What Are the Drivers of Bank Profitability in the World? A Critical Review of the Empirical Literature with the Layout of a Blueprint Model

ABSTRACT

Despite the existence of an extensive literature on determinants of bank profitability, there exists no paper which comprehensively weaves through this literature. We humbly undertake such a review by painstakingly discussing all the potential proxies to end up with a holistic model. We keep abreast of the evolving dynamics by proposing two new metrics, namely aging population and digitization to cope with the detrimental sequels of COVID-19. Our full-fledged model consists of bank-specific, macroeconomic-specific, crisis dummies and interacting variables. Operational risk is found to be an area that will need to be further developed in the literature. Our proposed model can be applied to a specific country or a group of countries with researchers being able to flexibly tweak our blueprint model to suit their own specific applications.

KEYWORDS:

• Banks
• profitability
• review of literature
• global analysis

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 The criterion employed by Schwert (2018) to capture highly bank-dependent firms pertains to those companies which do not have a public debt rating.

2 These abnormal returns are computed as the difference between realized returns and expected returns implied by a market model.

3 Sohn and Park (2016) define credit as the volume of credit market debt outstanding of the non-financial corporate sector as captured by the Federal Reserve bank under its reported funds of flows accounts.

4 Banks in less competitive markets restrict their lending to high risk-return profile loans leading to a sub-optimal portfolio of loans.

5 Goldstein (2017) labels the leverage ratio as the highest quality capital.

6 Technically speaking, reserves and provisions are distinct as the former represent an appropriation of profit targeted toward a specific purpose while the latter reflect an appropriation of profit for an estimated expense.

7 Actual reserves consist of the sum of both required reserves and excess reserves.

8 Total costs are regressed on a set of independent variables comprising of: log of total assets, half of log total assets squared, price of deposits (interest expenses over deposits and short-term funding), price of labor (personnel expenses over total assets), price of physical capital (other non-interest expenses over book value of fixed assets), country fixed effects, year dummies, and bank specification dummies.