FY05–15 to an estimated US$ 1.48 trillion in FY15. Deposit growth has been mainly driven by strong growth in savings amid rising disposable income levels. Rising incomes are expected to enhance the need for banking services in rural areas and therefore drive the growth of the sector. The Reserve Bank of India (RBI) has relaxed its branch licensing policy, thereby allowing banks (which meet certain financial parameters) to set-up new branches in tier-2 to tier-6 centers, without prior approval from RBI. It has emphasized the need to focus on spreading the reach of banking services to the un-banked population of India. On the operating environment, Moody's expects that India will record the GDP growth of around 7.5% in 2015 and 2016. "Growth has been supported by low inflation and the gradual implementation of structural reforms. As for asset risk and capital, Moody's said that asset quality will stabilise. In particular, while the banks' stock of non-performing loans may continue to rise, the pace of new impaired loan formation in the current financial year ending March 2016 will be lower than the levels seen in the past four years. 2. LITERATURE REVIEW The issue of bank profitability and performance efficiency has been widely discussed in the scientific literature, it has also been considered in a number of theoretical and empirical researches of different kind. However, return on assets (ROA) and return on equity (ROE) have always been mentioned among the main indicators characterizing bank performance. Bourke (1989) was one of the first who discovered in his research that exactly the internal factors of bank performance, such as net income before and after tax against total assets and capital and reserves factors, have the greatest impact on profitability indicators. In turn, the studies conducted in the USA and Europe demonstrate that a great concentration of banks and financial institutions surpass profitability (Petersen and Rajan, 1995; Koskela, 2000; Shaffer, 2004; Degryse and Ongena, 2007). At the same time, Ramlall (2009) and Sufian (2009) discovered a positive relationship between the size of the bank and profitability – the larger the bank is, the more profitable it is in comparison with a smaller bank, thus demonstrating the effect of economy of scale. In contrast, Kosmidou (2008) states that large size of the banks may leave a negative impact on bank profitability, and Luo (2003) and Hannan and Prager (2009) note that small banks can earn higher profit because they have lower expenses and better performance efficiency. At the same time, Sayilgan and Yildirim (2009) maintain that bank liquidity declines along with the growth of the number of debtors and interest rate increase. Other studies, which address profitability, discuss positive operational efficiency. Kosmidou (2008) states that profitability grows along with the increase of the operational efficiency, in their turn, Berger et al (2000) correlate it with routine practical activities of an enterprise. Despite difference of opinion, all scholars agree that profitability and efficiency indicators consist of external and internal factors. For example, Rasiah et al (2010) in his research mentions asset portfolio mix, loans and interest income, investments, non-interest income earning assets, total expenses, operating expenses, personnel expenses, liability composition, deposit composition, liquidity ratios, capital structure as internal factors influencing profitability. In turn, external factors comprise regulations, inflation, interest rate, short and long terms effects of interest rate on assets, market share, market growth, firm size. Gul et al (2011) mention size, capital, loans, and deposits as internal factors influencing profitability of the bank, and GDP and inflation as external factors. 3. RESEARCH METHODOLOGY (i)Research Design Research design provides the glue that holds the research project together. A design is used to structure the research, to show how all of the major parts of the research project -- the samples or groups, 286 G. Rathika, “Impact On Indian Banks’ Profitability Indicators – An Empirical Study” – (ICAM 2016)
International Journal of Management (IJM), ISSN 0976 – 6502(Print), ISSN 0976 - 6510(Online), Volume 7, Issue 2, February (2016), pp. 285-290 © IAEME Publication measures, treatments or programs, and methods of assignment -- work together to try to address the central research questions. (ii) Type of Research The Empirical research is done under the study. It is based on observed and measured phenomena and derives knowledge from actual experience rather than from theory or belief. (iii) Tools for Data Collection The data is secondary in nature. Annual reports of all banks and data base of RBI are the main source to collect the necessary details. The finance books are also used for the study. (iv) Sampling methods The Indian banking system consists of 26 public sector banks, 20 private sector banks, 43 foreign banks, 56 regional rural banks, 1,589 urban cooperative banks and 93,550 rural cooperative banks. The consolidated data of all banks have taken for analysis. (v) Period of Study The study uses five years data which is from 2011 to 2015 4. OBJECTIVES OF THE STUDY MAIN OBJECTIVES: To find out the factors affecting banks’ profitability ADDITIONAL OBJECTIVES 1. To analyse the factors that affects profitability which are specific to the banks. 2. To analyse the factors which are uncontrollable that affects banks’ profitability. 3. To extract the variables that show significant impact on the profitability. 5. RESULT ANALYSIS AND INTERPRETATION The internal and external factors influencing profitability indicators of Indian commercial banks. The factors and their abbreviations are presented in Table 1. Table 1 Bank Profitability Indicators, Abbreviations Specific Internal External Return on assets (ROA) Asset size Gross Domestic Product Return on equity (ROE) Leverage Annual inflation (INF) Capital Adequacy Economic Growth Net Interest Margin Growth in Money Supply Non Performing Loans to Total Loans Exchange rates of USD/INR Growth in assets In order to determine profitability of the banks and macroeconomic indicators, performance indicators of return on assets (ROA) and return on equity (ROE) of the commercial banks have been evaluated. For assessment of the profitability indicators, correlation and linear regression analyses of the obtained data have been performed. 287 G. Rathika, “Impact On Indian Banks’ Profitability Indicators – An Empirical Study” – (ICAM 2016)
International Journal of Management (IJM), ISSN 0976 – 6502(Print), ISSN 0976 - 6510(Online), Volume 7, Issue 2, February (2016), pp. 285-290 © IAEME Publication 6. CORRELATION ANALYSIS Table 2 Correlation Analysis of ROA on External and Internal Indicators NET ECON MONE CAPIT GROW INTER OMIC INFLA Y ASSET AL TH IN CREDI GDP ROA ROE EST GROW TION SUPPL SIZE ADEQ DEPOS T RISK MARG TH Y UACY ITS IN GDP 1.00 -0.34 0.59 1.00 -0.21 -0.31 0.95 -0.77 0.39 1.00 0.56 ECONOMIC GROWTH -0.34 1.00 -0.23 -0.38 0.02 0.03 -0.41 0.21 -0.28 -0.39 -0.25 INFLATION 0.59 -0.23 1.00 0.59 0.29 0.05 0.48 -0.34 0.40 0.59 -0.02 MONEY SUPPLY 1.00 -0.38 0.59 1.00 -0.25 -0.34 0.97 -0.74 0.40 1.00 0.56 ROA -0.21 0.02 0.29 -0.25 1.00 0.92 -0.45 -0.01 -0.05 -0.25 -0.65 ROE -0.31 0.03 0.05 -0.34 0.92 1.00 -0.53 0.15 -0.08 -0.34 -0.57 ASSETSIZE 0.95 -0.41 0.48 0.97 -0.45 -0.53 1.00 -0.68 0.35 0.96 0.61 NET INTEREST MARGIN -0.77 0.21 -0.34 -0.74 -0.01 0.15 -0.68 1.00 -0.42 -0.73 -0.33 CAPITAL ADEQUACY 0.39 -0.28 0.40 0.40 -0.05 -0.08 0.35 -0.42 1.00 0.40 -0.06 GROWTH IN DEPOSITS 1.00 -0.39 0.59 1.00 -0.25 -0.34 0.96 -0.73 0.40 1.00 0.58 CREDIT RISK 0.56 -0.25 -0.02 0.56 -0.65 -0.57 0.61 -0.33 -0.06 0.58 1.00 EXCHANGE RATE 0.71 -0.32 0.27 0.74 -0.74 -0.77 0.86 -0.39 0.12 0.75 0.81 7. INTERPRETATION The above table doesn’t show any multi collinearity between independent variables and dependent variables. The asset size has high positive correlation on growth in deposits and increase in money supply. Table 3 Regression Analysis of ROA on External and Internal Indicators Unstandardized Standardized Coefficients Coefficients T Sig. B Std. Error Beta (Constant) 1.458 0.414 3.524 0.024 GDP 0.001 0.001 2.795 0.931 0.404 ECONOMICGROWTH -0.015 0.013 -0.254 -1.156 0.312 INFLATION 0.022 0.012 0.42 1.854 0.137 MONEYSUPPLY 0 0.001 -2.679 -0.831 0.452 EXCHANGERATE -0.018 0.006 -0.944 -2.891 0.044 ASSETSIZE -1.256 0.293 -2.432 -4.281 0.013 NETINTERESTMARGIN -0.089 0.104 -0.188 -0.855 0.441 CAPITALADEQUACY -0.143 0.083 -0.301 -1.725 0.16 GROWTHINDEPOSITS 0.001 0 2.463 4.034 0.016 CREDIT RISK -0.103 0.031 -0.671 -3.375 0.028 288 G. Rathika, “Impact On Indian Banks’ Profitability Indicators – An Empirical Study” – (ICAM 2016)
International Journal of Management (IJM), ISSN 0976 – 6502(Print), ISSN 0976 - 6510(Online), Volume 7, Issue 2, February (2016), pp. 285-290 © IAEME Publication Table 4 Regression Analysis of ROE on External and Internal Indicators Unstandardized Standardized Coefficients Coefficients t Sig. Std. B Beta Error (Constant) 101.796 31.214 3.261 0.031 ASSETSIZE -18.917 6.708 -2.592 -2.82 0.048 NET INTEREST MARGIN 0.043 2.375 0.007 0.018 0.986 CAPITAL ADEQUACY -1.272 1.896 -0.189 -0.671 0.539 GROWTH IN DEPOSITS 0.013 0.005 2.485 2.515 0.066 CREDIT RISK -0.936 0.701 -0.43 -1.336 0.253 GDP 0.009 0.025 1.587 0.365 0.734 ECONOMIC GROWTH -0.201 0.272 -0.235 -0.739 0.501 INFLATION 0.092 0.247 0.122 0.373 0.728 GROWTH IN MONEY -0.006 0.021 -1.311 -0.281 0.793 SUPPLY EXCHANGERATE -0.28 0.127 -1.042 -2.204 0.092 Table 5 Model Summary of ROA Model R R Square Adjusted R Square Std. Error of the Estimate 1 .957a .916 .811 .05519 Table 6 Model Summary of ROE Model R R Square Adjusted R Square Std. Error of the Estimate 1 .883a .780 .505 1.26220 8. INTERPRETATION 1. The impact of bank characteristics represented by net interest margin. The regression results show that has a positive and significant impact on both return on equity (ROE) and return on asset (ROA). The value of the coefficient is (0.43) and (-0.89) respectively. This means that net interest decreases Indian banks (ROA) by 89% and (ROE) by 43% when it is increased by 1% keeping other variables fixed. This supports that the banks use their assets properly and effectively. 2. The bank financial structure represented by bank size measured by logarithmic of total assets (LTA): The regression results show that the log total assets (LTA) has a negative and significant impact on both return on assets (ROA) and return on equity (ROE). The result suggests that smaller the size of the bank, the more profitable the bank will be, cost can be reduced and therefore, performance can be improved. 3. The impact of bank characteristics represented by credit risk which is non performing loans to total loans shows that has a negative significant impact on return on assets (ROA) and a negative significant impact return on equity (ROE). This shows that the profitability decreases while credit risk increases. 289 G. Rathika, “Impact On Indian Banks’ Profitability Indicators – An Empirical Study” – (ICAM 2016)
International Journal of Management (IJM), ISSN 0976 – 6502(Print), ISSN 0976 - 6510(Online), Volume 7, Issue 2, February (2016), pp. 285-290 © IAEME Publication 4. The capital adequacy shows that if the loans will become bad, the bank can well absorb the losses being made. The regression equation reveals that there is negative insignificant impact on ROA but there is a significant negative impact on ROE. This shows that the assets are well managed by the banks but because of the increases in bad loans the ROE will be seriously affected. This should be taken into account for all banks. 5. The growth in deposits had less or negotiable impact on ROE and ROA. 6. The impact of macroeconomic factors measured by the GDP. The regression results show that there is less variation on the return on assets (ROA) and return on equity (ROE). 7. The impact of macroeconomic factors measured by the economic growth has insignificant impact on return on assets (ROA) and (ROE). 8. The macroeconomic factor inflation has a significant and negative impact on bank profitability. This shows that if inflation increases the deposits will come down which in turn decreases in the profitability 9. The regression results of exchange rates of USD/INR shows that there is significant impact on return on assets and return on equity. The assets invested in foreign countries by Indian banks will have the changes in profit and this will clearly seen in the regression analysis. 10. The regression equation of increase in money supply has very less or no impact on return on assets (ROA) and (ROE). 11. The values of R-squared is equal to (. 957) for (ROA) and (0.883), for (ROE) this means that 94% and 88.3% respectively of the total variation in the level of ROA and ROE for Indian banks attributed to the variation in the internal variables and the variation in external variables. 9. CONCLUSION Profitability is an important criterion for assessing operational efficiency of banks in the changing financial environment. With current research authors were able to find interconnection between bank specific and macroeconomic indicators in the Indian commercial banks in the period from 2011 to 2015. On the basis of the obtained results, the profitability has had a significant effect on Net interest margin credit risk and portfolio composition and management. With regard to macroeconomic indicators, inflation has negative impact on exchange rate of USD/INR has a positive impact on profitability as measured by ROA and ROE. Considering the changes in macroeconomic indicators, the banks should be able to anticipate potential crises in order to avoid negative consequences for the bank-specific indicators. This issue is topical not only for researchers but also for the bankers themselves, including bank management and shareholders. REFERENCES [1] Abrahamson, E. (2000). "Change without Pain," Harvard Business Review, 1 July, 5. [2] Alexiou, C. & Safoklis, V. (2009)."Determinants of Bank Profitability: Evidence from the Greek Banking Sector," Economic Annals, 182, 93-118. [3] Berger, A. N., Bonime, S. D., Covitz, D. M. & Hancock, D. (2000)."Why are Bank Profits so Persistent? The Roles of Product Market Competition, Informational Opacity, and Regional-Macroeconomic Shocks," Journal of Banking & Finance, 24(7), 1203- 1235. [4] Degryse, H. & Ongena, S. (2007)."The Impact of Competition on Bank Orientation," Journal of Financial intermediation, 16(3), 399-424. [5] www.rbi.org.in [6] www.worldbank.org 290 G. Rathika, “Impact On Indian Banks’ Profitability Indicators – An Empirical Study” – (ICAM 2016)