The Determinants of Profitability in the Banking Industry: Empirical Research on Selected Balkan Countries

Abstract

The determinants of bank profitability in general, and of the impact of market structure and efficiency on bank performance in particular, remain a much- researched topic in bank performance analysis. The purpose of this article is to investigate the relevance of the structure-conduct-performance (SCP) hypothesis versus the efficiency hypothesis in explaining bank performance by analyzing 127 commercial banks from six Balkan countries (Slovenia, Croatia, Serbia, Bosnia and Herzegovina, Montenegro, and Macedonia) over the period 2005–2009. In order to account for the dynamic nature of bank profits, it uses a GMM estimator in testing the determinants of bank profitability. The estimation results suggest that profits persist to some extent, indicating that the deviation from a perfectly competitive market structure is marginal. In addition, the findings suggest that efficiency is significantly and positively associated with profitability, whereas the industry concentration variable is insignificant in explaining profitability, indicating support in favor of the efficiency hypothesis. Moreover, among the bank-specific control variables, only size is reported insignificant, and the rest of the variables affect bank profitability in the anticipated manner. Finally, the results suggest that neither inflation nor economic growth has an impact on bank profitability.

Keywords:

• bank profitability
• bank-specific control variables
• efficiency hypothesis
• macroeconomic variables
• structure-conduct-performance hypothesis

JEL Classification:

• G21
• C22
• C51
• C58.

Notes

1. The unobserved bank-specific effect captures all unobserved, time-constant factors that affect profitability (Wooldridge 2005).

2. Idiosyncratic error is defined as a time-varying error, and represents the unobserved factors that change over time and affect bank profitability (Wooldridge 2005).

3. The two-tier banking system underlines (1) the separation between central banks and commercial banks, and (2) that commercial banks are in direct contact with companies (Athanasoglou, Delis, and Staikouras 2006).

4. The literature suggests testing for stationarity in the case of large time series. Although, only six years are used in the analysis, unit root testing is still conducted. In the case of unbalanced panel data set, the Fisher-type panel unit root tests are suggested (Choi 2001; Maddala and Wu 1999).

5. Estimates will be biased and inconsistent due to the correlation between unobserved panel-level effects and the lagged dependent variable (Flamini, McDonald, and Schumacher 2009).

6. As mentioned previously, not enough data are available for the countries of interest; hence, preserving degrees of freedom is very important.

7. Since it was not possible to consider changes in the ownership variable during the sample period, this variable is excluded from the dynamic model.

8. It is also important to mention that additional tests were conducted for the purpose of investigating whether the two efficiency measurements included in the model capture different aspects of bank efficiency. More specifically, the model was run twice, including the efficiency variables separately. The findings show that the NII_it variable remains highly significant in the model where the cost efficiency variable is excluded, and this does not change when the cost-efficiency variable is included. Such findings indicate that there is no transfer of effect, but rather that the two variables capture different aspects of efficiency.

Additional information

Notes on contributors

Vesna Bucevska

Vesna Bucevska is a professor in the Faculty of Economics, Ss. Cyril and Methodius University, Skopje, Macedonia. Branka Hadzi Misheva is a doctoral student in University of Pavia, Department of Economics, Italy.

Branka Hadzi Misheva

Vesna Bucevska is a professor in the Faculty of Economics, Ss. Cyril and Methodius University, Skopje, Macedonia. Branka Hadzi Misheva is a doctoral student in University of Pavia, Department of Economics, Italy.