Investigating internal and external factors influencing profitability of banking industry

Abstract

This paper presents an empirical investigation to learn the impact of some internal and external factors on profitability in banking system. The proposed model of this paper introduces three econometrics methods to study the behavior of internal, external and a combination of both factors on return on assets. The proposed study of this paper uses Vector Auto- Regressive (VAR) and Vector Error Correction Model (VECM) to provide estimation of the proposed model and we use historical data over the period of 1989-2010. The results of the first model for internal factors, we consider some independent variables including ratio of total revenue on total assets (TR) and ratio of total equities on total assets (TE). The second model considers the effects of external variables on ROA such as growth domestic product (GDP) and market share (MS) and the last model includes a combination of both internal and external factors. The results indicates that there is a positive and meaningful relationship between logarithm of growth domestic product and return on equities, which means as we expect one unit increase in LGDP, there is an increase of 0.012 on ROA. In addition, when the market share increase by one percent, there will be an increase 0.025% increase on ROA and an increase of one percent in the ratio of TR will yield to an increase of one percent in ROA.

Keywords

• Return on assets
• Banking profitability
• Time series analysis