DETERMINANT OF COMMERCIAL BANKS PROFITABILITY:
THE CASE OF PRIVATE COMMERCIAL BANKS IN
ETHIOPIA
SALALE UNIVERSITY
COLLEGE OF BUSINESS AND ECONOMICS
DEPARTMENT OF ACCOUNTING AND FINANCE
A Thesis Submitted to Department of Accounting and Finance, College of
Business and Economics, Salale University for the Partial Fulfillment of the
Requirements for the Award of Masters of Science in Accounting and Finance.
Prepared by: Sabura Mengistu
ID.no.WM03141/14
Advisor: Dr.Shewit Kinfe.
Co-advisor: Shibiru Bayu.
June, 2023
Sululta, Ethiopia
DETERMINANT OF COMMERCIAL BANKS PROFITABILITY:
THE CASE OF PRIVATE COMMERCIAL BANKS IN
ETHIOPIA
A Thesis Submitted to Department of Accounting and Finance, College of
Business and Economics, Salale University for the Partial Fulfillment of the
Requirements for the Award of Masters of Science in Accounting and Finance.
Prepared by: Sabura Mengistu
.
June, 2023
Sululta, Ethiopia
i
DECLARATION
I, Sabura Mengistu Abera, ID.No. WM/0341/14, do hereby declare that this thesis entitled
“Determinant of commercial bank profitability: the case of selected private commercial bank
in Ethiopia” is my original work and that it has not been submitted partially or in full by any other
person for an award of degree or publication in any other university.
Submitted by:
Full name: Sabura Mengistu Abera
Signature _________________Date____________
ii
CERTIFICATE
This is to certify that the thesis entitled “Determinant of commercial bank profitability: the
case of selected private commercial bank in Ethiopia” submitted to Department of Accounting
and Finance College of Business and Economics, Salale University by Sabura Mengistu Abera for
the degree of Masters of science in Accounting and Finance, is original work done by the candidate
under my supervision. I further certify that the entire thesis represents the independent work of
Sabura Mengistu Abera and all the thesis works were undertaken by the candidate under my
supervision and guidance.
This thesis has been submitted for examination with my approval.
Name of main advisor _____________________ Signature ____________Date______________
Name of co-advisor _______________________Signature ______________Date ____________
iii
SALALE UNIVERSITY
COLLEGE OF BUSINESS AND ECONOMICS
DEPARTMENT OF ACCOUNTING AND FINANCE
BOARD OF EXAMINERS THESIS APPROVAL SHEET
The undersigned certify that I have read and hereby recommend Department of Accounting and
finance, Salale University, to accept the thesis entitled “determinant of commercial bank
profitability the case of selected private commercial banks in Ethiopia” which had been
submitted by SABURA MENGISTU ABERA in partial fulfillment of the requirements for the
award of a Master Degree in Accounting and finance.
Submitted by:
SABURA MENGISTU ABERA
Name of the Student
_______________
Signature
_____________
Date
Approved by:
Name of the Main advisor
___________________________
Name of Co-advisor
_______________________
Name of External Examiner
_______________________
Name of Internal Examiner
_______________________
Name of Chairperson
_____________________
Name of Department Head
_______________________
Signature
____________________
Signature
__________________
Signature
_________________
Signature
_________________
Signature
________________
Signature
_________________
iv
Date
________________
Date
____________________
Date
____________________
Date
______________________
Date
__________________
Date
____________________
ACKNOWLEDGEMENTS
First of all, I would like to thank the almighty God for all his assistance to accomplish my thesis.
My sincere and deepest gratitude goes to my advisor, Dr Shewit Kinfe (Ass. Prof), and my coadvisor Mr Shibiru Bedada for their unreserved follow up, comments and constructive guidance
throughout conducting this study.
I would also like to express my unreserved and deepest love to Mr dessalegn Geneti for his kind
advice and appreciation to start my master education.
I also want to thank Mr. Fikadu Gemechu from the bottom of my heart for the financial help and
advice you gave me, especially the one who encouraged me by saying that “teaching you is
teaching the country.”
Finally I would like to thank you all of my friends who have encouraged me from far and near to
overcome all my breakdowns and reach at this place. On the contrary, may those who wish me a
break and fail to succeed, may he give you heart.
v
LIST OF TABLES
page
Table 1. List of Public and Private Commercial Banks in Ethiopia
15
Table 2: Descriptive analysis
59
Table 3.The Correlation Analysis
60
Table 4 Regression Analysis
61
Table 5.The Hypotheses Summary
62
vi
ABSTRACT
The purpose of the study was to investigate determinants of private Commercial bank profitability
in Ethiopia by using panel data from 2017 to 2022. The study employed an explanatory type of
research and secondary source of data were used. The study has been done by using Return on
Asset (ROA) as a measure of profitability. This paper used ordinary least squares method to
estimate the model. The major findings of the study revealed that, interest income, and branch
expansion have significant and positive relationship with banks’ profitability. However, the
relationship for bank asset, and operating expense were found to be statistically significant and
have negative relationship with banks’ profitability.
Keywords: Bank profitability, ordinary Least Squares method, return on assets
vii
TABLE OF CONTENTS
Page
Contents
DECLARATION .......................................................................................................................................... ii
CERTIFICATE ............................................................................................................................................ iii
ACKNOWLEDGEMENTS .......................................................................................................................... v
LIST OF TABLES ....................................................................................................................................... vi
ABSTRACT ................................................................................................................................................ vii
List of Acronyms .......................................................................................................................................... x
CHAPTER ONE ........................................................................................................................................... 1
1.INTRODUCTION ..................................................................................................................................... 1
1.1 Background of the study ......................................................................................................................... 1
1.2 Statement of the Problem. ....................................................................................................................... 2
1.3 Hypotheses of the study .......................................................................................................................... 3
1.4 Objective of the study. ............................................................................................................................ 4
1.4.1 General objective ............................................................................................................................. 4
1.4.2. Specific objectives .......................................................................................................................... 4
1.5 Significance of the Study ........................................................................................................................ 4
1.6 Scope of the Study. ................................................................................................................................. 4
1.7 Organization of the Paper ....................................................................................................................... 5
CHAPTER TWO .......................................................................................................................................... 6
2.REVIEW OF RELATED LITERATURE ................................................................................................. 6
2.1 Theoretical Review of literature ............................................................................................................. 6
2.1.1 Types of Banks ................................................................................................................................ 8
2.1.2 The nature of commercial banks .................................................................................................... 16
2.1.3 The role of banks. .......................................................................................................................... 19
2.1.4 Determinant variables of Banks Profitability................................................................................. 20
2.1.4.1 Dependent variable. ................................................................................................................ 21
2.1.4.2 Independent variables. ............................................................................................................ 22
2.2. Review of empirical studies ................................................................................................................. 29
2.2.1. Studies in Global Context ............................................................................................................. 29
2.2.2 Studies in single Countries............................................................................................................. 32
viii
2.2.3. Studies in Ethiopian Context......................................................................................................... 34
2.3 Conceptual Framework ......................................................................................................................... 36
2.4 Summary and Knowledge gap .............................................................................................................. 37
CHAPTER THREE .................................................................................................................................... 39
3.METHODOLOGY OF THE STUDY ..................................................................................................... 39
3.1 Research design .................................................................................................................................... 39
3.2 Research approach ................................................................................................................................ 39
3.3 Type and source of data ........................................................................................................................ 39
3.4 Data collection techniques. ................................................................................................................... 40
3.5 Target population for the study. ............................................................................................................ 40
3.6 Sample design ....................................................................................................................................... 40
3.7 Method of Data Analysis. ..................................................................................................................... 41
3.8 Model Specification .............................................................................................................................. 41
CHAPTER FOUR....................................................................................................................................... 43
4. DATA ANALYSIS AND INTERPRETATION .................................................................................... 43
4.1. Results of the study .............................................................................................................................. 43
4.1.1 Descriptive Analysis ...................................................................................................................... 43
4.1.2. Correlation analysis ...................................................................................................................... 45
4.1.3 Regression Analysis ....................................................................................................................... 46
4.1.4 Test Results .................................................................................................................................... 47
4.2 Discussion of the study ......................................................................................................................... 48
4.2.1 Asset of the Bank ........................................................................................................................... 48
4.2.2 Interest Income............................................................................................................................... 48
4.2.3 Operating expense .......................................................................................................................... 48
4.2.4 Branch Expansion .......................................................................................................................... 49
CHAPTER FIVE ........................................................................................................................................ 50
5. CONCLUTIONS AND RECOMMENDATIONS ................................................................................. 50
5.1 summary of major findings ................................................................................................................... 50
5.2. Recommendations ................................................................................................................................ 52
5.3 Future area of investigation .................................................................................................................. 53
REFERENCES: .......................................................................................................................................... 54
ix
List of Acronyms
CBE Commercial Bank of Ethiopia
DBE Development Bank of Ethiopia
EPS Earnings Per-Share
GDP Gross Domestic Product
NBE National Bank of Ethiopia
NIB Nib International Bank
NIM Net Interest Margin
PBT Profit before Tax
PAT Profit after Tax
ROA Return on Asset
ROE Return on Equity
ROC Return on Capital
x
CHAPTER ONE
1. INTRODUCTION
This chapter covered the background of the study, statement of the problem, objective of study
and hypothesis of the on determinates profitability of private.
1.1 Background of the study
The main purpose of any business is maintaining profitability. Profitability means the ability to
make profit from all the business activities of an organization, company, firm, or an enterprise.
That means it shows how efficiently the management can make profit by using all the resources
available in the market. Bank profitability attracts the interest of academics, economists, investors
and policymakers. In identifying bank profit determinant, it’s hard to evaluate which variable have
more impact on profit, and important for management to make timely decisions. Many researchers
have conducted numerous studies about the profitability of commercial banks and their
determinants. The banking sector is an engine of modern trade and economic development by
providing the necessary finance. The bank performance is one of the main concerns of
management experts, investors, and economic analysts. Which means they concern closely relates
to the significant effect of the profitability of financial organizations in general, and commercial
banks in particular, on the potential growth of the economy as a whole (Husain and Bhatti, 2010).
Banks mobilize, allocate and invest the greatest part of the economic agent’s savings. Accordingly,
their performance has substantial consequences on capital allocation, firm expansion, industrial
growth and economic development. Therefore, efficiency and profitability of banks is of interest
not just at the individual bank level, but also is important at a broader macroeconomic level. The
main role of the financial system is to channel the funds from savers to borrowers. If this process
is done efficiently, then the profitability should improve, the flow of funds should increase, too,
and there should better quality services for customers. Indeed, financial intermediation determines,
among other factors, the efficient allocation of savings, as well as the return on savings and
investments Aremu and Mejabi (2013).
In the developed nations, financial markets and the banking system work in union to achieve this
main purpose. Unlike this, in the developing countries financial markets are usually
1
underdeveloped and undersized so in this case the banks fill in the gap between borrowers and
savers and provide the profitable and secure funds channeling. Taking in to consideration that
savings and investments are among the most important determinants of economic growth, the
health of the general economy of a country is in a great way dependent on the well-functioning
financial system. That is especially true for countries like Ethiopia, where the banking sector is the
backbone of the economy. Ethiopia financial sector is characterized by the dominant role of the
commercial banks. There are plenty aspects of banks which could analyzed, but this study focuses
specifically on bank profitability. Profitability is a reflection of how banks are run, given the
environment in which they operate. More precisely, it should mirror the quality of a bank’s
management and the shareholder’s behavior, the bank’s competitive strategies, efficiency and risk
management capabilities Aburime (2007).
1.2 Statement of the Problem.
Banks play a vital role in the economy of a country. This is particularly true in the case of Ethiopia
where no capital market exists. Banks are the main providers of funds, and their stability is of
paramount importance to the financial system. As such, an understanding of determinants of their
profitability is essential and crucial to the stability of the economy. In banking literature, the
determinants of profitability are empirically well explored although the definition of profitability
varies among studies. Disregarding the profitability measures, most of the banking studies have
noticed that the capital ratio, loan-loss provisions and expense management are important factors
in achieving high profitability (Chan and Vong, 2010). In Ethiopia, few studies have been made
on the determinants of bank profitability in case of private banks, with varying types and numbers
of variables taken into consideration.
The phenomena observed in the banking industry is, an increasing number of private commercial
banks with in the country while they are unable to enlarge their market share. Rather they share
the existing market with high competition. As the researcher can observe that, the newly emerging
private banks grow rapidly than the existing one as a result of inter transfer of existing customer
among banks rather than finding new market. Large number of customers with existing private
bank transfers their bank facilities to newly emerging private banks.
2
Plenty of research works were done to identify determinants of private commercial banks
profitability. However, as far as the researcher knowledge, there is scanty research that had been
done on this area particularly during establishment of newly emerging private banks and its impact
is not measured on private commercial banks profitability. This has necessitated the investigation
to find out the main factors that determine the profitability of private commercial banks in
Ethiopian during the establishment of more newly emerging private banks.
Tesahle (2011) in his study on ‘Determinants of bank profitability in Ethiopia on selected
commercial banks’ found that inflation has significant impact on profitability of selected banks for
the period of (2003-2009). The researcher examined his study by including the large government
banks and private banks. Belayneh (2011) analyzed the determinants of bank profitability in
Ethiopia as whole by taking government as well as private banks in Ethiopia. The researcher
concluded that bank specific drivers have immense effect in explaining bank profitability.
Internal factors (bank specific variables) such as asset of bank, interest income, branch expansion,
and operating expense effect on profitability of private banks were not empirically well explored
in these studies. Therefore, the novel features of this study are to fill the literature gap and to
examine sole effects of bank profitability drivers in private commercial bank in Ethiopia by taking
into consideration newly established banks versus formerly established bank.
1.3 Hypotheses of the study
In line with the broad purpose statement the following hypotheses are formulated for investigation.
Hypotheses of the study stands on the theories related to a bank’s profitability that has been
developed over the years by banking area researcher’s and past empirical studies related to a bank’s
profitability. Hence, based on the objective, the present study seeks to test the following four
hypotheses:
HO1: There is positive or negative relationship between asset and profitability of bank.
HO2: There is positive or negative relationship between interest income and banks profitability.
HO3: There is positive or negative relationship between branch expansion and profitability of the
banks.
3
HO4: There is positive or negative relationship between Operating Expense and banks
profitability.
1.4 Objective of the study.
Objectives of the study classified into two the following objectives.
1.4.1 General objective
The main objective of the study was to investigate the determinants of commercial bank
profitability the case of selected private commercial banks in Ethiopia.
1.4.2. Specific objectives
The specific objectives of the research include: To analyze relationship between bank sizes and bank’s profitability.
To examine relationship between interest incomes and bank’s profitability.
To analyze the relationship between branches expansion and profitability of the bank.
To examine relationship between Operating Expense and bank’s profitability.
1.5 Significance of the Study
This empirical study which deals with the determinants of commercial banks profitability in
Ethiopia is beneficial for different stakeholders, Banks managers and executives and for other
researchers. For the researcher, the finding of the study is used as a reference; thus, it can minimize
the literature gap in the area of the study especially in Ethiopia. Moreover, this study initiates the
commercial Banks managers and executives to give due emphasis on the management of identified
variables and provides them with understanding of activities that enhance their banks profitability.
Finally, it helps Government organ to know which companies operate successfully or failed, to
take the necessary measures to avoid crises of the bankruptcy in these companies.
1.6 Scope of the Study.
The scope of the study was restricted to the determinant of private commercial bank profitability
in Ethiopia that have five years data (2017-2022 G.C). The study was about only internal
determinants of private commercial bank profitability in Ethiopia. These determinants are only
4
bank specific that are collected from balance sheet and income statement of five selected private
commercial banks, Buna, Awash, Enat, Nib and Birhan bank. Therefore, external factors are not
included in the study.
1.7 Organization of the Paper
The study is organized under five chapters. The first chapter consists of: background of the study,
statement of the problem, objective of the study, significance of the study, scope of the study, and
organization of the paper. The second chapter consists review of related literature. The third
chapter consists of: research design, source and type of data, data collection technique, sample
design, and study population. The fourth chapter present the data analysis and presentation. The
final chapter draw conclusion and give recommendation.
5
CHAPTER TWO
2. REVIEW OF RELATED LITERATURE
Introduction
This chapter covered the literature review on determinates profitability of private commercial
banks dividing in two parts these are theoretical literatures and empirical literatures. The
theoretical framework on determinant of commercial banks will encompass models, theories, and
definition, while the empirical literature reviewed several studies results and highlighting the
knowledge gap.
2.1 Theoretical Review of literature
The study of profits is important not only cause of the information it provides about the health of
the bank in any given year, but also cause profits are a key determinant of growth and employment
in the medium-term. Changes in profitability are an important contributor to economic progress
via the influence profits have on the investment and savings decisions of companies. This causes
a rise in profits improves the cash flow position of companies and offers greater flexibility in the
source of finance for corporate investment (i.e., through retained earnings). Easier access to
finance facilitates greater investment which boosts productivity, productive capacity,
competitiveness and employment. The existence, growth and survival of a business organization
mostly depend upon the profit which an organization is able to earn. It is true that when
Profitability increases the value of shareholders may increase to considerable extent. The term
profitability refers to the ability of the business organization to maintain its profit year after year.
The profitability of the organization is definitely contributed to the economic development of the
nation by way of providing additional employment and tax revenue to government exchequer (the
fund of a government). Moreover, it contributes the income of the investors by having a higher
dividend and there by improve the standard of living of the people. In order for a business entity
(whether public or privately owned) to continue to prosper, there is need for its earnings to
relatively stable for its expansion and growth over time. In addition to its level of earnings, its
external environment must also carefully understand and reliably anticipated. The business
organization must ensure that right technology is pursued so as to achieve organizational
objectives, Burns and Mitchell, (1946) and Aremu, Mejabi, and Gbadeyan, (2011).
6
Profitability connotes a situation where the income generated during a given period exceeds the
expenses incurred over the same length of time for the sole purpose of generating income Banwo
(1997), Sanni (2006). The fundamental requirements here are that the income and the expenses
must occur during the same period of time (Matching Concept) and the income must a direct
consequence of the expenses. The period of time may one week, three months, one year etc. Sabo
(2007). It is not immaterial whether or not the income has been received in cash nor is it
compulsory that the expenses must have been paid in cash. The term profit can take either its
economic meaning or accounting concept which shows the excess of income over expenditure
viewed during a specified period of time. On one hand, profit is one of the main reasons for the
continued existence of every business organization. On the other hand, profit is expected so as to
meet the required return by owners and other outsiders.
John J. Hampton (2009) clarified profitability ratio as a class of financial metrics that are used to
assess a business’s ability to generate earnings as compared to its expenses and other relevant costs
incurred during a specific period of time. Accordingly, the term profitability is a relative measure
where profit is expressed as a ratio, generally as a percentage. Profitability depicts the relationship
of the absolute amount of profit with various other factors.
Michael Koller (2011) argued that profitability is the most important and reliable indicator as it
gives a broad indicator of the ability of company to raise its income level. In practice, executives
define profits as the difference between total earnings from all earning assets and total expenditure
on managing entire asset-liabilities portfolio Kaur and Kapoor, (2007). For a profit-oriented
organization, profit is the soul of business. The importance of profitability, therefore, stems from
its being the reason (purpose) of business. A company remains in operation because it expects to
make profits. Once that expectation is confirmed unattainable, the most rational decision is to close
shop or exit the business. Three indicators, namely: Return on Assets (ROA) Return on Equity
(ROE) and Net Interest Margin (NIM), were identified by Ahmed (2003) to mostly employed in
the literature to measure profitability. However, there are divergent views among scholars on the
superiority of one indicator over the others as a good measure of profitability. For instance,
Goudreau and Whitehead (1989) and Uchendu (1995) believed that the three indicators are all
good. Hancock (1989) used only ROE to measure profitability in his study. Also, Odufulu (1994)
7
used only the gross profit margin in measuring profitability. Ogunleye (1995) did not believe that
gross profit margin could constitute a good Measure of profitability and therefore used ROA and
ROE. Profitability measures, according to Akinola (2008) include Profit before Tax (PBT), Profit
After Tax (PAT), Return on Equity (ROE), Rate of Return on Capital (ROC) and Return on Assets
(ROA). Sanni (2009) used Earnings Per-Share (EPS).
On the other hand there are some theories that can be applied to measure banks profit other than
ROA, ROE and NIM. According to Standard asset pricing models arbitrage should ensure that
riskier assets are remunerated with higher returns. These risks can be banks specific risk which
means liquidity, foreign currency, credit, management inefficiency, capital inadequacy and etc.
which can be solved by itself. The other, Non-diversified risk (Systematic risk) like risk associated
with macroeconomic environment, natural disaster, political instability, government regulations
and supervision of Bank (Ibid). For this study, the researcher limited profitability to the one widely
used profitability measure namely Return on Asset (ROA).
2.1.1 Types of Banks
The National Bank of Ethiopia
The National Bank new of Ethiopia was created by order No 30/1963 and reconstituted by
the Monetary and Banking Proclamation No 83/1994 as an autonomous organ, which is engaged
in the provision of regular banking services to the government and other banks and insurance
companies’. The main purpose of the bank is to forester monetary stability financial system and
such other credit and exchange conditions as are conducive to the balanced growth of the economy
of Ethiopia. / Art 6/
The bank will have the following powers and duties that will help it to achieve its purpose, /Art 7/
Regulate the supply and availability of money and fix the minimum and maximum rates of interest
that banks and other financial institutions may charge for different types of loans, advances and
other credits and pay on various classes of deposits. (Art 7 and Art 30).
-
Implement exchange rate policy, allocate foreign exchange, manage and administer the
international reserve fund of Ethiopia. This reserve fund consists of gold, silver, foreign exchange
and securities, which are used to pay for imports into the country and pay foreign international
debts and other commitments (Art 50).
-
License, supervise and regulate banks, insurance companies and other financial institutions
such as savings and credit associations/co-operatives and postal savings.
-
Set limits on gold and foreign exchange assets that banks and other financial institutions,
which are authorized to deal in foreign exchange, can hold in deposits (Art 39).
8
-
Set limits on the net foreign exchange position and on the terms and the amount of external
indebtedness of banks and other financial institutions.
-
Make short and long term refinancing facilities available to banks and other financial
institutions.
-
Accept deposits of any type from foreign sources.
-
Act as banker, fiscal agent and financial advisor to the government/Art 24, 25/.
-
Promote and encourage the dissemination of banking and insurance services throughout the
country.
-
Prepare periodic economic studies together with forecasts of the balance of payment, money
supply, prices and other statistical indicators of the Ethiopian economy used for analysis and for
the formulation and determination by the bank of monetary, savings and exchange policies.
(http://nbe.gov.et)
Commercial Banks
Commercial banks are banks with the power to make loans that, at least in part, eventually become
new demand deposits. Because a commercial bank is required to hold only a fraction of its deposits
as reserves, it can use some of the money on deposit to extend loans. When a borrower receives a
loan, his checking account is credited with the amount of the loan; total demand deposits are thus
increased until the loan is repaid. As a group, then, commercial banks are able to expand or contract
the money supply by creating new demand deposits.
The name commercial bank was first used to indicate that the loans extended were short-term loans
to businesses, though loans later were extended to consumers, governments, and other nonbusiness institutions as well. In general, the assets of commercial banks tend to be liquid and carry
less risk than the assets held by other financial intermediaries. The modern commercial bank also
offers a wide variety of additional services to its customers, including savings deposits, safedeposit boxes, and trust services.
The Commercial Bank of Ethiopia and all the privately owned banks in Ethiopia fall under this
category as they are primarily engaged in receiving money on deposit and providing loans to the
public. (http://nbe.gov.et)
9
Savings Banks
A savings bank is a financial institution that gathers savings and that pay interest or dividends to
savers. It channels the savings of individuals who wish to consume less than their incomes to
borrowers who wish to spend more. The savings deposit departments of commercial banks, mutual
savings banks or trustee savings banks (banks without capital stock whose earnings accrue solely
to the savers), savings and loan associations, credit unions, postal savings systems, and municipal
savings banks serve this function. Except for the commercial banks, these institutions do not accept
demand deposits. Postal savings systems and many other European savings institutions enjoy a
government guarantee; savings are invested mainly in government securities and other securities
guaranteed by the government. (http://nbe.gov.et)
Savings banks frequently originated as part of philanthropic efforts to encourage saving among
people of modest means. The earliest municipal savings banks developed out of the municipal
pawnshops of Italy. Local savings banks were established in The Netherlands through the efforts
of a philanthropic society that was founded in 1783, the first bank opening there in 1817. During
the same time, private savings banks were developing in Germany, the first being founded in
Hamburg in 1778. (http://nbe.gov.et)
The first British savings bank was founded in 1810 as a Savings and Friendly Society by a pastor
of a poor parish; it proved to be the forerunner of the trustee savings bank. The origin of savings
banking in the United States was similar; the first banks were nonprofit institutions founded in the
early 1800s for charitable purposes. With the rise of other institutions performing the same
function, mutual savings banks remained concentrated in the northeastern United States.this type
of specialized banking service is not yet introduced in Ethiopia and hence there is no bank, which
may be considered as a savings bank. However, the commercial banks accept savings as one form
of money deposit. (http://nbe.gov.et)
Investment Banks
Investment bank is a firm that originates, underwrites, and distributes new security issues of
corporations and government agencies. The investment-banking house operates by purchasing all
of the new security issue from a corporation at one price and selling the issue in smaller units to
10
the investing public at a price sufficiently high to cover expenses of sale and leave a profit. The
major responsibility for setting the public offering price rests on the investment bank because it is
in close contact with the market, is familiar with current interest rates and yields, and is best able
to judge the probable demand for the issue in question. (http://nbe.gov.et)
In the underwriting and distribution of most security issues, a syndicate of investment banking
firms is organized. If the amount of capital sought is large enough to prohibit one investment
banking firm's undertaking the risk of purchasing the entire issue, the investment bank that initiates
the issue with the corporation organizes a group of investment bankers to divide the liability for
the purchase, with the originator acting as manager of the group. (http://nbe.gov.et)
If the market coverage that can be obtained by the members of the syndicate is deemed insufficient,
selected dealers are used to bring about a wider distribution. Securities are sold to the dealers at a
reduction (known as a concession), which reimburses the dealer for his expenses and provides him
with a profit if the distribution is performed skillfully.when new securities are to be issued, an
investment firm having close contact with the corporation is likely to be asked to originate the
issue. This process often is called private negotiation. An alternative arrangement is competitive
bidding, under which the corporation itself settles upon the terms of the issue to be offered and
then invites all banking firms to submit bids. The issue will be sold to the highest bidder.
(http://nbe.gov.et)
The fact that Ethiopia is a predominantly agrarian state and business in general is limited to a small
scale under takings by individuals, the idea of investment through purchase of stocks/ shares and
bonds is common. Further, more, the very few companies that were established towards the end
of the imperial era, were nationalized by the military government which adopted the Socialist
ideology and economic system, which does not allow private ownership of big manufacturing,
agricultural and service providing undertakings or businesses. This fact has prevented the
introduction of investment banking in Ethiopia. Though a market economic policy has been
adopted after the fall of the military government and business in general and companies in
particular are expanding, companies have not started offering their shares to the public and hence
there was no conducive environment for the establishment and operation of these types of banks
in Ethiopia. (http://nbe.gov.et)
11
Development Banks
It refers to a national or regional financial institution designed to provide medium- and long-term
capital for productive investment, often accompanied by technical assistance, in less-developed
areas.
The number of development banks has increased rapidly since the 1950s; they have been
encouraged by the International Bank for Reconstruction and Development and its affiliates. The
large regional development banks include the Inter-American Development Bank, established in
1959; the Asian Development Bank, which began operations in 1966; and the African
Development Bank, established in 1964. They may make loans for specific national or regional
projects to private or public bodies or may operate in conjunction with other financial institutions.
One of the main activities of development banks has been the recognition and promotion of private
investment opportunities. Although the efforts of the majority of development banks are directed
toward the industrial sector, some are also concerned with agriculture. (http://nbe.gov.et)
Development banks fill a gap left by undeveloped capital markets and the reluctance of commercial
banks to offer long-term financing. Development banks may be publicly or privately owned and
operated, although governments frequently make substantial contributions to the capital of private
banks. The form (share equity or loans) and cost of financing offered by development banks
depends on their cost of obtaining capital and their need to show a profit and pay dividends.
The Development Bank of Ethiopia is established with the purpose of providing long-term loans
to agricultural and industrial undertakings, which are considered crucial in the development of the
economy. It was intended to serve as the major financer for the various co-operatives and
government owned farms and factories. Now it also provides long-term loans to private investors
who are engaged in agricultural and manufacturing activities. (http://nbe.gov.et)
Islamic Banking
General Overview of Islamic Banking
"Islamic banking refers to a system of banking activity that is consistent with the Islamic law
(Sheria). It is guided by principles of Islamic economics. At this juncture, it is important to note
that Islamic law prohibits usury, that is, the collection and payment of interest which is commonly
known as riba in Islamic discourse. In addition, Islamic law prohibits investing in businesses that
are considered unlawful, or harem (such as businesses that sell alcohol or dork or business that
12
produce media such as gossip columns or pornography which are contrary to Islamic values. In
line with this, in the late 20th century a number of Islamic banks were established.
(http://nbe.gov.et)
The Meaning of Riba
The word riba literally means increase or excess. It covers both usury and interest. In Quranic
verses it essentially refers to the practice of lending money for predetermined rate of return or
interest. Riba can also be interpreted as the addition to the principal sum advanced through loan
from the lender to the borrower. The Shariah disallow riba and there is now a general consensus
among Muslim economists that riba is not restricted to usury but encompasses interest as well. The
Qur’an is clear about the prohibition of riba. You who believe fear Allah almighty and give up that
remains of your demand for usury if you are indeed believer.
Muslim scholars have accepted the word riba to mean any fixed or guaranteed interest payment on
cash advance or on deposits. Several Quranic verses expressly admonish the faithful to shun
interest. (http://nbe.gov.et)
History of Islamic Banking
The history of interest free banking could be divided into two parts. First, when it still remained
an idea; second when it became a reality by private initiative in some countries and by law in
others.
A, Interest Free Banking as an Idea
Interest free banking seems to be of very recent origin especially in our country. But the earliest
reference to the reorganization of banking on the basis of profit sharing written by Anwar Qureshi
(1946), Naiem Siddiq (1948) and Mohamed Ahmed (1952). In the last forties it was followed by
more elaborate exposition by Mawdudi in (1950). They have all recognized the need of
commercial banks that use in profit and loss sharing mechanism and have proposed a banking
system based on the concept of mudarabh (profit and loss sharing). In the next two decades interest
free banking attracted more attention because of the emergence of young Muslim economists. The
first such works emerged in that of Muhammed vzair (1955). Another set of works emerged in the
late sixties and early seventies, Abdullah al-araby (1967), Nejatullah Siddigi (1961.1969), Al
Najjar (1971) and Baqir al-sadr (1961, 1974) were the main contributors.
13
The early seventies saw the institutional involvement that is conference of the finance Ministers
of the Islamic countries held in Karachi in 1970, the Egyptian study in 1972, the first international
conference on Islamic Economics in Mecca in 1976 etc.
B, the Coming in to Being of Interest Free Bank
“The institutional and governmental involvement led to the application of theory to practice and
resulted in the establishing of the first interest free banks”. The Islamic development bank, an
inter-governmental bank established in (1975) was born of this process. The first private interest
free bank is the Dubai Islamic bank; it was set up in 1975. Before this modern bank experiment,
Islamic banking was undertaken in Egypt without projecting on Islamic image for fear of being
seen as manifestation of Islamic fundamentalism that was an anathema to the political regime. The
pioneering effort led by Ahmed El-Najjar took the form of saving bank based on profit sharing in
the Egyptian town of Mit Ghamr in 1963. By this time there were Nine (9) such banks in the
country. In ten years, since the establishment of the first private commercial bank in Dubai, more
than 50 interest free banks have come into being. In most countries the establishment of interest
free banking had been by private; in Iran and Pakistan, however, it was undertaken by government
initiative and covered all banks in the country. (http://nbe.gov.et)
Principles of Islamic Banking
“The Islamic beliefs prevent the believer from dealing that involves usury or interest (riba). Yet
Muslims need banking service as much as anyone else and for many purposes to finance new
business ventures to buy a house, car, to facilitate capital investment, to undertake trading
activities, and to offer a safe place for savings”.
Islamic banking based on the Quranic prohibition of charging interest has moved from a theoretical
concept to embrace more banks operating in 45 countries with multi-billion dollar deposit worldwide. Islamic banking is widely regarded as the fastest growing sector. An estimated $ US 70
billion worth of funds are now managed according to shariah.
The best known feature of Islamic banking is the prohibition of interest. The Quran forbids the
charging of riba on money lent. The Sharia disallow riba and there is now a general consensus
among Muslim economists that riba is not restricted to usury but encompasses interest as well.
Let us look at the rule regarding Islamic finance, which is simple and can be summed up as follows:
14
1. Any predetermined payment over and above the actual amount of principal for any is prohibited.
Islam allows only one kind of loan and that is qard-el hassan (literally good loan), where the lender
does not charge any interest or additional amount over the money lent.
2. The lender must share in the profits or losses arising out of the enterprise for which the money
was lent for the business. Islam encourages Muslims to invest their money and to become partners
in order to share profits and risk in the business instead of becoming creditors.
As defined in the Shari'ah or Islamic law, Islamic finance is based on the belief that the provider
of capital and the user of capital should equally share benefit and the risk of business ventures.
Translated into banking terms the depositor, bank and the borrower should all share the risk and
the rewards of financing business ventures. This is unlike the interest based commercial banking
system, where all the pressure is on the borrower, who must pay back his loan, with the agreed
interest regardless of the success or failure of his enterprise. (http://nbe.gov.et)
The principle, which thereby emerges, is that Islamic Law encourages investments in order that
the community may benefit. It is not instilling to allow a loophole to exist for those who do not
wish to invest and take risks but rather content with hoarding money in bank in return for receiving
an increase on these funds for no risk. Accordingly, either people invest with risk or suffer loss
through devaluation by inflation by keeping their money idle.
Making money from money is not Islamic ally acceptable; money is only a medium of exchange,
a way of defining the value of a thing it has no value in itself and should not be all owed to give
rise to more money through fixed interest payments, simply by being put in a bank or lent to
someone else. "Muslim jurists consider money as a potential capital rather than capital, meaning
that money becomes capital only when it is invested in business"
Gharar (uncertainty risk or speculation) is also prohibited; and any transaction entered into should
be free from uncertainty risk and speculation. Contracting parties should have perfect knowledge
of the counter values intended to be exchanged as a result of their transactions. (http://nbe.gov.et)
15
2.1.2 The nature of commercial banks
A commercial bank is a type of bank that provides services such as accepting deposits, making
business loans, and offering basic investment products. Commercial bank can also refer to a bank
or a division of a bank that mostly deals with deposits and loans from corporations or large
businesses, as opposed to individual members of the public (retail banking). In the United States
the term "commercial bank" was often used to distinguish it from an investment bank due to
differences in bank regulation. After the great depression, through the Glass–Steagall Act, the U.S.
Congress required that commercial banks only engage in banking activities, whereas investment
banks were limited to capital market activities. This separation was mostly repealed in the 1990s.
(http://nbe.gov.et)
The activities of commercial banks:
Commercial banks engage in the following activities, processing payments via telegraphic transfer,
electronic fund transfer, point of sales, internet banking, or other, issuing bank drafts and bank
cheques, accepting money on term deposit, lending money by overdraft, installment loan, or other,
providing documentary and study guarantees, performance bonds, securities underwriting
commitments and other forms of off balance sheet exposure, cash management and treasury,
merchant banking and private equity financing. Traditionally, large commercial banks also
underwrite bonds, and make markets in currency, interest rates, and credit-related securities, but
today large commercial banks usually have an investment bank arm that is involved in the
aforementioned activities. (http://nbe.gov.et)
Types of loans granted by commercial banks
Secured loans: A secured loan is a loan in which the borrower pledges some asset (e.g., a car or
property) as collateral for the loan, which then comes a secured debt owed to the creditor who
gives the loan. The debt is thus secured against the collateral in the event that the borrower defaults,
the creditor takes possession of the asset used as collateral and may sell it to regain some or the
entire amount originally lent to the borrower, for example, foreclosed a portion of the bundle of
rights to specified property. If the sale of the collateral does not raise enough money to pay off the
debt, the creditor can often obtain a deficiency judgment against the borrower for the remaining
amount. The opposite of secured debt/loan is unsecured debt, which is not connected to any
16
specific piece of property and instead the creditor may only satisfy the debt against the borrower
rather than the borrower's collateral and the borrower.
A mortgage loan is a very common type of debt instrument, used to purchase real estate. Under
this arrangement, the money is used to purchase the property. Commercial banks, however, are
given security - a lien on the title to the house - until the mortgage is paid off in full. If the borrower
defaults on the loan, the bank would have the legal right to repossess the house and sell it, to
recover sums owing to it. In the past, commercial banks have not been greatly interested in real
estate loans and have placed only a relatively small percentage of assets in mortgages. As their
name implies, such financial institutions secured their earning primarily from commercial and
consumer loans and left the major task of home financing to others. However, changes in banking
laws have allowed commercial banks to make more home mortgage loans. In acquiring mortgages
on real estate, these institutions follow two main practices.
First, some of the banks maintain active and well-organized departments whose primary function
is to compete actively for real estate loans. In areas lacking specialized real estate financial
institutions, these banks come the source for residential and farm mortgage loans.
Second, the banks acquire mortgages by simply purchasing them from mortgage bankers or
dealers. In addition, dealer service companies, which were originally used to obtain car loans for
permanent lenders such as commercial banks, wanted to broaden their activity yond their local
area. In recent years, however, such companies have concentrated on acquiring mobile home loans
in volume for both commercial banks and savings and loan associations. Service companies obtain
these loans from retail dealers, usually on a non-recourse basis. Almost all bank/service company
agreements contain a credit insurance policy that protects the lender if the consumer defaults.
Unsecured loan: In finance, unsecured debt refers to any type of debt or general obligation that is
not collateralized by a lien on specific assets of the borrower in the case of a bankruptcy or
liquidation or failure to meet the terms for repayment. In the event of the bankruptcy of the
borrower, the unsecured creditors have a general claim on the assets of the borrower after the
specific pledged assets have been assigned to the secured creditors. The unsecured creditors is
usually realize a smaller proportion of their claims than the secured creditors. In some legal
systems, unsecured creditors who are also indebted to the insolvent debtor are able (and in some
jurisdictions, required) to set-off the debts, which actually puts the unsecured creditor with a
17
matured liability to the debtor in a pre-preferential position. Under risk-based pricing, creditors
tend to demand extremely high interest rates as a condition of extending unsecured debt. The
maximum loss on a properly collateralized loan is the difference tween the fair market value of the
collateral and the outstanding debt. Thus, in the context of secured lending, the use of collateral
reduces the size of the "bet" taken by the creditor on the debtor's creditworthiness. Without
collateral, the creditor stands to lose the entire sum outstanding at the point of default, and must
boost the interest rate to price in that risk. Where high interest rates are considered usurious,
unsecured loans are either not made at all, or are made by loan sharks unafraid of the law.
Oftentimes Unsecured Loans are sought out in cases where additional capital is required although
existing (not necessarily all) assets have been pledged to secure prior debt. Secured lenders is more
often than not include language in the loan agreement that prevents debtor from assuming
additional secured loans or pledging any assets to a creditor. (http://nbe.gov.et)
Functions: Commercial banks perform many functions. They satisfy the financial needs of the
sectors such as agriculture, industry, trade, communication, so they play very significant role in a
process of economic social needs. The functions performed by banks, since recently, are coming
customer-centered and are widening their functions. Generally, the functions of commercial banks
are divided into two categories: primary functions and the secondary functions.
Primary functions include: Commercial banks accept various types of deposits from public
especially from its clients, including saving account deposits, recurring account deposits, and fixed
deposits. These deposits are payable after a certain time period Commercial banks provide loans
and advances of various forms, including an overdraft facility, cash credit, bill discounting, money
at call etc. They also give demand and demand and term loans to all types of clients against proper
security. Credit creation is most significant function of commercial banks. While sanctioning a
loan to a customer, they do not provide cash to the borrower. Instead, they open a deposit account
from which the borrower can withdraw. In other words, while sanctioning a loan, they
automatically create deposits, known as a credit creation from commercial banks. Along with
primary functions, commercial banks perform several secondary functions, including many agency
functions or general utility functions. The secondary functions of commercial banks divided into
agency functions and utility functions.
Agency functions include:
18
 To collect and clear checks, dividends and interest warrant.
 To make payments of rent, insurance premium, etc.
 To make deal in foreign exchange transactions.
 To purchase and sell securities.
 To act as trustee, attorney, correspondent and executor.
 To accept tax proceeds and tax returns.
Utility functions include:
 To provide safety locker facility to customers.
 To provide money transfer facility.
 To issue travelers cheques.
 To act as referees.
 To accept various bills for payment: phone bills, gas bills, water bills, etc.
 To provide merchant banking facility.
 To provide various cards: credit cards, debit cards, smart cards, etc.
2.1.3 The role of banks.
To start very basic, this paragraph discusses the role of banks in the economy and examines the
question why banks exist. At first sight, the answer to this question is very intuitive and simple;
banks act as an intermediary tween those who are in need for money and those who have excess
of money. Looking more closely to this question there could a more detailed explanation. Namely,
in a perfect capital market of Modigliani-Miller (1958), financial institutions are superfluous
Santos (2001); namely, entities can borrow and save directly through the capital market. In reality,
such perfect market does not exist; transaction costs and monitoring costs distort capital markets.
Furthermore, capital markets suffer from the information asymmetry and the agency problem. The
agency problem refers to the dissimilar incentives of borrowers and savers, in a broader context it
refers to the dissimilar incentives of principles and agents Jensen & Meckling (1976). In a case of
financial distress, borrowers are limited liable; implying that they have incentives to alter their
behavior by taking on more risk than savers are willing to accept. Monitoring the borrower’s
behavior is time consuming, complex and expensive for individuals. In general, in inefficient
markets, financial intermediation is beneficial since banks have lower monitoring and transaction
costs than individuals, due to economies of scale and scope. Another important aspect of banking
is the function of maturity transformation. Banks receive short-term savings from depositors and
19
transform those savings into long-term loans to borrowers. By holding a part of the short-term
savings in liquid assets and cash, banks could withstand daily withdrawals from depositors. Banks
offer a unique service; lending long term while guaranteeing the liquidity of their liabilities to
depositors, which can withdraw their money at any time without a decline in nominal value
Schooner & Talyor (2010) cited in van Ommeren (2011).
Capital markets cannot achieve maturity transformation with the same benefits as banks can.
Individual investors face liquidity, price and credit risk, which they cannot diversify to the extent
banks can. As savers do not withdraw their deposits at the same time, banks hold only a minor part
of the savings in liquid cash. Thus, banks diversify liquidity risks over a large pool of savers.
Individual savers can also diversify their investments in terms of credit and price risks but it
remains unlikely that they could withdraw the investments at any time without facing liquidity
issues. Nowadays, bank activities are more diverse than ever. In the past decades, competition has
increased and new activities have emerged. The traditional form of banking, receiving deposits
and extending credits, has come less important. Ever since the complexity of balance sheet has
increased, as did balance sheet and risk management van Greuning & Bratanovic (2009) cited in
van Ommeren (2011).
2.1.4 Determinant variables of Banks Profitability
Theoretically factors affecting bank profitability are mainly divided into two categories as internal
and external variables. The internal (bank-specific factors) are factors that are related to internal
efficiencies and managerial decisions. As stated in the above section the efficiency theory highly
assumes as bank performance is influenced by those internal factors that are related to internal
efficiencies and managerial decisions. Such factors include determinants such as bank size, interest
income, operating expense, branch expansion, liquidity risk, operational efficiency (expenses
management), management efficiency, employee efficiency and funding cost. On the other hand,
the capital asset pricing theory assumes as bank profitability is a function of external market
factors. Accordingly, one of the external factors (variables) that can affect bank profitability is
industry specific factors. Such factor mainly includes bank sector development as a major
determinant factor of bank profitability. Finally, the macroeconomic factors that can affect bank
20
profitability include factors such as real GDP, foreign exchange rate and inflation rate among
others. The exact relationship between these factors and the bank profitability and the significance
of the relationship remain as questions to be addressed more specifically in the context of Ethiopia.
2.1.4.1 Dependent variable.
Return on Asset (ROA)
The ROA reflects the ability of a bank‘s management to generate profits from the bank‘s assets. It
shows the profits earned per birr of assets and indicates how effectively the bank‘s assets are
managed to generate revenues. This is probably the most important single ratio in comparing the
efficiency and operating profitability of banks as it indicates the returns generated from the assets
that bank owns Getahun, (2015). There are different accounting-based measures for banks
profitability. For instance, Return on Equity (ROE), Return on Assets (ROA), Profit Earning Ratio
(PER) and Net Interest Margin (NIM). In this study Return on Assets (ROA) used to measure
profitability of the studied banks.
Profit is the ultimate goal of commercial banks. All the strategies designed and activities performed
thereof are meant to realize this grand objective. However, this does not mean that commercial
banks have no other goals. Commercial banks could also have additional social and economic
goals. However, the intention of this study is related to the first objective, profitability. To measure
the profitability of commercial banks there are variety of ratios used of which ROA and ROE are
the major ones Alexandru et al (2008). ROA reflects the ability of bank’s management to generate
profits from the bank’s assets, although it may bias due to off-balance-sheet activities. ROE shows
the return to the shareholders on their equity. As highlighted by Athanasoglou et al (2008) and
Sufian (2011), many scholars suggest that ROA is the key ratio for the evaluation of bank
profitability given that ROA is not distorted by high equity multipliers, while ROE disregards the
risks associated with high leverage and financial leverage. In this respect, we rarely find the paper
utilizes ROE as a single measure of profitability. Other papers utilize ROE for checking the
consistency with ROA, e.g., Naceur & Omran (2011) and Sufian (2011). While a bulk of studies
employ ROA as profitability measure, e.g., Pasiouras & Kosmidou (2007), Athanasoglou et al.
(2008) and Olweny & Shipho (2011). Therefore, this study attempts to measure profitability by
using ROA similar to most of the aforementioned researchers. ROA is measured as net profit after
tax divided by total assets similar to Olweny & Shipho (2011). Return on Asset (ROA) ROA is
21
the major ratio that indicates the profitability of a bank. It is a ratio of net income to its total asset
Khrawish (2011). It measures the ability of the bank management to generate income by utilizing
company assets at their disposal. In other words, it shows how efficiently the resources of the
company are used to generate the income. It further indicates the efficiency of the management of
a company in generating net income from all the resources of the institution Khrawish (2011).
Wen (2010), state that a higher ROA shows that the company is more efficient in using its
resources.
2.1.4.2 Independent variables.
This subsection describes the independent variables that are used in the econometric model to
estimate the dependent variables. Following prior researches towards the determinants of banks
profitability, the independent variables are classified into bank-specific, industry-specific and
macroeconomic variables Athanasoglou et al. (2008), Flamini et al (2009) and Sastrosuwito and
Suzuki (2011). The bank-specific variables are internal factors and controllable for banks
managers while the industry-specific and macroeconomic variables are uncontrollable and hence
external. Moreover, these subsection present hypotheses, by proposing the expected sign of the
coefficients, based on academic literature. Note that some relationships tween selected
independent variables and profitability are rather straightforward. Nevertheless, the inclusion of
irrelevant variables does not lead to biased coefficients or standard deviations while the omission
of relevant variables does. Hence, some variables that look rather predictable at first sight are
included to prevent biased results.
Bank specific variables
The bank-specific variables are selected by using some key drivers of profitability like earnings,
efficiency, risk taking and leverage. Profitability is driven by the ability of a bank in generating
sufficient earnings or in lowering operational cost. Furthermore, due to the special nature of banks,
risk taking and leverage are also very important drivers for profitability. Theoretical academic
literature suggests that there is a risk-return tradeoff, higher risks is associated with higher profits.
Risk taking could relate to the quality of assets, liquidity of assets and to the capital structure of a
bank. Hence, the following part of this particular section clearly presents the bank-specific
variables that are used in this particular study.
22
Bank Size: In most studies of bank profitability determinants, the total asset is used a measure
for bank size. Bank size is usually used to account for potential economies or diseconomies of
scale in the banking sector. Additionally, bank size is associated with diversification which may
impact favorably on risk and product portfolio. Economies of scale is reducing the cost of gathering
and processing information Boyd et al., (1993) so that a positive effect of bank size is associated
with profitability. Akhaveinet al. (1997) and Smirlock (1985) found a positive and significant
relationship between size and bank and profitability. Short (1979) argues, size is closely related to
the capital adequacy of a bank since relatively large banks tend to raise less expensive capital and
hence, appear more profitable. These results imply that as size increases, profitability increases.
This is especially true in the case of small to medium-sized banks. On the other hand, increased
diversification can reduce risk in the credit portfolio thereby reducing returns. Banks that have
come extremely large may exhibit negative relationship tween size and profitability as a result of
bureaucracy and agency cost.
Capital adequacy: The ratio of Equity to total Asset is employed as a measure for bank Capital
Adequacy. This measures the percentage of the total asset that is financed with equity capital.
Capital adequacy therefore describe the sufficiency of the amount of equity that can absorb shocks
that banks may experience. It is expected that the higher the Equity to Asset ratio, the lower the
need for external funding and therefore the higher the profitability of the bank. In addition, wellcapitalized banks face a lower cost of going bankrupt which reduces their cost of funding
Kosmidou (2008). But that is not all. Bank with higher capital to asset ratio are considered
relatively safer and tend to have a better margin of cushion, remaining profitable even during
economically difficult times. Conversely, banks with lower capital adequacy are considered riskier
relative to highly capitalized banks. Thinking in line with the conventional Risk-Return
Hypothesis, we anticipate an inverse relationship between capital adequacy and profitability.
Considering the fact that capital adequacy may have an ambiguous effect on profitability,
theoretical expectation of capital adequacy remains a puzzle to be answered by empirical
investigation.
Liquidity risk: Liquidity is a prime concern for banks and the shortage of liquidity can trigger
bank failure. Banking regulators also view liquidity as a major concern. This is causing banks
without sufficient liquidity to meet demands of their depositor’s risk experiencing bank run.
23
Holding assets in a highly liquid form tends to reduce income as liquid asset are associated with
lower rates of return. For instance, cash which is the most liquid of all assets is a non-earning asset.
It would therefore expect that higher liquidity would negatively correlates with profitability.
Indeed, Molyneuxet al., (1992) and Guru et al., (1999) discovered that negative correlation exists
between the level of liquidity and profitability. Liquidity risk is one of the types of risk for banks;
when banks hold a lower amount of liquid assets, they are more vulnerable to large deposit
withdrawals. Therefore, liquidity risk is estimated by the ratio of liquid assets to total assets. Based
on the risk-return hypothesis, more liquidity risk is associated with higher expected returns.
Otherwise stated more cash and other liquid non-earning assets result in a lower expected return
cause these assets do not generate any return. Following prior research of Pasiouras & Kosmidou
(2007), a negative relationship for liquid assets to total asset ratio and profitability is hypothesized.
Operating Efficiency: The expense to income ratio is used as proxy for operating efficiency.
The expense to income ratio is defined as the operating costs over total generated revenues. The
major elements of operating cost are staff salaries and administrative cost. It is used as an indicator
of management’s ability to control costs and is expected to have a negative relation with profits,
since improved management of these expenses increase efficiency and therefore raise profits. It is
also one of the key drivers of profitability that is examined. Similar to Pasiouras & Kosmidou
(2007), Trujillo Ponce (2012) and others, the expense to income ratio is used, to measure banks
operational efficiency. It is also used to provide information on the variation of bank cost over the
banking system. A negative correlation is expected between the operating cost and profitability
implying that higher operating cost means lower profit and vice versa. However, this may not the
case as higher amounts of operating cost could also reflect higher volume of banking activities.
Management Efficiency: A sound management is crucial for the success of any institution.
Management quality is generally given greater weighting in the assessment of the overall CAMEL
composite rating brickwork rating. The quality of the management determines the success of a
bank or financial institution. The performance of a bank is largely dependent on the vision,
competence, and integrity and risk appetite of the management, Financial Management and
Analysis of Projects (2006). Management Efficiency is one of the key internal factors that
determine the bank profitability. It is represented by different financial ratios like total asset
growth, loan growth rate and earnings growth rate. Yet, it is one of the complexes subject to capture
24
with financial ratios. Moreover, operational efficiency in managing the operating expenses is
another dimension for management quality. The performance of management is often expressed
qualitatively through subjective evaluation of management systems, organizational discipline,
control systems, quality of staff, and others. Yet, some financial ratios of the financial statements
act as a proxy for management efficiency. The capability of the management to deploy its resources
efficiently, income maximization, reducing operating costs can measured by financial ratios. The
ratios of operating expenses to operating income and operating expenses to total assets are
commonly used to measure Managerial efficiency of the banks. Indranarain (2009), Bourke (1989)
and Molyneux and Thornton (1992) used operating expense to operating income and stated that
Higher the efficiency level of a bank, higher its profits level. Hence a positive relationship is
expected between efficiency and profitability of banks. The analysis of the quality of a
management is based on the experience of the management and their track record in terms of their
vision and competence in running the bank.
Employee Efficiency: The people in a bank are the most valuable resources and the major
driving force for successes and failures. The quality of human resources employed by a bank
greatly affects its profitability. The recruitment process and training standard of the financial
institution, which reflects the quality of the people in the organization, their ability to guidance
and support to operations staff, compensation package as per the industry norms and attrition rate
in the financial institution, which reflect the satisfaction among the employees and staff towards
their work and organization. The human capital in organizations is valuable cause of the
capabilities that the people have. As part of the strategic role, Human Resource managers are often
seen as responsible for expanding the capabilities of the human resources in an organization. Yet
the mobility of human capital is less a threat to competitive advantage than it would first seem to
cause once an organization integrates human capital with other complementary resources and uses
this integration to create organizational capabilities, losing one or a few individuals may not lead
to a loss of competitive advantage Aremu M. A, Mejabi (2013) found negative and significant
relationship between employee efficiency and profitability.
Funding cost: the interest rate paid by commercial banks for the funds that they deploy in their
business, the cost of funds is one of the most important input costs for a financial institution, since
a lower cost generate better returns when the funds are deployed in the form of short term and
25
long-term loans to borrowers. The spread between the cost of funds and the interest rate charged
to borrowers represents one of the main sources of profit for most financial institutions. The most
common ratio used to examine funding costs is the ratio of interest expenses on deposits to total
deposits. Macroeconomic theory states that there is a negative relationship between funding costs
and profits because a lower cost is generate better returns for banks that make profits off of the
loans to borrowers. Dietrich and Wanzenried (2011) find a negative relationship between this ratio
in Switzerland, and Lindblom et al (2010) find that decreasing rates during crisis periods have
lowered funding costs for banks in Sweden. This result is in line with the theory that banks adjusted
their deposit rates in line with declining market rate.
Interest income
Interest income is the amount of interest that has been earned during a specific time period. It is
earned from investments that pay interest, such as in a savings account or certificate of deposit.
Interest Income is the revenue earned by lending money to other entities. The term is usually found
in the company’s income statement to report the interest earned on the cash held in the savings
account, certificates of deposits, or other investments. Interest income is usually taxable income
and is presented in the income statement for the simple reason that it is an income account. Usually,
the two categories in the income statement, namely “Income from Operations” and “Other
Income” are listed separately. In such an instance, the presentation of interest income will largely
depend on the nature of the business’ primary operations.
If, for example, the income from interest is a major source of funds for the company, then it falls
under “Income from Operations.” If it is not a primary revenue source, then it is classified as
“Income from Investments” or “Other Income.”
Branch expansion
Branch banking allows a financial institution to expand its services outside of its home location
and into smaller storefronts that function as extensions of its greater operations. Branch expansion
is the increase in the number of bank branches will have an effect on getting many customers
particularly those in far remote areas who are unbanked society. Branch expansion is among the
main strategies of the bank. This strategy is to increase quality of service such as giving intended
26
service within few minutes and increasing accessibility of the bank that enables to mobilize deposit
and increase customers. The researcher tried to identify the success of this strategy by using branch
expansion. The distribution of branches defines markets for financial services because branches
are where deposits are held and loans are arranged.
Branches are the most important interface between banks and their customers. Branching enables
banks to diversify their loans and deposits over a wider geographical area or customer base. In
order to give credit banks should collect deposit from their customers and it is generally assumed
that in order to mobilize deposit having more branches in different areas is very important. Aside
from collecting deposits, branch networks also generate new lending especially consumer and
small business lending. While at many banking organizations credit decisions have been
centralized in regional or national credit offices branches continue to serve as an initial point of
contact for new consumer and small business customers (Hirtle, 2007).
Industry-specific variables
This subsection discusses the industry concentration and banking sector development variables
separately from bank-specific variables as far as this variable is to some extent external. That
means managers cannot change the variable immediately like that of bank-specific variables.
Banking sector development: a total asset of the industry to GDP ratio indicates that
financial development plays an important role in the economy. When the market comes more
competitive, banks need to adapt different strategies in order to retain profitability. Demirguc Kunt
and Huizinga (1998) present evidence that financial expansion and structure are important
variables. Their results show that banks in countries where bank assets comprise a large portion of
GDP generally have smaller margins and less profitability.
Macroeconomic variables
The environments in which banks operate can influence their performance and can impact on their
strategic positioning. The external determinants represent events outside the scope and influence
of the banks. The external environment defines the legal, political, economic, technological, and
social landscapes in which banks operate. These factors are external because the banks do not have
control over them although banks can anticipate changes in the external environment and position
27
themselves strategically to take advantage of them. The external landscape can further divide into
industry-specific (financial structure) determinants and macroeconomic determinants. The
industry-specific determinants are only specific to the banking industry such as the industry
concentration, price elasticity and developments in the banking industry. The macroeconomicspecific determinants reflect the general macroeconomic and market conditions in the country. In
this study, real gross domestic product, inflation and exchange rate are adopted as external factors
examined as they are widely studied in other countries.
Gross Domestic Product: The real gross domestic product is the measure of total economic
activity within the economy and it is commonly used economic indicator. In this study we employ
the gross domestic product growth as a measure of macroeconomic conditions. The gross domestic
product growth is the annual change in the real GDP. According to Demirguc Kunt et al., (1998),
Bikkeret al (2002), and Athanasoglou et al., (2008), there is a positive association between
economic growth and commercial banks profitability. We anticipate therefore a positive
correlation between real GDP growth and profitability.
Inflation rate: Another important macroeconomic condition which may affect both the costs
and revenues of banks is the inflation rate (INFL). In this regard, after some authors introduces the
issues of the relationship between bank profitability and inflation, stating that the effect of inflation
on bank profitability depends on how inflation affects both salaries and the other operating costs
of the bank. In this context, Staikouras & Wood (2003) point out that as inflation may have direct
effects, that is, increase in the price of labor, and indirect effects, that is, changes in interest rates
and asset prices, on the profitability of banks. Perry (1992) also suggests that as the effects of
inflation on bank performance depend on whether the inflation is anticipated or unanticipated. In
the anticipated case, the interest rates are adjusted accordingly, resulting in revenues to increase
faster than costs and subsequently, having positive impact on bank profitability. On the other hand,
in the unanticipated case, banks may slow in adjusting their interest rates resulting in a faster
increase of bank costs than bank revenues and consequently, having negative effects on bank
profitability. Thus, the expected sign of the inflation is unpredictable based on prior research.
Foreign exchange Rate: Foreign Exchange risk arises when a bank holds assets or liabilities
in foreign currencies and impacts the earnings and capital of bank due to the fluctuations in the
28
exchange rates. No one can predict what the exchange rate is in the next period, it can move in
either upward or downward direction regardless of what the estimates and predictions were. This
uncertain movement poses a threat to the earnings and capital of bank, if such a movement is in
undesired and unanticipated direction. Songul Kakilli (2013) Turkish banking sector’s profitability
factors found positive relationship between exchange rate and profitability. Thus, this variable has
significant and positive impact on profitability. Official exchange rate refers to the exchange rate
determined by national authorities or to the rate determined in the legally sanctioned exchange
market. It is calculated as an annual average based on monthly averages (local currency units
relative to the U.S. dollar)
2.2. Review of empirical studies
There are numerous studies which deal with bank profitability though those studies vary to a great
extent. Some studies on the bank profitability were carried out focusing on a single country, while
others on a panel of countries. To make this current research project more meaningful some
references of previous studies from both panel countries and single countries are presented here.
2.2.1. Studies in Global Context
Abreu and Mendes (2000) investigated the determinants of bank’s interest margins and
profitability for some European countries in the last decade. They indicated that well-capitalized
banks face lower expected bankruptcy costs and this advantage “translate” into better profitability.
Although with a negative sign in all regressions, the unemployment rate was relevant in explaining
bank profitability. The inflation rate was also relevant in their study. Bashir (2003) examined the
determinants of profitability of Islamic banks evidence from some Middle East countries. He found
that high capital to asset and loan to asset ratios lead higher profitability in study area. The results
also revealed that implicit and explicit taxes affect the bank performance and profitability
negatively while macroeconomic conditions impact performance measures positively. On another
study, Falmini et al., (2009) used 389 banks in 41 sub-Saharan African countries to study on the
determinants of bank profitability. They found that apart from credit risk, higher returns on assets
are associated with larger bank size, activity diversification, and private ownership. Bank returns
are affected by macroeconomic variables, suggesting that macroeconomic policies that promote
low inflation and stable output growth do boost credit expansion. The results also indicate
moderate persistence in profitability. This indeed means that the existence of competition among
29
banks in sub-Saharan countries reasonable fair. To carry out the study, they utilized random effect
model in estimating the explanatory variables. Guru et al., (2002) attempted to identify the
determinants of successful deposit banks based on a sample of seventeen Malaysian commercial
banks in order to provide practical guides for improved profitability performance of these
institutions. The profitability determinants were divided in two main categories, namely the
internal determinants (liquidity, capital adequacy and expenses management) and the external
determinants (ownership, firm size and external economic conditions). The findings of this study
revealed that efficient expenses management was one of the most significant factors in explaining
high bank profitability. Among the macro-indicators, high interest ratio was associated with low
bank profitability and inflation was found to have a positive effect on bank performance.
Naceur (2003) investigated the impact of bank’s characteristics, financial structure and macroeconomic indicators of bank’s net interest margins and profitability in the Tunisian banking
industry. The study found that bank characteristics explain a substantial part of the within-country
variation of bank interest margins and profitability. High net interest margin and profitability tend
to associated with banks that hold a relatively high amount of capital, and with large overheads.
Other important internal determinants of bank’s interest margins bank loans which have a positive
and significant impact. The size has mostly negative and significant coefficients on the net interest
margins. This latter result may simply reflect scale inefficiencies. Finally, the paper found that the
macro-economic indicators such inflation and growth rates have no impact on bank’s interest
margins and profitability. Athanasoglou et al., (2005) assessed the effect of bank-specific,
industry-specific and macro-economic determinants of bank profitability on a panel of Greek
banks. The estimation results suggested that profitability persists to a moderate extent, indicating
that deviations from perfectly competitive market structures may not that large. All bank-specific
determinants, with the exception of size, affect bank profitability significantly in the anticipated
way.
Aburime (2008) studied company level determinants of bank profitability in Nigeria for the period
of 2000 to 2004. The result showed that capital size, size of credit portfolio and ownership
concentration significantly determines bank profitability in Nigerian banking sector. Size of
deposits liabilities, labor productivity, and state of information technology, control-ownership
30
disparity and structural affiliation are insignificant determinants of bank profitability in Nigeria;
and the relation between bank risk and profitability inconclusive. Ramlall (2009) considered many
variables of bank specific, industry specific and macroeconomic factors for Taiwanese banks.
Results show that the main determinant of profitability for Taiwanese banks rests on credit risk,
captured by allowance for doubtful debts, entailing the highest effect not only in terms of statistical
but also in terms of economic significance. The researcher also transpired that capital positively
impact on profits, though the economic significance is significantly less than that of credit risk.
Moreover, the study variables were estimated based on panel model.
Chan and Vong (2010) examined the impact of bank characteristics as well as macroeconomic and
financial structure variables on the performance of the Macao banking industry. Utilizing bank
level data for the period of 1993 to 2007, they adopted panel data regression to determine the
important factors in achieving high bank profitability. Finally, they concluded that a wellcapitalized bank is perceived to lower risk. On the other hand, the asset quality as measured by the
loan-loss provisions, affects the performance of banks adversely. In addition, banks with a large
retail deposit-taking network did not achieve a level of profitability higher than those with a
smaller network. Lastly, with regard to macroeconomic variables, only the rate of inflation
exhibited a significant relationship with banks’ performance. And they analyzed their study by
taking ROA as a dependent variable. On their study, Anwar et al., (2011) concluded that Total
Assets, equity to total assets, deposits to total assets, and loans to total assets are the major internal
determinants of profitability of banks in Pakistan. They employed ten top banks over the period of
2004-2008 in their study and used pooled ordinary least square method (POLS) to investigate the
above internal variables. Moreover, they have used return on Assets as a dependent variable to
measure the profitability of Pakistan banks. Olweny and Shipho (2011) used panel data to
investigate the determinants of commercial banks profitability in Kenya for the period of 2002 to
2008 of 38 banks. They ascertained that banks specific factors are the most significant factors
influencing the profitability of commercial banks in Kenya than market factors. They indicated
that profitable commercial banks are those that strive to; improve their capital bases, reduced
operational costs, improve assets quality by reducing the rate of non-performing loans, employ
revenue diversification strategies as opposed to focused strategies and keep the right amount of
liquid assets. Indeed, they concluded that profitability in Kenyan banking sector is largely driven
by managerial decision than market factors.
31
2.2.2 Studies in single Countries
Studies in single Countries this sub section presents some of the single country studies reviewed
by the researcher chronologically. Guru et al. (2002) investigates the determinants of bank
profitability in Malaysia. The findings revealed that efficient expenses management was one of
the most significant in explaining high bank profitability. Among the macro indicators, high
interest ratio was associated with low bank profitability and inflation was found to have a positive
effect on bank performance. Chantapong (2005) investigates the performance of domestic and
foreign banks in Thailand during the period 1995 to 2000. All banks were found to have reduced
their credit exposure during the crisis years and have gradually improved their profitability during
the post-crisis years. The results indicate that foreign bank profitability is higher than the average
profitability of the domestic banks although importantly, in the post-crisis period, the gap between
foreign and domestic bank profitability has closed, suggesting that the financial restructuring
program has yielded some positive results.
Kosmidou, Tanna and Pasiouras (2006) investigated the impact of bank-specific characteristics,
macroeconomic conditions and financial market structure on UK owned commercial bank‟s
profits, measured by Return on Average Assets (ROAA) and Net Interest Margins (NIM). An
unbalanced panel data set of 224 observations, covering the period 1995-2002, provided the basis
for the econometric analysis. They relied on two commonly used measures of profit performance
namely Return on Assets (ROA) and Net Interest Margin (NIM). The five measures used as
internal determinants of performance are: cost to income ratio as an indicator of efficiency in
expenses management, ratio of liquid assets to customer and short-term ratio of loan 34 loss
reserves to gross loans as an indicator of bank’s asset quality, ratio of equity to total assets
representing capital strength, and the total assets of a bank representing its size. Turning to external
determinants, four measures were considered, two of which represent the influence of
macroeconomic conditions and the other two of financial market structure. The results showed that
capital strength, represented by the equity to assets ratio, is the main determinant of UK bank‟s
profits. The other significant determinants are cost-to-income ratio and bank size, both of which
impact negatively on bank profits. Athanasoglou et al. (2008) examined the effect of bank-specific,
industry-specific and macroeconomic determinants of bank profitability of Greek commercial
banks and covers the period 1985-2001. They employed an empirical framework that incorporates
the traditional Structure-Conduct-Performance (SCP) hypothesis. The profitability variable is
32
presented by two alternative measures: the ratio of profits to assets, i.e., the Return on Assets
(ROA) and the profits to equity ratio, i.e., the Return on Equity (ROE). Five bank-specific factors
used to test the correlation with bank profitability. Capital variable which is peroxide by equity to
assets ratio, and productivity growth variable produced a positive and significant relationship with
profitability. Next, credit risk and operating expenses management were found too negatively
significant. Lastly, the effect of bank size on profitability was found too not important. Two
industry-specific profitability determinants utilized namely ownership and concentration was
found to insignificant in affecting the profitability. Macroeconomic control variables, such as
inflation and cyclical output, clearly affect the performance of the banking sector. In conclusion,
their findings indicated that all bank-specific determinants, with the exception of size, affect bank
profitability significantly in the anticipated way.
Naceur and Goaied (2008) examine the impact of bank characteristics, financial structure, and
macroeconomic conditions on Tunisian bank’s net-interest margin and profitability during the
period of 1980 to 2000. They suggest that banks that hold a relatively high amount of capital and
higher overhead expenses tend to exhibit higher net-interest margin and profitability levels, while
size is negatively related to bank profitability. During the period under study, they find that stock
market development has positive impact on bank’s profitability. The empirical findings suggest
that private banks are relatively more profitable than their state-owned counterparts. The 35 results
suggest that macroeconomic conditions have no significant impact on Tunisian bank’s
profitability. A study on bank profitability is also been achieved by Dietrich and Wanzenried
(2009) focusing on 453 Swiss Commercial Banks over the period of 1999 to 2006, it has 1919
observations. The research includes the recurrent determinants such as bank-specific, industryspecific and macroeconomic factors. Most interestingly, their results demonstrate the existence of
significant differences in profitability between the Swiss Commercial Banks and the determinants
listed above are the main influences hind this positive impact on profitability. Some controversy
matters are also listed, Banks in Lake Geneva region are slightly profitable than Banks in the
Zurich region. Furthermore, results also show that foreign banks are clearly less profitable
compared to public banks. And also, some of macroeconomic variable such as effective tax rate
and market concentration rate have negative effect on profitability.
33
Grygorenko (2009) investigated the influence of price setting strategy on bank performance in
Ukraine. He employed the Instrumental Variables Technique (IVT) to explore this effect. It was
found that the relationship between performance of the bank and its price setting policy is positive
and statistically significant. According to these findings, banks with higher margins were more
profitable. Also, it was estimated that more profitable banks were characterized by strong
capitalization level and high deposit-to-asset ratio. Such external factors as market concentration
and inflation rate appeared to insignificant in determination of bank performance in Ukraine,
contradicting the inflation findings of Kosmidou (2008). Sufian (2011) investigated the
profitability of the Korean banking sector for the period of 1992- 2003 and he comes up with the
following findings that the banking system in Korea impulses profitability when there is low
liquidity in their assets and their macroeconomic determinants especially inflation have a
significant impact on bank profitability. However, the impact of credit risk and cost are always
negative. Furthermore, it is observed that on average the Korean banking sector is relatively more
profitable during the pre-crisis period under both profitability measures, i.e., ROA and ROE. One
relevant view that is included in Sufian paper is that the Korean banking system was under fire
during the Asian financial crisis.
2.2.3. Studies in Ethiopian Context
Few studies were undertaken on determinants of private bank profitability in Ethiopia with varying
types and number of variables taken into consideration. A number of internal and external factors
were used to predict profitability and efficiencies.
Melaku (2016) investigate determinants of bank profitability in Ethiopian private banks using
Secondary data. The data were obtained from audited financial statements of six sampled private
commercial banks from 2004 to 2011 and the national bank of Ethiopia. Both descriptive statistics
and econometrics model specifically fixed effects estimation were used to analyze the relationships
between dependent and explanatory variables. The study used return on assets (ROA) as the
dependent variable and asset size, capitalization, labor productivity, liquidity and non-interest
income, credit risk, loan and overhead efficiency, GDP growth rate, inflation and market share as
explanatory variables. The regression result revealed that asset size, capitalization, labor
productivity, liquidity and non-interest income, showed a positive magnitude and significant
impact on the financial performance of private banks in Ethiopia measured in ROA whereas credit
34
risk and overhead efficiency has a significant and negative relationship with the financial
performance of Ethiopian private banks. Moreover, the regression result revealed that the GDP
growth rate has a significant positive effect on the financial performance of private commercial
banks in Ethiopia.
Million(2018) examined the determinants of private commercial banks profitability. To achieve
the overall objective of the study data were collected from annual report of the selected nine private
commercial banks. The study used ROA as a Dependent variable and liquidity, capital adequacy,
cost income ratio, Non-performing loan, bank size, loan and advance, net interest margin, GDP
and inflation as independent variables. Accordingly the finding implied that, Capital adequacy,
bank size, loan and advance, NIM, and GDP have positive significant relationship with
profitability of Ethiopian private commercial banks. While, liquidity NPL, inflation and cost
income ratio shows negative significant relationship with profitability of Ethiopian private
commercial banks. Based on the major finding the study recommended some important
recommendations such as, in order to maximize profitability of bank, Ethiopian commercial banks,
it is advisable to lower the liquidity ratio to increase the income from loan.
Yigremachew (2008) concluded that interest and noninterest incomes and interest expense are the
main determining factor for the profitability of private banks in Ethiopia both in static and dynamic
conditions. Other bank level variables like fixed asset investment, and capital adequacy ratio had
considerable positive impact on profit. Macroeconomic conditions such as inflation have
significant unfavorable impact on operational performances of private banks.
Tesahle (2011), studied determinants of bank profitability in Ethiopia on selected commercial
banks, analyzed a number of internal and external factors to predict profitability and efficiencies.
Controlling for macroeconomic environment and market concentration the result indicated that
inflation has significant impact on profitability of selected banks. Other bank specific factors such
as total Assets, non-interest expenses to total assets, ratio of equity to total assets, loan loss
provisions to total loans, ratio of loans to total Assets, and ratio of noninterest income to total
assets have significant impact on profitability of selected commercial banks for the period of 20032009. The researcher tried to incorporate both government banks and private banks in his study.
35
layneh (2011) observed capital, assets size, loan, deposits, noninterest income, non-interest
expense, and credit risk of bank specific variables have significant influence on profitability of
commercial banks in Ethiopia. The researcher utilized seven commercial banks financial data
including huge government banks and private banks for the period of 2001-2010. Among
macroeconomic variables, GDP growth has positive influence on profitability of Ethiopian bank
and market concentration also affect bank profitability in his study. Basically, he applied return on
assets (ROA) as a dependent variable to measure profitability in the bank Ethiopia.
2.3 Conceptual Framework
A conceptual framework depicts a relation that exists between study variables. The study seeks to
identify determinants of banks profitability hence independent variables will include bank‘s bank
asset, interest income, branch expansion and operating expense.
Research on the determinants of bank profitability has focused on both the returns on bank assets
and equity, and net interest rate margins. It has traditionally explored the impact on bank
performance of bank-specific factors, such as risk, market power, and regulatory costs. More
recently, research has focused on the impact of macroeconomic factors on bank performance
(Valentina Flamini, et al, 2009).
A company remains in operation because it expects to make profits. Once that expectation is
confirmed unattainable, the most rational decision is to close shop or exit the business. Three
indicators, namely: Net Interest Margin (NIM), Return on Assets (ROA) and Return on Equity
(ROE) were identified by Ahmed (2003) to be widely employed in the literature to measure
profitability. However, there are divergent views among scholars on the superiority of one
indicator over the others as a good measure of profitability.
From the literature review mentioned above, the investigator developed the following schematic
representation of the conceptual frame work.
36
Dependent variable
Independent variables
Bank asset
ROA
Branch expansion
Interest income
Operating expense
2.4 Summary and Knowledge gap
There are plenty of research works done in analyzing the determinants of Ethiopian commercial
banks profitability in general and private commercial banks in specific. The reviewed literatures
identified different factors that determine the private commercial banks profitability, broadly
classifying them as bank specific factors, industry or sector specific factors and macroeconomic
factors.
Ashenafi (2022) investigated determinants of commercial banks profitability in Ethiopia a study
on internal factor by using panel data of thirteen commercial banks from year 2010 to2018. The
study employed an explanatory type of research and secondary financial data were used. On this
study Return on Asset (ROA) has been used as a proxy variable for the dependent variable. Based
on the result of Haussmann specification test the study used fixed effect model. The fixed effect
regression model was applied to investigate the effect of bank size, capital adequacy, liquidity risk,
operation efficiency, debt management, funding cost, and loan to asset ratio on profitability. The
major findings of the study show that, operation efficiency, capital adequacy and bank size have
statistically significant and positive relationship with banks’ profitability. However, the
relationship for liquidity risk, debt management, funding cost, and loan to asset ratio were found
to be statistically insignificant. But the study fails to disclose the impact of some very important
variables in Ethiopian context such as bank asset, interest income, branch expansion and operating
expense.
37
The study of Million (2018) was good in many aspects when compared to prior studies that are
conducted on the same area but study fails to include some important variables that are not tested
in Ethiopian context like bank asset, interest income, branch expansion and operating expense. In
general, the lack of sufficient research (based on the researcher knowledge) on the determinants
of bank profitability in the context of Ethiopia and the existence of variables that are not tested in
Ethiopian banking industry initiate this study. Therefore, the objective of this study is to examine
the factors that affect bank profitability in Ethiopia and to fill the knowledge gap that exists in the
area by including and testing four new variables (bank asset, interest income, branch expansion
and operating expense) that are not tested by prior Ethiopian researchers.
Plenty of research works were done to identify determinants of private commercial banks
profitability. However, as far as the researcher knowledge, there is scanty research that had been
done on this area particularly during establishment of newly emerging private banks and its impact
is not measured on private commercial banks profitability. This has necessitated the investigation
to find out the main factors that determine the profitability of Ethiopian private commercial banks
profitability during the establishment of more newly emerging private banks
38
CHAPTER THREE
3. METHODOLOGY OF THE STUDY
Introduction
In this chapter, the researcher concentrates on the methods that adopted throughout the study to
accomplish the research objectives. It includes the research design adopted to examine the
determinants of banks profitability, the type of data used and the sampling design employed to
collect the data, the methods employed to analyze the data.
3.1 Research design
In order to achieve the objectives of the study, the research undertakes the explanatory type of
research design to establish causal relationship between variables being studied. The researcher
has used panel data (Longitudinal data) of five private commercial banks operating in Ethiopia.
To examine the effect of independent variables (Bank asset, interest income, operating expense,
and branch expansion) over the dependent variable (Return on Asset) for the period 2017-2022.
3.2 Research approach
The study was done by using quantitative research approaches. Quantitative research is a means
for testing objective theories by examining the relationship among variables (Creswell 2009). On
the other hand, qualitative research approach is a means for exploring and understanding the
meaning individuals or groups attribute to a social or human problem with intent of developing a
theory or pattern inductively (Creswell 2009). Finally, mixed methods approach is an approach in
which the researchers emphasize the research problem and use all approaches available to
understand the problem (Creswell, 2003). Hence, based on the above discussions of the three
research approaches and by considering the research problem and objective, in this study, the
quantitative method was adopted.
3.3 Type and source of data
The study was done by using secondary source data. The secondary data were collected from the
balance sheet and income statement from selected banks. In Ethiopia banks report and submit their
annual report to the controlling body to the NBE. As a result it was easy for the researcher to get
39
annual reports of all selected banks from the NBE central data base and the financial statements
from the annual audited report of NBE. Data from balance sheet and income statements were used
for this research and to run the model.
3.4 Data collection techniques.
In order to analyze the effect of bank specific factors on profitability of banks, audited financial
statements of five banks (Buna, Awash, NIB, Enat, and birhan bank) for 5 consecutive years. i.e.,
from 2017-2022 G.C. was collected. The secondary data was collected through structured
document reviews from the records held by NBE and the banks themselves. Moreover, in order to
analyze the relationship that exists between profitability and bank specific variables data was
collected for the same years.
3.5 Target population for the study.
The target population for the study is all private commercial banks registered by National bank of
Ethiopia and under operation in the country. Currently, in Ethiopia there are twenty-seven private
commercial banks which are operating throughout the country NBE (2021/2022).
3.6 Sample design
Sampling involves the various procedure used to select a part to represent a population. Purposive
sampling were used in determining the sample banks in the study taking into account size of the
bank and years of experience in operation. Therefore, out of twenty-seven private commercial
banks in Ethiopia that are currently in operation NBE (2021/2022); the researcher selects five of
them. The rationale behind selecting five banks out of the total population is based on the following
criteria’s:
 Time of establishment (by taking one firstly established private bank which is awash bank
and taking newly established bank, therefore awash banks’ who have long years’
experiences in the banking operations and newly established banks are included). This
indicates reasonable time is necessary to look changes in the business of banking.
 Ownership structure (only private commercial banks are included in the study). Here, state
owned banks are excluded from the study. Therefore, on the basis of the above criteria;
40
Awash, Buna, Enat, Nib and Birhan banks’ share companies are chosen in the studies. They
are assumed to be representative samples of all other banks in the country.
3.7 Method of Data Analysis.
To achieve the broad research objective, the study was primarily based on panel data, which was
collected through structured document review. Thus, the collected panel data was analyzed using
descriptive statistics, correlations and multiple linear regression analysis. Mean values and
standard deviations was used to analyze the general trends of the data from 2017 to 2022 G.C.
based on the sample of 5 banks. In addition, correlation analysis was used so as to select the
appropriate variables which to be included in the model and to check for multicollinearity of the
data. Regression analysis was used to explain the total variation in dependent variable by breaking
it into the explained variation due to explanatory variables to be included into the model and the
residual variation. The collected data structured as per the designed model using Excel sheet then
process it using the IBM SPSS statistics 20.software.
3.8 Model Specification.
The researcher used the multiple regression OLS time series model. Characteristics of the model
and proposed variables are likely not to violet the classical assumption underlying the OLS model.
The study used explanatory variable like asset of the bank, interest income, branch expansion, and
Operating Expense, while the dependent variables is ROA. In this study, panel data was used. As
noted in Brooks (2008), a panel keeps the same individuals or objects and measures some quantity
about them overtime. The regression model for the panel data was described in the following
equation as adopted from Brooks (2008):
Yit=α+βXit+εit
Where: Yit=is the dependent variable
α=is the intercept term
β=is a Kx1 vector of parameters to be estimated on the explanatory variables
Xit=is a 1xK vector of observations on the explanatory variables, t=1...T
εit =the normal error term.
41
i=1…N.
In this study, the profit of the bank is measured using the ROA. The study variables include bank’s
asset, interest income, branch expansion and operating Expense.
Therefore, time series model expressed as follows was used to analyze the relationship among the
variable.
The general linear regression equation of the study is:
ROAit = β0 + β1 Assetit + β2 interest incomeit + β3 operating expenseit + β4 no of Branchesit
+Uit
Where;
ROAit is a dependent variable for bank which is return on asset i at time t.
β0, β1, β2, β3, and β4 refers to the coefficient of independent variables.
Uit = Error term
42
CHAPTER FOUR
4. DATA ANALYSIS AND INTERPRETATION
Introduction
The purpose of this chapter is to present and analysis of data collected from the sampled banks
annual publications of the national bank of Ethiopia (NBE) and each commercial banks audited
annual financial reports. The audited financial statements of the banks over the study period have
been obtained from National Bank of Ethiopia, (which is responsible for maintaining the audited
financial statements of all banks operating in the country and regulate their operating activities),
the country ‘s central bank. Basically, the balance sheet, income statements and annual reports
were the main sources of the relevant data to address the stated objectives of the study.
4.1. Results of the study
The purpose of this section is to present the results of data obtained from method involved in the
study. Therefore, this section deals with the results of research paper like descriptive analysis,
correlation analysis and regression analysis.
4.1.1 Descriptive Analysis
Conducting descriptive analysis before undertaking regression analysis the researcher used to
show much about the relationships between dependent and independent variables. The bellow table
shows the descriptive analysis of variables under study. This analysis includes mean, minimum,
maximum and standard deviation. The value of the mean reports the arithmetical average of the
variables which are included in the study. The minimum and maximum values indicate the lower
and the highest value of the variable. The standard deviation exhibits how much variation or
dispersion exists from the mean. A low standard deviation indicates that the data points are inclined
to be extremely close to the mean; while high values of standard deviation (SD) indicates that the
data set is broaden out over a large range of values. The descriptive analysis that would be carried
out in this section mainly depends on summary statistics presented below.
Table 2: Descriptive analysis
(Dependent variable (ROA) and independent variables in millions except BRANCH)
43
ROA
ASSET
INTEREST
OPERATING
INCOME
EXPENSE
BRANCH
Mean
0.02
49,240.55
2,043.39
762.12
286.24
Maximum
0.04
242,726.00
11,997.00
4,073.00
977.00
Minimum
-0.02
2,733.65
153.00
86.00
158.00
Std. Dev.
0.01
63,038.49
3,007.31
Observations 5
5
5
948.02
5
228.97
5
Source: author computed, 2023
As stated in the above table, mean of ROA is 0.02 for the private commercial bank in Ethiopia for
the study period undertaken. This is to mean that an average amount of net profit obtained from
one birr investment is 2.00 cents. Therefore, 2% of profit is obtained by investment. Minimum
value loss of 0.02 and 0.04 is the maximum value in the data set. This means, when the bank earns
highest profit, it earned 4 cents of net income from one birr investment in asset. This shows 4% of
net income for the bank comes from investment. The least return on asset of the bank in the study
is loss of 2 cents from one birr investment. On the other hand, 2% of net income loss comes from
investment. The data set has the standard deviation of 0.010 which is low and indicates that there
is very low variation in the data set and closer to the mean.
The observation of interest income of the private commercial banks has showed the mean for the
given data set is 2.4 billion. On the other hand, this study shows the minimum interest income in
5 years is 153 million and maximum interest income is 12 billion. Data set of interest income has
experienced standard deviation equal to 3 billion which closer to the mean value. This indicated
that there is lower variation in average interest income of the bank over the period.
Average operating expense of the data set equal to 762 million. 4 billion is the highest operating
expense in the given data set and 86 million is the minimum operating expense in the study period
44
undertaken. Standard deviation has registered the value equal to 948 million which is closer to
mean value operating expense.
On average the branches of the bank in 5 years sample period are 286. Minimum number of
branches during the study period is 158 at first year of the study and maximum number of branches
during the study is 977. Data set of study of number of branches has experienced standard deviation
equal to 228.97.
4.1.2. Correlation analysis
Correlation analysis was used in this study to find out the relationship between variables.
Table 3 the Correlation Analysis
Correlation
ROA
(Asset)
(Branches) (Interest_ Income)
ROA
1.000000
(Asset)
0.228989
1.000000
(Branches)
0.386145
0.145878
1.000000
(Interest Income)
0.593771
0.816148
0.152473
(Operating expense)
-0.300074
0.049762
0.235427
(Operating exp.)
1.000000
-0.031884
1.000000
Source: Author Computed, 2023
From the correlation coefficients presented in the Table 3 above, there is no serious
Multicollinearity among the independent variables. Highest correlation is between asset of the
Bank and its interest income from all independent variables. Operating expense and interest
Income are negatively correlated that when operating expense increases, interest income
Reduces.
Profitability of the bank which is represented by return on asset has strong positive association
(0.59) with its interest income and followed by branch expansion but moderately correlated with
The rest of the independent variables. But operating expense and return on asset are negatively
Correlated that increase in operating expense is decreasing profitability of the bank.in addition,
45
Return on asset and asset are positively associated.
4.1.3 Regression Analysis
This section presents the empirical findings from the econometric results on the determinants of
profitability of private commercial bank in Ethiopia. The section covers the empirical regression
model used in this study and results of the regression analysis. OLS time series model used for the
study is expressed as follows with only significant variables.
Table 4 Regression Analysis
Variable
Coefficient
Std. Error
C
0.013529
0.001923
7.036001
0.0000
(Asset)
-0.029984
0.008458
-3.545035
0.0022
(No of Branch)
0.039253
0.011941
3.287272
0.0039
(Interest income)
0.043646
0.007998
5.456805
0.0000
(Operating expense)
-0.007125
-2.675157
0.0150
Mean dependent var
0.017797
0.002663
t-Statistic
Prob.
R-squared
0.744354
Adjusted R-squared
0.690534
S.D. dependent var
0.013299
S.E. of regression
0.007398
Akaike info criterion
-6.792128
Sum squared resid
0.001040
Schwarz criterion
-6.546700
Log likelihood
86.50554
Hannan-Quinn criter.
-6.727016
F-statistic
13.83037
Prob(F-statistic)
0.000019
Durbin-Watson stat
1.261040
Above mentioned table 4 represents the result of regression analysis. The value of R-Squared is
0.74 in the model which shows that 74.44% variation in the dependent variable or ROA is
described by the independent variables of the model and 25.56% variation is not explained by the
independent variables or internal factors in the study. The value of F- statistic 13.83 and is
significant supporting the model relevant to the study. F-statistic is greater than F-critical (prob(Fstatistic)) that implies independent variables are jointly affecting profitability of the bank. The
value of Durbin Watson is 1.26 which shows that there is no autocorrelation in residuals.
46
Asset of the bank is negatively affecting the profitability of the bank i.e., when asset of the bank
increases, profitability of the bank decreases if other variables remain constant. Specifically, when
asset of the bank increases with one birr, return on asset of the bank decrease by 0.02 birr. Branch
expansion is also significant determinant of the profitability of the bank. The relationship between
return on asset and branch expansion is positive i.e., when number of branches increase return on
asset rises if other independent variables are constant. Branch expansion is ensuring quality service
which increases performance of the bank by mobilizing deposits. When number of branches
increases by one, return on asset increases by 0.039. Another variable of the study that affects
profitability of the bank is interest income. This is the most significant variable in the study with
coefficient of 0.043. This implies that when the interest income increases with one birr, return on
asset increases by 0.043 birr when other variables are constant. On the other hand, operating
expense is significantly affecting profitability of the bank. When operating expense is increasing
by one birr, return on assets decreases by 0.007 and vice versa. All independent variables are
significant at level of 5%.
The empirical model used in the study in order to analyze determinants of the profitability of the
Banks is as follows;
Estimation Equation:
ROA = 0.013-0.03*Asset+0.039* Branch+0.043*interest income-0.007*operating expense
4.1.4 Test Results
The regression analysis from Table 4 is used to test the hypothesis.
Table 5 the Hypotheses Summary
Test
Hypothesis
There is positive relationship between interest income and banks profitability.
accepted
There is positive relationship between branch expansion and profitability of the accepted
banks.
There is negative relationship between asset and profitability of bank.
accepted
There is negative relationship between Operating Expense and banks profitability.
accepted
47
As expected, interest income and branch expansion have significant positive relationship with
profitability of the bank. Although the relationship of asset with profitability is significant, it is
negative. The researcher expected positive relationship based on the strategy of the bank. As it was
expected operating expense and bank profit are negatively associated.
4.2 Discussion of the study
This study was intended to find determinants of profitability of private commercial banks in
Ethiopia by using data period from 2017 to 2022 G.C. As a result, the study identified determinants
that have potential of affecting profit of the bank. The following result obtained from the regression
analysis as depicted in the above table 4 the next section tries to present the analysis with respect
to each profit determinant.
4.2.1 Asset of the Bank
Asset of the bank shows the natural logarithm of total assets and demonstrates significant negative
relationship with the profitability of private commercial bank in Ethiopia which means that the
asset of banks affects profitability of the banks negatively.
The major outcome of this study is that higher total assets may not necessarily lead to higher
profits. The negative coefficient of asset indicates that this relation might be negative due to
diseconomies of scale suffered by banks due to uncontrollable increased size.
4.2.2 Interest Income
The result suggest that interest income has the positive significant relationship with the ROA.
Interest income is a primary source of income for the banks because banks make loan and receive
interest income. According to the study when the interest income is higher, profitability is higher.
It implies that a more efficient bank should have higher profits since it is able to maximize on its
net interest income. As expected, interest income has positive effect on profitability of commercial
banks.
4.2.3 Operating expense
Consistent with expectation the result suggests that operating expense has the negative significant
relationship with the ROA. This negative relationship shows that when the operating expense ratio
increases profitability of the commercial bank’s decreases. According to the study increases in
48
bank operation expenses reduce bank profitability, this suggesting that profitable banks operate at
lower costs. The results for this paper, implies that poor expenses management explains the poor
performance of private commercial banks of Ethiopia. Managing expenses well will improve the
performance of the banks. Bank operation expenses significantly reduce the profitability of the
bank. This suggests that there is possibility for the private commercial bank in Ethiopia to increase
their profits by putting more effort on proper costs control and operating efficiency. This can be
achieved by finding ways of optimal utilization of bank resources during production of banking
products and services. Private Commercial banks need to invest on efficient utilization of resources
and in technologies that reduce costs of operations in order to enhance their performance.
4.2.4 Branch Expansion
Branch expansion is among the main strategies of the bank. This strategy is to increase quality of
service such as giving intended service within few minutes and increasing accessibility of the bank
that enables to mobilize deposit and increase customers. The researcher tried to identify the success
of this strategy by using branch expansion as a one variable. According to the study branch
expansion has positive significant impact on return on asset of the bank. Therefore, the bank that
have many branches is successful in increasing ROA.
49
CHAPTER FIVE
5. CONCLUTIONS AND RECOMMENDATIONS
Introduction
The preceding chapter presented the analysis of the findings, while this chapter deals with the
conclusions and recommendations based on the findings of the study. Accordingly, this chapter is
organized into the following sub-sections. Section 5.1 presents the conclusions and section 5.2
presents the recommendations.
5.1 summary of major findings
The main objective of this study was to investigate internal factors affecting profitability of private
commercial banks in Ethiopia using econometric model. By considering the nature and objective
of the research, a quantitative research approach was adopted. To collect the necessary data the
study used structured review of financial records. The collected data from a sample size of five
private commercial banks over the period of 2017 to 2022 were analyzed using descriptive
statistics, correlation analysis and multiple linear regression analysis. The analyses were made in
accordance to the stated hypotheses formulated in the study.
In order to conduct the empirical analysis, one dependent variable (profitability measured by
ROA), and four independent variables were selected; asset of the bank, interest income, operating
expense, and branch expansion. The variables were selected by refereeing different theories and
empirical studies that have been conducted on banks profitability. The study used secondary time
series data collected from the National Bank of Ethiopia and websites of the bank. The regression
analysis was done using data. Consequently, the empirical findings of this particular study
suggested the following conclusions:
Asset has negative significant effect on profitability of the bank. This negative relationship is
suggesting that when asset of the bank is increasing, it’s earning lower profit through diseconomies
of scale. The private commercial bank in Ethiopia is still losing from diseconomies of scale. From
this result the researcher concludes that, the bank is losing from large assets it owns. Therefore,
asset of the bank is an important factor in determining profitability of private commercial bank in
Ethiopia.
50
Operating expense has significant negative effect on profitability of the bank. According to the
result, best performing bank operates at lowest operating expense. Decreasing operational expense
is decreasing costs and increasing profitability. The researcher concludes that banks that lower
operating expense earns higher profit than that do not. Therefore, operating expense is among
major determinants of the profitability of the bank. Operating expense significantly determines
performance of the private commercial banks. This suggests that there is possibility for private
commercial banks to increase their profits by putting more effort on proper costs control. This can
be achieved by finding ways of optimal utilization of bank resources during production of banking
products and services. However, further research is needed to clear the grey areas especially over
a longer period of time.
Interest income has significant positive effect on profitability of the bank. According to the result,
the best performing bank collects highest interest income. Increasing interest income is increasing
net income of the bank and increasing its profitability. The researcher concludes that when interest
income of the bank increases, it earns higher profit. Therefore, interest income is among major
determinants of the profitability of the bank that it significantly determines performance of the
bank. This suggests that there is possibility for the banks to increase its profits by putting more
effort to increase interest income. This can be achieved by finding ways increase saving deposits
of the bank. However, further research is needed to clear the grey areas especially over a longer
period of time and including other banks.
Branch expansion has positive significant effect on profitability of the bank. This positive
relationship is suggesting that when number of branches of the bank is increasing, the bank gain
more customer to collect more deposit and then give loan to borrower which increases profit by
gaining interest on the loan .The private commercial bank in Ethiopia is still gaining from branch
expansion. From this result the researcher concludes the bank is gaining from branch expansion.
Therefore, branch expansion strategy is successful in determining profitability of the bank.
All independent variables are significant at the 5% level in the regression with the predictions.
This significance suggests that the asset, number of branches, interest income and operating
expense are important in jointly determining the profitability of private commercial bank in
Ethiopia.
51
5.2. Recommendations
In line with the findings of the study, the following recommendations have been forwarded.
Asset is among the main determinants of profitability of the bank. It is increasing from year to
year. Asset increase has negative impact on profitability of the bank. The bank is costing from
asset expansion. The study shows asset is reaching to uncontrollable size i.e., it is creating
diseconomies. The bank has to use existing assets rather than purchasing the new. Management of
the bank has to focus on asset management instead of increasing the size. According to the study
asset and return on asset of the bank are inversely related. The asset is not properly managed.
The study shows that interest income is significant factor of profitability of the bank. The results
also confirmed that improvement in interest income of private commercial bank in Ethiopia leads
to higher profits. Main source of income for private commercial banks is interest income. Interest
income is collected by giving loan and advances. It is not easily achievable because there must be
loanable deposit such as time deposit and mobilizing this deposit is not easy task. The bank is
recommended to increase its interest income by providing loan and improving loan collection
mechanisms such as lending for feasible projects and holding collateral.
Expenses are significantly decreasing profitability of the bank. The bank has to decrease
unnecessary expenses by investing on efficient management and in technologies that reduce costs
of operations in order to enhance their performance. The results of this paper, implies that poor
expenses management explains the poor performance of private commercial banks in Ethiopia.
Managing expenses well will improve the performance of the banks. This can be achieved by
finding ways of optimal utilization of bank resources during production of banking products and
services.
Branch expansion is significantly affecting profitability of the bank. It is one of the main strategies
used by the bank to increase its profit by more accessible to the existing and new customers. But
branch expansion comes with asset expansion that has negative impact on profitability of the bank.
The bank has to expand branches by efficient management and in technologies. Therefore, the
bank has to increase branches without significantly increasing an asset.
52
Finally, the study sought to investigate factors affecting profitability of private commercial banks
in Ethiopia. For comprehensive investigation future researcher could increase the number of
observations by increasing the sample size and extending the period of time with unbalanced data.
5.3 Future area of investigation
Finally I will recommend future researcher who want to do research on this particular topic by
taking into consideration of other variable such as, political instability, increasing number of bank,
and brand name.
53
REFERENCES:
Abaw, K. and Kapur, D. (2011) What drives the performance of commercial banks in Ethiopia,
Journal of Research in Commerce and Management, 2(7), pp. 38-43.
Amdemikael (2012), Factors affecting profitability: an empirical study on Ethiopian banking
industry, MSc project paper, Addis Ababa University.
Ashenafi (2022), determinants of commercial banks profitability in Ethiopia, Journal
http://journalppw.com 2022, Vol. 6, No. 8, 1219-1238 Parul University, Faculty of commerce
Department of Accounting and Finance.
Belayneh, H. (2011) Determinants of commercial banks profitability: an empirical study on
Ethiopian commercial banks. Published Master project. Addis Ababa University.
Damena, (2011), Determinants of commercial banks profitability: an empirical study on Ethiopian
commercial banks, MSc project paper, Addis Ababa University.
Guru, B, Shanmugam, B, and Staunton, J. (2002) Determinants of commercial banks profitability
in Malaysia, University of Multimedia, Working Papers.
http://www.enatbanksc.com/
Kosmidou K. (2008), The determinants of Bank’s Profits in Greece during the period of EU
financial integration, Emerald Group Publishing Limited, Managerial Finance, Vol. 34 No. 3, p:
146-159
Melaku,(2016), Determinants of Bank Profitability in Ethiopia, Research Journal of Finance and
Accounting www.iiste.org ISSN 2222-1697 (Paper) ISSN 2222-2847 (Online) Vol.7, No.7, 2016
Modigliani, F & Miller, MH (1958), The Cost of capital, corporation finance & the theory of
investment, The American Review, vol. 48, no. 3, pp. 261-297
Molyneux, P. and Thornton, J. (1992) Determinants of European bank profitability: A note,
Journal of Banking and Finance, 16, pp. 1173-1178.
NBE 2013/114, “Annual report”, National Bank of Ethiopia, Addis Ababa, Ethiopia
NBE 2021/2022, “Annual report”, National Bank of Ethiopia, Addis Ababa, Ethiopia
Odufulu O. (1994), Monetary Policy and Bank’s Profitability in Nigeria. First Bank of Nigeria Plc
Bi-Annual Review, Dec, 1995.
Tesahle, B. (2011) Determinants of bank profitability in Ethiopia: on selected commercial banks.
Unpublished Master thesis. Mekelle University.
54
Annex 1 Study Data (in million birr except Branch)
Year
Asset
Interest income
Operating expense
branch
ROA
2017
2,960
153
87
158
0.013
2018
22,146
586
395
193
-0.021
2019
14,455
836
378
174
0.002
2020
242,726
11,977
3,436
977
0.040
2021
17,434
876
358
181
0.004
Source: National Bank of Ethiopia, 2022
55