The Determinants of Commercial Bank Profitability in china

Chapter 1.0: Introduction

1.1 Research Background  – The Determinants of Commercial Bank Profitability in china

Commercial Banks have a vital role in economic growth of a country and competent banking system is critical for economic development and resource allocation. (Coates, 2014) Likewise, financial intermediaries such as bank deliver payment mechanism; manage difficult financial instruments, offer market efficiency and transparency, complement demand and supply of money markets as well as guarantee risk management in financial markets (Ennew & Waite, 2013).

The two-folded influence of banking system in which efficient system deliver economic growth but an inefficient and weak banking system could start systematic crisis and negative economic aftermath in the country  (Chen, Liu, & Su, 2013). Furthermore, banks position in Chinese financial system is prominent with the fact that it provides 70% of total credit to the private sector in the country. In contrast with US financial system where non-banks and money markets are major source of credit for private institution compare to banks. (Xiaoming, 2014)

The intervention of the Chinese government in banking is also a prominent force and its affect decision making of the bank. Therefore, it is critical to recognise the determinants of banking sector profitability to ensure the safe and efficient banking system in Chinese banking context. (Chang, Hu, Chou, & Sun, 2012)

The factors that can affect the bank’s profitability could be internal (management decision and resources) as well as external factors (macroeconomic variables). Therefore, this dissertation attempts to examine the internal and external determinants of commercial bank profitability in china over the period of 9 years from 2006 to 2014. (Dietrich & Wanzenried, 2011)

1.2 Research Problem

Today, after the US, China is the second largest economy in the world. The rapid expansion of the Chinese economy is supported by the banking system of the country. However, there is lack of understanding on Chinese banking system that had dominated by five state-owned banks. Nevertheless, recently banking system in china has gone through rapid structural, regulations and operational changes to meet political changes and economic development. (Nolke, 2015)

There are 349 commercial banks, 85 rural commercial banks, 2560 rural cooperatives as well as 223 rural cooperative banks in the country. (Martin M. F., 2012) This banking sector concentration has resulted that these big five banks control more than half of the market assets. The diagram below shows the market share of the bank based on their type. (Elliott & Yan, 2013)

Figure 1: Market share of the bank based on their type

Hence, this has presented logical argument on the profitability of the banks in china. In free market economies, the strength of the bank is link with profitability and the desire of the management is to make a profit to ensure continuity and secure future of the bank. (Lin, Sun, & Wu, 2015)

According to Caijing (2014), the Chinese banking sector has strong profitability with a return on assets (ROA) for cheese commercial banks is an average of 1.3% during 2011 to 2012. Despite the complex structure and un-proportionate markets share, Chinese banks are profitable. (Caijing, 2014)

Therefore, it presents an important context to understand that what internal and external determinants of bank profitability in the different economic structure of china.  (Mileris, 2015)

1.3 Rational of Research

The lack of understanding on bank profitability determinants in the second largest economy of world has provided motivation to conduct this research. The understanding of determinants is critical to ensure that survival of banks in china market. The empirical research has showed that capital ratio, interest rates, deposits and liabilities, loan-loss provisions as well as control of expense are drivers of profitability.

In this dissertation, the profitability determinants are examined into two categories, which are internal and external driver of commercial bank profitability in china. Therefore, focus of the research is to evaluate bank-specific (bank size, liquidity and capital adequacy) and macroeconomic variables (Gross domestic product (GDP), interest rates and inflation rate) of the commercial banks in china. Nevertheless, the research is limited to 30 commercial banks and utilizing the data for 9 years from 2006 to 2014.

1.4 Aims of the study

The internal determinants of the bank profitability are associated with the decision of the management and i.e. quality of management impact upon the performance of the bank and consequently on profitability. The important source to examine the performance of the bank is it financial statements which reflect performance and profitability of the bank (Zhang, Wang, & Wang, 2012).

On the other hand, external determinants are macroeconomic variables which are beyond the control of the bank. These factors present such as inflation and GDP affect in a wider context the profitability and growth of the bank. Nevertheless, management can anticipate these factors and manage the profitability. (Xiaochuan & Li, 2014)

The empirical research has established the connection between internal and external determinant and their interaction with the profitability of the bank. Conversely, this research focuses on the interaction of these variables particular in the Chinese market. The lack of research to examine the profitability determinants particular in china which helps to highlight the how banking profitability is managed in the control market economy of china. (Wang, Huang, Wu, & Liu, 2014)

1.5 Research Questions

The aim of the study is to examine the internal and external determinant of the commercial bank profitability in china. Therefore, the research questions are design to determine

  • What are the profitability determinants in Chinese market and extent of association with commercial bank profitability in China?
  • What is impact of the internal and external determinants on commercial bank profitability in China?

1.5.1 Research objectives

The fundamental objective of the research is to examine and evaluate internal and external profitability determinants of commercial bank in china. The aim is to investigate the factors in Chinese market context that how management decision making and asset structure affect the performance of the bank as well as effect of the external macroeconomic variable such as GDP, inflation and interest rate control effect the profitability of the banks in the control economic system of china.

  • To investigate the internal determinants of commercial bank profitability in china.
  • To investigate the external determinants of commercial bank profitability in china.
  • To evaluate extent and association of these determinants with commercial bank profitability in china.
  • To evaluate the impact these internal and external determinants on commercial bank profitability in China.

1.6 Importance of research

There have numerous researches on determinants of the profitability of commercial banking and explore the relation and impact on the profitability in context of free market economy system. These researches have highlighted common determinants which impact of profitability. (Mirzaei, Moore, & Liu, 2013)

However, there is limited research exist on the profitability of the banks in the control economies. In addition, bank operations and performance is china (emerging market) is different and complex to free markets economy. Therefore, tis research is useful highlight the internal and external profitability determinants in control market economy of china. (Beck, Jonghe, & Schepens, 2013)

The impact of the management decisions on the profitability of banks as well as macroeconomic factors which are different form the free markets which highlight the important interactions of the variables in control extent. The cultural, political and diverse economic structure will highlight the variables from Chinese economic perspective. (Stockmann & Gallagher, 2011)

The complex, different and diverse will help to study the impact of internal and external profitability in control market economy context and it is expected it will be important new finding in terms of profitability of the commercial banks in control market economy. (Guang, Yu, Xiaoyan, & Tian, 2014)

1.7 Research Methodology

Quantitative research method was applied to achieve the research objectives. Secondary data was found from Bankscope database. Moreover, deductive approach has been used to make a well structure  (Curwin & Slater, 2007).

First, 3 dependent variables have been chosen to measure commercial bank profitability in China and 5 independent variables are chosen to be determinants. Second, a hypothesis has been developed for each variables based on the relationships among the variables. Third, the hypotheses have been text that whether there are cause-effect relationships among them or not.

Finally, the extent of these relationships has been identified from multiple linear models based on the credible data from Bankscope. EXCEL and SPSS have been used to process data. (Martin & Bridgmon, 2012)

1.8 Limitation of the study

The study is focused on only 30 commercial banks out of nearly 450 different size commercial banks in china. The profitability of the banks is examined over the period of 9 years from 2006-2009. The study is based on the secondary data and focuses on few macroeconomic variables. Nevertheless, the robustness of the financial system is associated with microenvironment of the country.

Furthermore, primary data such as interviews and questionnaire could be used to understand the management perspective on internal determinants and impact of macroeconomic variables on the profitability of the bank. Another important consideration in the context of the Chinese market is political interventions impact on the profitability of banks from a macroeconomic perspective.

1.9 Structure of the Dissertation

This dissertation is arranged into five chapters. The first chapter highlights the research problem as well as research objectives to be achieved in this research. Moreover, it discusses the importance and limitation of the research. The second chapter of the dissertation includes the literature which evaluate the theoretical framework, research hypothesis and empirical literature on the determinants of the commercial bank profitability in china.

The third chapter of the dissertation discusses and evaluate the effectiveness of suitable research method and data analysis technique. The fourth chapter conducts the data analysis and discussion of the results. Descriptive statistics, results of the regression analysis and hypothesis are evaluated.  At last, not least, the last chapter of the dissertation encloses the conclusion and recommendations.

Chapter 2.0: Literature Review

2.1 Introduction

The objective of an organisation is profit maximisation and i.e. commercial banks focus on the profitability for growth and long development of the bank. (Falzon, 2013) Profitability represents the scenario when expenses of the banks are lower than the income of the bank. The profitability of the bank is effect based on the effectiveness of the management in optimal resource allocation which result in the generation of return on assets. (Aremu, Ekpo, & Mudashiru, 2013)

The success of the banks is determined through profit generate by the bank during a financial period. The banking industry is enclosed to high risks because of deposits and liabilities associated. The risks associated with bank profitability are liquidity risk, interest rate risk and credit risk. (Staikouras & Wood, 2011)

Liquidity risk encloses a situation in which withdrawal suddenly increased and banks have to an alternative source of finance. Therefore, short-term and long-term deposits are an important part of the management of the bank operation. (Anbar & Alper, 2011)

Another risk faced by the bank includes the credit risk which represent customer unable to repay the loans and bad debts for the bank. Interest rate risk is another critical challenge for the bank management as changes in the interest serious impact the profitability of the bank. The changes in the interest rate have a direct impact on the income of the bank. (Curak, Poposki, & Pepur, 2012)

Consequently, it is important management proactively manage the risk faced by the banks to ensure the profitability and survival of the bank. Nevertheless, in banking sectors, external environment have major implication on the profitability of the bank. (Sufian, 2012)

The range of macroeconomic factors such as GDP, inflation and interest variation affect the profitability of the bank. For example, during the lower economic growth there is the lesser demand of the credit which represents lower profit for the banks. (Olson & Zoubi, 2011)

On the other hand, during rapid economic development, there is greater demand for credit which means higher profits for the bank. Moreover, the ranges of factors such as exchange rates, monetary policies and regulations have a significant impact on the profitability of the banks. (Kanas, Vasiliou, & Eriotis, 2012) Internal controls variables are influenced by the management and under the control of the management such as acquiring new liabilities and assets. External variables are beyond the control of the management. (Firth, Li, & Wang, 2013)

2.2 Profitability – Theoretical framework

The profit is the soul of the commercial business and it is important that expenses and income of the company must occur during the same time period and the expenses incurred must be directly associated with income generated. (Delis & Kouretas, 2011) (Matching concept)

The three important variables which highlight the profitability of the bank include return on equity (ROE), net interest margin (NIM) as well as return on asset (ROA). (Nguyen, 2012) To study the effect of the determinants, three specific factors used in this study are bank size, liquidity and capital adequacy. (Naceur & Omran, 2011)

2.2.1 Structural efficiency and market power

The relationship between bank size and profitability are better explained by the theories such efficiency structures and market power theories. (Azzam & Rettab, 2013) The study shows that profitability of the bank is affected by the market power of the bank which consequently influences the structure of the industry. Moreover, efficient market explains that profitability of the bank is based on the operating efficiency of the bank. (Kutlu & Sickles, 2012)

Market power theory affects the profitability of the bank based on the external market forces where efficiency structure depicts that profitability is influenced by the internal performance and efficiency of the bank. (Hintermann, 2011)

2.2.2 Capital adequacy and Profitability

The relationship between profitability and capital is enlightened through risk return, signalling theory as well as bankruptcy cost hypothesis. According to bankrupt theory, the cost of bankruptcy cost relative higher and to avoid such problems bank holds a larger amount of equity. (Lee & Hsieh, 2013)

Moreover, signalling theory suggests that bank can achieve a better return on assets based on the availability and quality of information. Both signalling and bankruptcy theory have an evident positive relationship between profitability and capital of the bank. The lower leverage ratio of the bank indicates that its can raise capital much efficiently than its competitors and have no effect on the profitability. (Hall, 2013)

Nevertheless, risk-return theory suggests that increased risk deliver a better return for the bank. Nevertheless, according to this theory when the bank takes on excessive then it’s increased its leverage and which resulting the equity-asset ratio of the bank decreases. Therefore, it reflects the negative relationship between the profitability and capital of the bank. (Arnold, Borio, Ellis, & Moshirian, 2012)

2.2.3 Liquidity and Profitability

The function of the bank is to mobilise the deposit and give it as advances or loans is known as financial intermediation. This involves several risks for the banks such as liquidity risk and commercial bank liquidity involves meeting the contractual date to honour the investment and liabilities commitments. (Saleem & Rehman, 2011) Profitability of the bank involves generating income in excess of its cost in relation to capital base of the bank. Research has shown liquidity as the profitability measure of the bank. (Uremadu, 2012)

Banks holding more liquid assets have a better reputation in the money markets improve profitability and reduced financing cost. Nevertheless, research has shown holding extra liquidated assets involves more cost for the banks which affect the profitability of the bank. (Singh & Prusty, 2015)

2.3 Determinants of bank profitability

The profitability of the bank is expressed through internal and external factors. The internal factors are further classified into financial and non-financial variables. (Sufian, Noor, & Noor, eterminants of Bank Performance in a Developing Economy Does Bank Origins Matters?., 2012) The financial statements variables include the interest rates, earning of the bank, deposits, operating efficiency as well as liquidity and capital. The non-financial statement factors are the size of the bank, location and branches of the banks.

Moreover, the external determinants which are under the control of the bank management include financial regulation, market share, competition and ownership. (Shehzad, Haan, & Scholtens, 2013)

Therefore, the liquidity is a trade-off between a number of funds banks holding and revenues generated. (Javaid, 2011)

Profitability and liquidity are important indicators to determine the financial health of the commercial bank. The liquidity of the bank is an important indicator to assure the shareholders bank has adequate funding available, assures the depositors that their funds are safe as well as a bank have sufficient fund for advances and generate profits. (Ben Selma Mokni & Rachdi, 2014)

The objective of the commercial funding is to maintain the optimum level of funding with avoid the risk of default but also avoid the too much cost of holding funds. The study of the 300 banks in the US shows that balance sheet and income of the bank have positive relations with the earning of the bank. (Staikouras & Wood, 2011)

Moreover, studies have shown that demand for deposits, time and liability of the bank negative effect with profitability of the bank. (Albulescu, 2015)

2.3.1 Bank Specific internal independent variables

2.3.1.1 Size of the bank (Si)

The size of the bank have significant role to achieve economies of scale for the bank in the marketplace. Research has shown that big banks generate better return on assets through large of transactions, implicit regulatory environment as well as more marketing power. (Samad, 2015)

Nevertheless, if banks grow too big to manage and it involves complex range of transactions, then may result in diseconomies of scale. The empirical research has mixed result between the size of the bank and profitability. (Olson & Zoubi, 2011)

There is positive relationship between the profitability of bank where as some studies have shown negative result between the size of the bank and profitability which in sometime was statistically insignificant to observe. (Ongore & Kusa, 2013) The studies have used total assets of the bank to develop the hypothesized relationship which is non-linear between the bank profitability and size of the bank. (Hoffmann, 2011)

The size of the bank is concerned with economies and diseconomies of scale and size of the bank is distinguishing factor to control the cost of the asset. De Jonghe and oztekin (2015) suggest that size of the bank have psotive affect on the profitbality of the bank and larger banks tend to more profitbale when compared with smaller bank. The reason behnd the profitbality of the larger bank ncludes the diversification, economies of scale and number of product offered. Nevertheless, diversification have negative affect on the profitbality of the bank as it give lower return. (Anbar & Alper, 2011)

2.3.1.2 Liquidity of the bank (Li)

The liquidity ratio indicates the ability of the bank to meet the demand of the depositors and creditors. The liquidity is measured using the ratio as liquid assets to total asset of the bank. Holding the large amount of liquid asset involves opportunity cost. (Perera, Skully, & Chaudhry, 2013) The range of studies has shown positive relationship between the profitability of the bank and liquidity. Bank holds large amount of cash which mitigate the risk of asset. Commercial bank is confronted with the issue of bank run; the bank may experience liquidity issue. (Coates, 2014)

In such a circumstance the bank may be urged to raise extra fluid trusts by borrowings or auctioning off some of their fluid resources and it is surely understood that transient borrowings are normally positive (Hall, 2013). Also, the circumstance where by the bank race to auction the fluid resources makes an impression in the brains of financial specialists that the bank is attempting to discard awful resources and consequently these fluid resources regularly pulls in lower costs The study of 90 banks in Europe has suggested that profitability of the bank and liquidity have positive relationship (Choon, Thim, & Kyzy, 2012).

Liquidity is an important indicator and reassures the depositors that financial position of the bank is relative strong and supports the loans and advances function to generate revenues for the bank. (Kanas, Vasiliou, & Eriotis, 2012) The quality of the assets affects the liquidity position of the bank and advances are significant source of revenues for the bank which generate the interest income for the bank. Liquidity is another component that decides the level of bank profitability. Liquidity suggests to the capacity of the bank to satisfy its commitments, predominantly of investors. (Ahmad, Nafees, & Khan, 2012)

Sufficient level of liquidity is emphatically related with bank productivity. The most widely recognized budgetary proportions that mirror the liquidity position of a bank as indicated by the above creator are client store to aggregate resource. (Batavia, Parameswar, Murthy, & Wague, 2013)

2.3.1.3 Capital adequacy of the banks (Ci)

Adequacy is an important indicator in terms of stability of the bank as well as regulator has significant interest on the capital base of the bank. Regulatory authorities have range of measures to ensure bank have capital to meet the risk and uncertainty. (Biswal & Gopalakrishna, 2015) Capital plays an important role in security of the bank to meet the unexpected demand of the depositor when operating in an uncertainty environment. The strong capital based help to mitigate the risk and losses. The capital of the bank is measured through ratio of equity to total assets of the bank. (De Jonghe & oztekin, 2015)

According to Allen, Napaporn and Robert (2013) in the light of bankruptcy theory that banks with better capital level have lower cost of funding which gives bank better ability to observe the shocks. The risk return theory suggest that banks with high level of capital have lower profitability because the low risk taking approach of the bank result in lower level of profitability for the banks. (Allen, Napaporn, & Robert, 2013)

According to Mahbub, Barker and Matthews (2014) bank with high level of capital are more profitable but at the same time lower level of capital result in lower profitability. The large number of studies has evident positive result between high level of capital and assets of the bank. (Mahbub, Barker, & Matthews, 2014)

Commercial bank experience loss of benefit as aftereffect of credit default or liquidity issue the bank still has the commitment to benefits its obligation, on the other hand a commercial bank with enough capital is proficient take higher danger furthermore guzzle shocks which radiate from liquidity and credits dangers. (Chiaramonte & Casu, 2013)

The capital structure of the bank which includes retained earnings, shareholders fund as well as reserves has direct effect on the risk and leverage of the bank. The financing of the commercial is managed through debt or capital and capital also have effect on the liquidity of the bank. (Mirzaei, Moore, & Liu, 2013)

According to Basel framework lack of capital reserves or poor structure is one of the major reasons of the bankrupts and it is recommended that bank should maintain minimum 8% of the asset base. (Ongore & Kusa, 2013)

2.3.2 Macroeconomic external independent variables

2.3.2.1 GDP growth rate of china (G)

Gross domestic product (GDP) is measure of the total economic activity in the country. The GDP of the country have wider economic of number of factors which affect the advances and deposit of the bank. (Tan & Floros, 2012) The researches have shown positive relation between GDP and profitability of the bank. There is positive relationship between GDP and profitability of the country. The relationship between bank profitability and GDP fails to explain the greater variability in the profit of the banking sector. (Chow, 2015)

The studies have shown that GDP have no direct effect on the profitability of the bank. If this mutable is not statistically important in explanation profitability, then the assumptions of the researchers are strengthened. (Zhang, Wang, & Wang, Financial development and economic growth: Recent evidence from China, 2012)

Then, the probable mark is positive since developed economies indicate both lower probabilities of default and a relaxed contact to credit. (Song, Storesletten, & Zilibotti, 2014)

Figure 2: GDP growth rate of china

Source: IMF World Economic Outlook (WEO), April 2015

During the period of the economic boom the loan rate is lower and during recession period the rate of default is high. When economy is booming then loan demand increased which helps the bank to generate large interest income and from other sources.  (Devinaga, 2010)

2.3.2.2 Inflation in china (I)

Inflation is useful measure for the consumer price index (CPI) for good and services in a country. Inflation affects the value of the goods and has direct effect on deposit and advances of the bank. The inflation has positive and negative affect with profitability of the bank and on level of the inflation. (Zhang, 2015)

When inflation level is increasing bank can increased the rate of borrowing in order to adjust its profitability. However, during the time of decreasing inflation rate is not anticipated then it is difficult of the bank to adjust the rate of borrowing. Large number of studies shows positive relationship between inflation and profitability of the bank. (Zhang, 2013)

The inflation have impact on that it increase the salaries cost as well as other cost of the bank. The significant factor to study is made whether inflation is anticipated or not. During the time of anticipated inflation bank management can increase the interest rate charge to the customers which helps to adjust the profitability of bank. (Wei, 2012)

In developing countries bank are less profitable during the period of high inflation as well as they have high capital ratio. Clearly the appearance of such circumstance might antagonistically influence the benefit of the business banks in light of the fact that banks acquire their income for the most part from the advances (De Jonghe & oztekin, 2015) they provide for the client so if the interest of advances falls as an aftereffect of the higher expense of obtaining then without a doubt profit also will fall subsequently the benefit. During the period of high inflation the cost of the bank increased at much faster rate compare to revenues of the bank. (Dreger & Zhang, 2013)

Figure 3: Inflation in china

Source: IMF World Economic Outlook (WEO), April 2015

2.4 Empirical studies

According to Anbar and Alper (2011) profitability of the commercial banks has been received greater attention in recent years which many studies focused on the management of resources and its impact on the profit of the bank. Researches have shown that effective resources management have a significant contribution towards profitability of the banks. (Anbar & Alper, Bank specific and macroeconomic determinants of commercial bank profitability: empirical evidence from Turkey, 2011)

Nevertheless, Louzis, Vouldis and Metaxas (2012) focused on the US, European and developing countries and few studies explore the profitability determinants in emerging market. There are few studies which attempt to explore the banking profitability determined in emerging markets. (Louzis, Vouldis, & Metaxas, 2012) The studies have shown the main internal determinants of bank profitably are capital, liquidity and expenses control. Moreover, the key external determined the involved size, liquidity and economic conditions. (Flamini, Schumacher, & McDonald, 2009)

According to Fungacova and Poghosyan (2011) the range of macro factors associated with bank profitability is inflation and high-interest ratio. Inflation has shown that it has positive effect on the performance and consequently profitability of the bank. The investigation of the Chinese bank performance during the period of 1999 to 2005 has shown that net interest margin, as well as economic value added, is an effective measure of profitability in a Chinese bank. (Fungacova & Poghosyan, 2011)

The studies of Chinese bank have shown that conventional profitability measure such as return on average assets (ROAA) and return on average equity (ROAE). Moreover, macroeconomic variables had the influence of the profitability of the bank but the size of the bank, as well as type of the bank, has impact on the profitability of the bank. (Campbell, Martínez-Jerez, & Tufano, 2012)

According to Frame and White (2014) the study of the bank-specific and macroeconomic determinants of bank profitability in turkey over the period of 2002 to 2010 has shown that ROA and ROE were key determinants of the profitability in the country. The study highlight that non-interest income, as well as size of the asset, had a significant impact on the profitability of the bank. The macroeconomic factors such as interest have a positive influence with the profitability of the bank. (Frame & White, 2014)

The research on 390 African banks in sub-Sahara African countries by Saeed (2014) shows that credit risk, ownership, the size of the bank as well as activity diversification. The macroeconomic factors such as inflation are a direct effect of the profitability of the bank. (Saeed, 2014)

According to Akhtar, Ali and Sadaqat (2011) the study Tunisian banking industry from 1980-2000 with a sample size of 10 banks has shown that banks net interest income and profitability of the bank were associated with capital and overhead in the banks. The efficiency of the banks management is one of the key internal components that focus the bank profitability. It is assume by distinctive monetary extents like cumulative profit growth and loan expansion rate management and liquidity of the bank. (Akhtar, Ali, & Sadaqat, 2011)

Additionally, operational productivity in dealing with the working costs is another measurement for management quality. The execution of policies by the management subjective assessment of administration frameworks, hierarchical order, control frameworks (Gunsel, 2012). However, some budgetary proportions of the money related proclamations go about as an intermediary for management proficiency. (Paul & Das, 2015)

Moreover, Buch, Eickmeier and Prieto (2014) study has shown that macroeconomic indicators such as inflation had no impact on the performance of the bank. The study of the Macau banking shows the capital strength of the bank has a direct influence on the profitability of the bank. Moreover, it highlights that loan-loss as well as asset quality has a significant impact on the profitability of the banks. (Buch, Eickmeier, & Prieto, 2014)

The study of the banks in Nigeria by Liu, Molyneux and Wilson (2013) to examine the profitability of commercial banks from 2001 to 2010 has shown that size of the bank, asset quality and capital adequacy was used in the model. The result shows a negative relationship between the size of the bank and profitability and positive relationship between assets and profitability of the bank. (Liu, Molyneux, & Wilson, 2013)

According to Lim (2012) the capital adequacy has shown a positive relationship with the profitability of the commercial banks. The study of the five largest commercial banks in the United States shows that GDP did not have a direct effect on the profitability of the banking sector. (Lim, 2012) The application of the correlation and linear regression shows that no considerable relationship.

Chiaramonte and Casu (2013) study of 29 Korean banks over the period between the period 1992 and 2003 shown that there is negative relationship between GDP and ROA of assets, but inflation has positive effect with the profitability of the bank. (Chiaramonte & Casu, 2013) In addition, Chava and Purnanandam (2011) examine the Taiwanese banks from 2002-2007 of the 14 banks based on the bank specific factors, macroeconomic and industry specific factors has shown that credit risk had negative impact on the profitability of the bank where capital level improves the profitability of the banks. (Chava & Purnanandam, 2011)

According to Athanasoglou, Brissimis and Delis (2008) The study of 14 banks in Lebanon from 2000-2010 in the light of the internal and external determinants such as GDP growth and inflation rate have shown that they have no impact on the profitability of the bank. The study of Tunisian banks in terms of structure, bank characteristic and macroeconomic indicators to examine the ROAE and NIM between the period of 1980-2000. The sample of the 10 banks shows that ROAE and NIM have positive relationship with level of capital. (Athanasoglou, Brissimis, & Delis, 2008)

Blonigen (2005) has argued that GDP and inflation has no relationship with the profitability of the bank. The study of the bank in Nigeria with bank specific and macroeconomic determinants and study their impact on return on assets. (Blonigen, 2005) Nevertheless, Ngai (2005) studied that bank profitability have positive relation with capital adequacy in the short term and in the long run size of the bank and asset have positive relationship with profitability of the bank. Moreover, study shows that location, size of the bank as well as time of deposit and advances affect the profitability of the bank. (Ngai, 2005)

The cross country analysis by Jun and Cai (2001) has shown that internal variables such as liquidity and capital ratios and operating expenses of the bank have positive relation with the profitability of the bank. The internal variables have significant impact on the profitability of the bank and the variable which was highly related with the profitability was capital of the bank. (Jun & Cai, 2001)

Rasiah (2010) examine the impact of the size and branches of the bank on the profitability of the bank have shown that branches of the bank had no positive relation between the profitability of the bank. Nevertheless, the study of the relationship between the locations of the bank branches has effect on the profitability of the bank. (Rasiah, 2010)

Moreover, it has have shown that inflation could have causation effect on the profitability of the bank. Researches Studies shown that inflation have positive relation with profitability of the bank. (Haron, 2004)

2.5 Description of the variables

2.5.1 Summary of Variables and measurement

Table 1: Summary of Variables and measurement

2.5.2 Ratio’s Description

  1. a) Return on average Assets

Return on average assets is important measure of the profitability of the bank and measured as net income of the bank divided by total asset. It is important indicator that how management is utilizing the assets of company to generate profit for the bank. The higher the rate of return mean bank has efficient management and utilizing the asset base effectively. The high level of ROA shows management has been successful in generating reasonable returns. (Greuning & Bratanovic, 2003)

  1. b) Return on average equity

Return on average equity is useful measure to determine the profitability of the banks and is calculated as the net income earned bank as he percentage of the shareholders equity. In other words, it measures the profitability of the bank as the percentage of the equity. Company with higher value of equity are more likely to generate cash and investors prefer to invest in the companies which are higher return on equity. It represent the amount of return generate by the bank on the shareholder’s equity (net worth). (Stowe, 2007)

  1. c) Net interest Margin

Net interest margin is an important indicator in the banking industry which measure the difference the amount of interest income generated by the bank and the interest paid to the lender. In other words, it shows how investment decision of the banks is successful to generate income in comparison of its debts. The negative values shows that firm decision in regard to its investment have failed to make optimal decision as the interest income of the bank is lower and income expenses of the bank is higher. (Emmerich, 2014)

  1. d) Liquidity Ratio

The liquidity ratio shows that ability of the bank to make payment to the short-term creditor from its cash/liquid assets. The liquid ratio is derived by dividing current asset of bank with current liabilities. (Lee, Lee, & Lee, 2009)

  1. e) Capital adequacy ratio

It is measure of the strength of bank and major regulatory requirement of the BASEL framework with highlight the requirement of 8%. This improves the stability of the bank in the financial market and improves the stability of the bank. (Adriaan, 2011)

2.6 Profile of Chinese banking industry

The Chinese banking industry has gone through rapid development over the period of last few years. There are number of foreign banks have enter the country after the WTO which has revolutionized the industry. The adaptation of international accounting policies, listing and application of international accounting standards (IAS) has improved the competition and performance of the banks.

The central bank of the country manages the monetary policy and maintains the strong control. The banking sector is managed through China’s Banking Regulatory Commission (CBRC) a ministry of finance have direct influences over the regulation and polices of the banking industry. Chinese banking industry is highly leverage with bank cab borrows art relative low rates. The availability of the low interest rate credit as well as fait policies has significant effect on the banking industry of the country. (Kumaravadivel, 2013)

Banking Indutry in china

Figure 4: Banking Structure in china


2.7 Conclusion

In this chapter, literature review on the profitability of the commercial banks is examined. The overview of the profitability and its importance for the business was evaluated. Moreover, theoretical framework for the profitability and how various factors such as capital and liquidity interact with bank’s profitability. In addition, internal and external determinants of bank profitability examined in studied detail.

The internal independent variables include the size of the bank, bank liquidity and capital adequacy of the bank was reviewed. The internal factors was reviewed to see how size of the bank affect the profit of the bank, role of liquidity and its effect on the profitability of the bank as well as capital of the bank and how its help the bank to secure its financial position. The internal variables are controllable by the management and they reflect the performance of the management.

The external variables examined are GDP and inflation the china. The data on GDP growth and inflation in china over the period of 2006-2014 is collected and examined. At last, not least, empirical studies on banking determined were evaluate to study the effect of internal and external determinant on the profitability of the commercial Chinese banks.


 

Chapter 3.0: Design and Methodology

3.1 Introduction

In this chapter, the approach and theory applied to this study are discussed. Choosing the appropriate approach and model are important to answer the study questions. Meanwhile, the collection and analysis of research data are stated in this part. The objectives of this study are showed as followed. First of all, identify the factors influencing commercial bank profitability in China. Second one is to determine the magnitude of the factors relate to commercial bank profitability in China.

Secondary data from Bankscope database has been used to achieve the study objectives. Data was from 30 different banks in China covering the period from 2006 to 2014. The variables chosen in this study are explained by using model which is explained in this chapter.

This chapter is divided into five sections. The first part explains the research data collection and analysis. Second part illustrates measurements of the variables of this study. Section three gives an explanation of research model. Section four presents the research framework. Finally, the ethical issues for this study are mentioned.

3.1 Research Design and Strategy

3.1.1 Explanatory Research

The design of the research is important I order to successfully achieve the objectives of the research. The research methodology is concerned with techniques used to collect, analyse and evaluation for data. (Creswell, 2013) The research design can be exploratory, descriptive and explanatory. Descriptive research is useful to answer the scenario such as how, what and when situation and it is useful to deduct the information from various contexts. (Neelankavil, 2015)

Moreover, exploratory research involves the study of what situation and it is effective to analyse the situation when no previous research exist. At last, not least, explanatory research is useful to examine and evaluate the scenario under why and how situation. (Babbie, 2015) In this dissertation, explanatory approach is to analyse the determinants of the bank profitability in china and its helps to evaluate how various internal and external determined effect the profitability of bank.

3.1.2 Qualitative vs. Quantitative Research

Qualitative research is useful to develop the understanding in the social context. It is useful to examine the relationship between the variables and it is effective when researcher cannot be separated from the scenario. (Hibberd, 2006) It employs non-numerical approach to evaluate the situation and deploy the participative approach. The research questions are flexible and data collection instrument are adjustable to the need of the respondent. (Saunders, Lewis, & Thornhill, 2009)

On the other hand, quantitative research is useful to analyse and evaluate the relationship between the variables and it examines the relationship based on the quantitative data. It helps to identify the problem and examine the relationship between the variables. (Denzin & Lincoln, 2011)  The advantage of the quantitative research is that it is useful to confirm the hypothesis and evaluate the problem is structural scenario. (Miller & Holstein, 2009)

In this dissertation quantitative approach is used to identify the variables and evaluate the problem. The subjective and numerical technique is used to gain better understanding and insight of the interaction of the internal and external determinants. In this research, the variables chosen for this study have been identified by other authors from many countries. After reading a number of relevant articles which examine determinants of bank profitability in different countries, researcher uses deductive approach to implement this research for commercial banks in China and chooses all variables.

3.1.3 Inductive or deductive reasoning

Inductive research is useful to examine and build the theory from the wider context. It is effective to investigate and study the event in wider context as it helps to narrow the problem from wider context. (Stebbins, 2011) On the other hand, deductive approach is useful to explore the knowledge, theory and hypothesis. Using a methodology with well structure is one of the important characteristics of deductive approach and the research can be more reliable. (Saunders, Lewis, & Thornhill, 2012)

In this study, deductive approach has been used to make a well structure. First, 3 dependent variables have been chosen to measure commercial bank profitability in China and 5 independent variables are chosen to be determinants. Second, a hypothesis has been developed for each variables based on the relationships among the variables. Third, the hypotheses have been text that whether there are cause-effect relationships among them or not. Finally, the extent of these relationships has been identified from multiple linear models based on the credible data from Bankscope. (Wrenn, Stevens, & Loudon, 2013)

3.2 Data Collection and Analysis

3.2.1 Data Collection

Primary and secondary data always is used to research. According to Kothari (2004) that the primary data is data collected at first time to explore the specific problem. In comparison, secondary data, the primary data is more credibly. There are mainly two ways to collect primary data that interview and questionnaire. On the other hand, the secondary data is resource which has been collected by other researchers or has already been passed through the statistical process. (Kothari, 2004)

Moreover, Wrenn, Stevens and Loudon (2013) points that when researcher wants to find some raw data they can choose primary data such as doing interview to company to get company information. On the other hand, the secondary data or information might have undergone through statistical process to some extent. (Wrenn, Stevens, & Loudon, 2013)

In addition, Whiteside, Mills and & McCalman (2012) claim that using secondary data has potential advantages which are slightly used for grounded theory studies. When researchers have difficult to collect primary data, they will choose to use secondary data to achieve their research objectives. (Whiteside, Mills, & & McCalman, 2012)

There are three main advantages for using secondary data. Firstly, it is easier for researchers to find data they need than using primary data. Secondly, compared with primary data, the secondary data has low cost. Thirdly, collecting secondary data is faster than primary data. This view can be supported by Mooi and Arstet (2011) who says secondary data is data that firm has already collected and published. It is accessible and flexible so that it can save time and money for researchers. (Mooi & Arstet, 2011)

For this study, the secondary data is more suitable than primary data because of following the objectives. Also, as the limitation of time, the data can be found from databases which are already published during 9 years. Researcher in this study uses Quantitative analysis to analysis data. Data about GDP growth rate and inflation rate are found from World Bank of database. Others are come from the Bankscope of database in University of Huddersfield summon database system. Also, in order to finish the objective, researcher will choose 30 banks. Time period for data are 9 years.

3.3.2 Sampling

The population selected to study in this dissertation are 30 Chinese commercial with data from 2006-2014. According to Teddlie and Tashakkori (2009) Purposive sampling is useful when there is need to reach particular group of population and the participants who don’t fit the purpose are reject from the stay population. In this dissertation, selective sampling is used. Selective sampling is useful when there is particular group or industry needs to study.

This technique used the non-probability approach result in subject bias or error.  This study involves the profitability determinants of the commercial banking in china. The total of 30 commercial banks is selected from large banking industry of china. (Teddlie & Tashakkori, 2009)

3.2.3 Data Analysis

According to this term of objective, data basically are quantitative data. Refer to the relationship between using qualitative and quantitative approach to analysis data, Bernard and Ryan (2010) claim that qualitative analysis is used to explain the meaning and substantive significance of statistical tests. On the other hand, quantitative refers to numerical or statistical analysis of numerical data. It is the best way for business student who want to get result from quantitative data or financial ratios such as ROA, ROE and so on. To conduct the data analysis statistical software (SPSS) and Microsoft excel is used. Moreover, different researcher will use different method or models as tools to analysis data such as correlation coefficient.

3.3 Measurement of the Variables

This part illustrates how to measure the different variables and what are the proxies allocated for these variables.

3.3.1 Bank Profitability

In order to achieve the research objectives, the proxies should be used to indicate bank profitability more clearly and directly. Some ratios are always been used to reflect the extent of profitability. Sufian (2009) and Aremu (2013) measured bank profitability by ROA and ROE. They thought that ROA reflects the ability to utilize the banks’ assets and ROE reflects the ability to utilize the share holders’ founds.

Dietrich (2014) and Sufian (2009) argued that ROAA and ROAE are better because the results become more accurate. Meanwhile, they also presented that NIM which shows the profit earned on bank’s interest activities should be the third measure. In this research, ROAA, ROAE and NIM have been chosen to measure commercial bank profitability in China. (Aremu, Ekpo, & Mudashiru, 2013) (Sufian & Habibullah, 2009) (Dietrich & Wanzenried, 2014)

3.3.2 Bank Size

Bank size is one of the most important determinants of bank profitability. Dietrich (2014) viewed that total assets can be a proxy of bank size. He separated bank size into three levels including large, medium and low level in order to measure all samples. However, Sufian (2009) and Tan (2012) argued that log of total assets could be more accurate and they also thought that the cause-effect relationship between bank size and profitability is not significant enough. Researcher put log of total assets into study as a proxy of bank size. (Tan & Floros, 2012)

3.3.3 Bank Liquidity

Farag (2013) stated that liquidity measures the ease of bank to change assets into cash so that it is a determinant of bank profitability. Sufian (2009) and Sufian (2009) measured bank liquidity by total loans divided by total asset. They found that there is positive relationship between this ratio and bank profitability.

Aremu (2013) also used this ratio but the result shows the relationship is not significant. In this research, the ratio of net loans divided by total asset is used as a proxy of bank liquidity like other researchers before. (Farag, Harland, & Nixon, 2013)

3.3.4 Capital Adequacy

Capital adequacy is another factors influencing commercial banks profitability in China. Aremu (2013) measured capital adequacy by equity divided total assets and he found that there are negative result between this ratio and bank profitability. However, Tan (2012) measured capitalization by shareholder’s equity divided total assets and got a highly positive relationship.

In this research, the ration of equity divided total assets have been used to measure capital adequacy because of the limitation of database where the ratio of shareholder’s equity divided total assets could not be found. (Aremu, Ekpo, & Mudashiru, 2013)

3.3.5 GDP Growth Rate and Inflation Rate

As the external determinants, GDP and inflation rate are also important factors influencing commercial bank profitability in China. Trujillo-Ponce (2013) used GDP growth to describe the cause-effect relationship. Sufian (2009) measured by nature log of GDP in model and found it is highly related to bank profitability.

In this research, GDP growth rate has been put into regression model. (Trujillo-Ponce, 2013) Refer to inflation rate, Dietrich (2014), Tan (2012), Sufian (2009) and Trujillo-Ponce (2013) all proved positive relationship between inflation rate and bank profitability. It has been used in this research directly.

3.3.6 List of Hypothesis

Table 2: List of Hypothesis

3.4 Models specification

According to Hair (2007), quantitative technology is very useful in the researches which study to find relationships among a number of different variables. It includes many forms, such as statistics, graphs and charts. They can all be applied into quantitative studies. In this research, all data collected from database is numerical, so some statistical methods can be used to analyse variables. This chapter illustrates these methods including correlation coefficient and linear regression model. (Hair, Money, Samouel, & Page, 2007)

3.4.1 Correlation Coefficient

When using statistical methods, researches often requires is to examine whether there is a relationship between two different variables exist. Correlation is used to express this relationship of continuous variables. The extent of this relationship is showed by correlation coefficient (Daya, 2004). The most popular way is Pearson correlation coefficient. The relationship between variables is measured on a scale of number from -1 to 1. If the result is near 1, it means there is positive correlation between variables. (Daya, 2004)

On the contract, is the result is near -1, it means there is negative correlation. If the correlation coefficient is bigger, the variables cannot be used in one study at the same time (Sedgwick, 2012). This research has processed data and texted Pearson correlation coefficient by using EXCEL and SPSS. (Sedgwick, 2012)

3.4.2 Linear Regression Model

Regression shows the relationships among different variables. The value of dependent variable can be predicted from values of other independent variables. Linear regression describes this relationship by using an equation of a straight line which is made from scatter plots of data. The model is called simple linear regression model if there is only one independent variable. The model is called multiple linear regression models if there is more than one independent variable (Daya, 2004).

This research has five independent variables so that it utilizes multiple linear regression models. The model equations are showed as follow.

3.5 Research Ethical Issues

Ethical issues are always faced during qualitative study. Ethical means that researchers need to observe the principles of conduct which are acceptable during the years of practice. Plagiarism is probably appeared when researchers collect data especially secondary data. Writers have to use the data after getting the permission from data holders. Meanwhile, maintaining confidentiality is also important (Kumar, 2011).

In this research, data is collected from Bankscope database provided by University of Huddersfield which is a credible and public data source. Researcher keeps confidential during the process to avoid ethical issues. Furthermore, researchers should avoid bias and treatment when process data. It is unethical if data is tampered to achieve positive result of the test (Kumar, 2011) Researcher has not changed data anymore so that there are not ethical issues existed in this research.

3.6 Conclusion

This chapter illustrated research method and framework. Quantitative analyse method was applied to achieve the research objectives. Secondary data was found from Bankscope database. This chapter states the measurement of the variables and research model in order to be prepared for the deeply study. Ethical issues had also been mentioned. In next chapter, the data will be processed by statistic tools and the model will be built. Result of regression model will test the hypotheses and give answers for research questions.

Chapter 4.0: Analysis and Discussion

This chapter present the analysis of the data and results for the determinants of the commercial bank profitability. The secondary data gather from Bankscope which be analyse in this to evaluate the impact of variables on the profitability of the commercial banks in china.

The aim is to investigate the factors in Chinese market context that how management decision making and asset structure affect the performance of the bank as well as effect of the external macroeconomic variable such as GDP, inflation and interest rate control effect the profitability of the banks in the control economic system of china.

  • To investigate the internal determinants of commercial bank profitability in china.
  • To investigate the external determinants of commercial bank profitability in china.
  • To evaluate extent and association of these determinants with commercial bank profitability in china.
  • To evaluate the impact these internal and external determinants on commercial bank profitability in China.

This chapter is divided into four sections. First descriptive statistics are discussed and analysed, then correlation coefficient is analysed and this part enclosed the result of regression analysis. The last part will discuss the result in detail and confirm the hypotheses.

4.1 Descriptive statistics

The table below present the Descriptive statistics for the internal and external determinants of the commercial bank of china.

Table 3: Descriptive statistics

4.1.1 Critical Analysis of Results

The result shows that banks has an average of 1.02 rate of return with minimum is negative return of -1.39 and maximum return of 2.36. According to Caijing (2014), the Chinese banking sector has strong profitability with a return on assets (ROA) for cheese commercial banks is an average of 1.3% during 2011 to 2012. The actual result have shown that the level of return 1.02.

Greuning and Bratanovic (2003) the higher the rate of return mean bank has efficient management and utilizing the asset base effectively. This represent some of the banks are generating higher rate of return while low ROAA shows management has not been successful in generating reasonable returns. Furthermore, results shows that ROAE is as high as 54.14 which represent the profitability of the bank as the percentage of the equity.

According to Stowe (2007) Return on average equity is useful measure to determine the profitability of the banks and is calculated as the net income earned bank as he percentage of the shareholders equity. The high variation of the result shows that -6.63 to 54.14 represent differences among the banks. The average return earn by the banks is 16 which relative high rate of return.

Net interest margin is an important indicator in the banking industry which measure the difference the amount of interest income generated by the bank and the interest paid to the lender. In other words, it shows how investment decision of the banks is successful to generate income in comparison of its debts. The average NIM is 3.11 with high value of 6.11 and low value of 0.59.

According to Emmerich (2014), the low values shows that firm decision in regard to its investment have failed to make optimal decision as the interest income of the bank is lower and income expenses of the bank is higher. Therefore, some of the bank has superior management decision which has yield higher rate of higher rate of return. The impact of the GDP has average value of 8.7 with high value of 14.2 and low value of 2.0.

According to Chow (2015), the relationship between bank profitability and GDP fails to explain the greater variability in the profit of the banking sector. The results show that profitability of the banks has hanged with GDP rate and its represent significant effect on the performance of the bank.

According to Samad (2015), The size of the bank have significant role to achieve economies of scale for the bank and big banks generate better return on assets through large of transactions, implicit regulatory environment as well as more marketing power. The average value for the size of the is 7.19 with low value of 5.2 and high value of 9.33. the result shows that size of the bank does not major variation and impact on the bank. Therefore, size of the bank have low variation and impact on the overall profitablity of the bank.

According to Coates, (2014) the liquidity is measured using the ratio as liquid assets to total asset of the bank. Commercial bank is confronted with the issue of bank run; the bank may experience liquidity issue and consequently bankruptcy. The mean value of 51.29 for the liquidity shows that banks are using only 50% of the deposit to advance the customers. Therefore, banks are keeping more money.

According to Perera, Skully and Chaudhry (2013), holding the large amount of liquid asset involves opportunity cost. Therefore, are taking minimum risk and have relative low level of returns. The cost of holding the deposit is much higher which reduce the NIM and consequently profit of the company. The result of liquidity is quite have significant variations with between 17.97 to 88.15 which some banks have more holding cost while other advance the large amount of customer deposits. Nevertheless, the average value for the inflation is 3 with high value of 5.9 and low value of -0.70.

According to Zhang (2013) when inflation level is increasing bank can increased the rate of borrowing in order to adjust its profitability. However, during the time of decreasing inflation rate is not anticipated then it is difficult of the bank to adjust the rate of borrowing. This shows that china economy is experience unanticipated inflation which has given minimum time to adjust for the inflation.

According to Lee and Hsieh (2013) the relationship between profitability and capital is enlightened through risk return, signalling theory as well as bankruptcy cost hypothesis. According to bankrupt theory, the cost of bankruptcy cost relative higher and to avoid such problems bank holds a larger amount of equity. However, results have shown that the average value for the capital is 7.11. The higher value of 31.35 and low value of 1.26 and its represent some the bank has critical low level of capital which represent high risk for the bank.

According to Ongore and Kusa (2013), Basel framework lack of capital reserves or poor structure is one of the major reasons of the bankrupts and it is recommended that bank should maintain minimum 8% of the asset base. Nevertheless, some banks have very high level of capital while other represents relative low of capital base.

4.2 Robustness test for the model

In order to test the hypothesis and answer the research question bivariate and linear regression will be used and test will be derived using the SPSS statistical software. Bivariate analysis is useful technique to analyse the relationship between the variables as well as it helps to over the multicollinearity problem. It is defined as situation when one variable have strong influence or impact on the multiple variables.

Therefore, the impact of multicollinearity may affect the result of the multi-linear regression. To examine the robustness of the models multi linear regression is used. The problem of the multicollinearity is better examined through the correlation coefficient (Neelankavil, 2015).

4.2.1 Correlation Coefficient

To examine the correlation between the variables (dependent and independent) variable, spearman correlation is run using the SPSS software. If the Sig. (2-tailed) value is less than 0.1, then reflect the variables have significant relationship between them.

The table below shows the results of the Correlations among the dependent and impendent (internal and external variables).

4.2.2 Evaluation of the correlation results

It is evident from the result that the value (Sig. (2-tailed) of all variables is less than 0.1 (P<0.1) which mean all variables have significant relationship. Return on average assets is important measure of the profitability of the bank and measured as net income of the bank divided by total asset. It is important indicator that how management is utilizing the assets of company to generate profit for the bank.

The result of the three internal independent variables bank size (LGTA) has value 0.114, liquidity (NLTA) value of 0.037 and capital adequacy (EQTA) have positive relationship with the profitability of the  bank. Relationship of the ROAA has positive relation but GDP have negative relation with the profitability of the bank.

There is strong relationship between return on equity and return on assets because of the range of factors such account receivable, payable, expenses have significant effect on the return generated from the assets.

Return on average equity is useful measure to determine the profitability of the banks and is calculated as the net income earned bank as he percentage of the shareholders equity. In other words, it measures the profitability of the bank as the percentage of the equity. The analysis shows that capital adequacy and liquidity have negative relationship with ROAE.

The range of strong variables such as liquidity (-.55), GDP (-.37) and capital adequacy (-0414) has negative relationship. The possible reason behind such strong negative relationship that bank earning got diluted when banks are required to hold the minimum level of deposits. The size of the bank and inflation has positive relation with the profitability of the bank.

Net interest margin is an important indicator in the banking industry which measure the difference the amount of interest income generated by the bank and the interest paid to the lender. The interesting fact is size of the bank have negative relationship with net income earning and expenses of the bank.

Therefore, size of the bank has significant impact on the investment decision of the bank. Similarly, GDP have negative relationship with the NIM of the bank. In other words, it shows how investment decision of the banks is successful to generate income in comparison of its debts. The negative values shows that firm decision in regard to its investment have failed to make optimal decision as the interest.

Income of the bank is lower and income expenses of the bank are higher. The other factors such as liquidity and inflation have strong influence on the interest income of the bank. However, in order to avoid the problem multicollinearity based on the strong relationship of the variables regression analysis will be tested.  (Neeleman, 2012)

4.3 Multiple Linear Regressions

Multiple linear regression (MLS) is deployed in this study to overcome the multicollinearity problem and examine the relationship of the variables in much detail without the problem relationship with multiple variables. (Montgomery, Peck, & Vining, 2015)

The Pearson correlation R was used to explore the relationship between the variables in order to examine the determinants of bank profitability of Chinese commercial banks. The value of the R was between -1 to 1and with stronger value it was evident that bigger value predicts the strong impact of the variable. Nevertheless, the value of 0 represent variables has no effect on the profitability of the bank. Nevertheless, there were variables with multiple relations and to overcome the multiple regressions was used. (Sharma, 2005)

According to Montgomery, Peck, & Vining (2015) value of the multicollinearity problem below the value of the 10 does not represent a significant problem. The tables below show that the value of multicollinearity is below 2 in all three models and i.e. does not represent a multiple variable relationship problem. Moreover, the Pearson correlation value was below 0.7 for the variables which means there is no problem of multicollinearity exist between the variables. (Pedace, 2013)

4.3.1 Model 1 – ROAA

The regression analysis for the model 1 (ROAA) in the table below shows that the value of the size of the bank does not have significant relation based on the value of 0.697. The result have shown that the effect of the internal determinant which liquidity have significant impact on the profitability of the bank. Moreover, capital adequacy has positive relationship with profitability.

The regression coefficient has significant relation between the GDP and inflation and its impact on the profitability of the bank. The value of R for the model is .308 which represent that model has only managed to study the effect of internal and external variables on the ROAA of the commercial banks in china. The model does not have variable relationship problem to in the model.

Table 5: Model 1 – ROAA

4.3.2 Model 2 – ROAE

The regression analysis for the model 1 (ROAE) in the table below shows that the value of the size of the bank does not have significant relation based on the value of 0.630. Moreover, liquidity with much higher value of .987 shows that return on equity does not have association with ROAE.

The interest fact is that capital adequacy as well as inflation has significant impact on the profitability of the bank. The possible reason behind such high values shows that inflation affects the income of the bank as well as higher level of the capital reduces the earning to capital ratio. The relationship between bank profitability and GDP fails to explain the greater variability in the profit of the banking sector.

The value of R is 0.47 which the degree of the effectiveness of the model in terms who much it has managed to explained the effect of internal and external determined on the profitability of the bank.

Table 6: Model 2 – ROAE

4.3.3 Model 3 – NIM

The regression analysis has shown that size of the bank have significant impact in terms of NIM of the commercial bank.. The negative values shows that firm decision in regard to its investment have failed to make optimal decision as the interest income of the bank is lower and income expenses of the bank is higher.

Therefore, the management decision have significantly affected by the size of bank. Moreover, liquidity plays an important role to determine the amount interest generated by the bank against its interest expenses. Similarly, the lending and borrowing have impact by the level of GDP activity as well as inflation affect the interest income of the bank significantly.

Table 7: Model 3 – NIM

 4.4 Hypothesis testing

The table below shows the result of the correlation and regression analysis for the 30 banks data to determine the effect of various factors on the profitability of the bank. The results are enclosed from the correlation and regression. However, in this study we validate the hypothesis based on the regression results. The result highlight that what factors internal and external have significant impact on the profitability of the bank. The summary of the results are

The bivariate analysis and regression are conducted with 95% confidence level and the results shows that GDP and capital level have negative relation with profitability of the commercial bank in the china. The remaining factors have positive relationship with the profitability and result shows that size of the bank, liquidity and inflation have significant impact on the profitability of the banks in china. The lower mean value from the descriptive statistics represents that lower capital base of the some banks.

Table 8: Hypothesis Results

4.5 Critical Evaluation of the Determinants

4.5.1 Internal Determinants

4.5.1.1 Size of the Bank

According to Samad (2015) the size of the bank have significant role to achieve economies of scale for the bank in the marketplace. The data analysis shows that size of the bank have effect on the profitability of the bank. The Chinese bank profitability has positive relationship with size of the bank.

According to Olson and Zoubi (2011) the empirical research has mixed result between the size of the bank and profitability. There is positive relationship between the profitability of bank where as some studies have shown negative result between the size of the bank and profitability which in sometime was statistically insignificant to observe. (Ongore and Kusa, 2013)

The result has evident data commercial banks profitability in china is associated with the size of the bank. Therefore, the total assets of the bank effect on the profitability. The big banks off the china which were previous owned by the government are tends to more profitability.

De Jonghe and oztekin (2015) suggest that size of the bank have positive affect on the profitability of the bank and larger banks tend to more profitable when compared with smaller bank. The study confirms the positive relationship between the sizes of the bank and alternative hypothesis Bank size does have positive relationship bank profitability is accepted.

4.5.1.2 Liquidity

According to Perera, Skully and Chaudhry (2013), the liquidity is measured using the ratio as liquid assets to total asset of the bank. Holding the large amount of liquid asset involves opportunity cost or lower level risk the danger of insolvency. The Bankscope data analysis show that the mean value of the liquidity for the Chinese bank is 51 and the maximum value stands at 88. This represent Chinese bank has high level of liquidity and prefers to hold cash to meet the uncertain events. The liquidity ratio shows that banks prefer to lend only 50% of the deposits and hold large volume of cash to meet the demand of the depositor and tackle the uncertainty situation.

According to Choon, Thim and Kyzy (2012) the study of 90 banks in Europe has suggested that profitability of the bank and liquidity have positive relationship. The regression analysis confirms the hypothesis that Liquidity does have positive relationship between bank profitability.

According to Kanas, Vasiliou and Eriotis (2012) liquidity is an important indicator and reassures the depositors that financial position of the bank is relative strong and supports the loans and advances function to generate revenues for the bank. The result of the hypotheses support the major studies that liquidity help the bank to manage the working capital of the bank.

4.5.1.3 Capital adequacy

According to Allen, Napaporn and Robert (2013) in the light of bankruptcy theory that banks with better capital level have lower cost of funding which gives bank better ability to observe the shocks. The interesting is that all three models have shown the negative relation between the profitability and capital of the bank.

The mean average for the banks is as low as 2% which represent a very low of capital and does not meet the international requirement for the capital of the banks. The data analysis shows that under all three models the level of the capital has not shown a significant positive relationship with the commercial bank profitability.

According to Basel framework lack of capital reserves or poor structure is one of the major reasons of the bankrupts and it is recommended that bank should maintain minimum 8% of the asset base. (Ongore and Kusa, 2013)

The lower level of capital base for the most of Chinese shoes highlight fails to meet the international requirement for the liquidity. The banks seem to more rely on the liquidity and hold focus that cash rather rising the long term for the bank. Therefore, the acceptance of the null hypothesis shows that H2-0: Capital adequacy does not have positive relationship between bank profitability and does not confirm various study from the developing and developed countries that capital base is important determinant of the bank profitability.

4.5.2 External determinants

4.5.2.1 Inflation

The inflation has positive and negative affect with profitability of the bank and on level of the inflation. (Zhang, 2015) Data analysis has shown that inflation have positive relation with profitability of the bank. When inflation level is increasing bank can increased the rate of borrowing in order to adjust its profitability. In developing countries bank are less profitable during the period of high inflation as well as they have high capital ratio. The different level of the inflation in the country have significant element of the profitability of the bank.

The banks prefer to have large cash (short-terms assets) and i.e. it is likely that unanticipated level of inflation in the country is affecting the profitability of the banks in the china. Inflation is appearing to influence the benefit of the business banks in light of the fact that banks acquire their income for the most part from the advances. (De Jonghe & oztekin, 2015)

The acceptance of the null hypothesis shows that inflation does have positive relationship with bank profitability. The unanticipated is helping the banks to issue more loans and recover most the cash during the inflation period based on uneven inflation in the country.

4.5.2.2 GDPG

The researches have shown positive relation between GDP and profitability of the bank. There is positive relationship between GDP and profitability of the country. The relationship between bank profitability and GDP fails to explain the greater variability in the profit of the banking sector. (Chow, 2015)

However, data analysis has shown that GDP level in the country have no effect on the profitability of the country. The acceptance of the null hypothesis shows that H4-0: GDP does not have positive relationship with bank profitability. However, it has been suggest in studies that GDP have no effect on the profitability of the banks. The possible reason behind the lack of GDP effect on the profitability that country is experience a continuous growth over the period of several years which facilitate the level of activity and consumer is less about economic situation and spending level.

Chapter 5.0: Recommendations and Conclusion

5.1 Conclusion

The purpose of the research was to examine the effect of internal and external determinants on the profitability of the bank in china. The focus of the research was 30 commercial banks of the china with the period from 2006-2014. The importance of the study was the study if the determinants which affect the profitability of the bank in the Chinese context. The market structure, composition and banking industry of china is distinctive and had subject to various reforms.

Therefore, the purpose to examine the effect of various determinants which highlight who the internal factors which are related to management, as well as external which exist in the macroeconomic environment, affect the profitability of the commercial banks in china.  The aim of the study is to examine the internal and external determinant of the commercial bank profitability in china. Therefore, the research questions are designed to conclude

  • What are the profitability determinants in the Chinese market and extent of association with commercial bank profitability in China?
  • What is the impact of the internal and external determinants on commercial bank profitability in China?

They were a conducted with a total of 8 variables which includes 3 dependent and 5 independent (internal and external variables). The proposed was to investigate who bank industry is managed in the Chinese market. The internal determinants examined were the size of the bank, liquidity as well as capital adequacy.

The range of external variables examines were GDP and inflation in the country over the period of 2006-2014. The secondary data was collected from the Bankscope and analysed using the SPSS.

The results of internal variables size of the bank, liquidity and capital adequacy has shown that mixed effect on the profitability of the banks. For examples, the size of the bank has a positive relationship in term of the effect on the profitability of the bank. In the light of the Chinese banking industry structure, the big 4 and dominance of the large bank is one of the important areas behind the positive relationship between banks and profitability.

The liquidity of the bank has shown a positive relationship with the profitability of the bank. The liquidity has an impact on the bank and banks have high liquidity ratio.  Nevertheless the interesting fact includes is that capital adequacy ratio of the banks is relative low up 2% which does not meet the BASEL framework requirement. Moreover, the analysis has shown that profitability and capital adequacy have no positive relation.

Hence, this represents that market structure and banking operations in the country have a different dynamic and have much lower level of the capital base. The possible implication behind the no relationship between the capital adequacy and profitability is the availability of the low interest based credit. Banks prefer to hold a large amount of cash or short-terms assets to meet the unexpected situation.

The investigation of the external factors has highlighted that GDP have no positive relation with the profitability of the commercial banks. The range of studies has shown that GDP have a significant positive relation with the profitability of the bank. However, the acceptability of the null hypothesis has shown that bank profits are not associated with the GDP.

The possible reason behind the lack of relationship between the two variables is that china is experienced many decades of positive economic growth which has made it less relevant whether people are taking advances for investment. Therefore, economic growth is possibly concerned determinants for the banks. Moreover, inflation has shown a positive relationship with the profitability of the bank.

When inflation level is increasing bank can increased the rate of borrowing in order to adjust its profitability. However, during the time of decreasing inflation rate is not anticipated then it is difficult of the bank to adjust the rate of borrowing. The inflation graph shows that chin is an experience expecting the level of inflation over the china which is difficult to predict. Therefore, this unanticipated level of inflation has an effect on the profits of the banks.

In addition, the large number of studies shows a positive relationship between inflation and profitability of the bank. Therefore, the positive relationship and acceptance of the alternative hypothesis shows that inflation is important determinants in terms of the impact on the profitability of the commercial bank in the country.

The relationship of the bank size is significant and possibly largely based on the monopoly of the large institutions in the country. All the same, if banks grow too big to manage and it involves a complex range of transactions, then may result in diseconomies of scale. However, in case of the Chinese banking industry size of the bank has seemed to deliver positive growth and better revenues.

The element of liquidity has shown that banks prefer to hold a lot of short-terms and rely on the availability of the low-interest financing. The objective of the commercial funding is to maintain the optimum level of funding with avoid the risk of default but also avoid the too much cost of holding funds.

However, Chinese bank has uneven level of liquidity and its balance capital of the bank. This shows the lower level of ROAA because of avoidance of excessive risk taking while hold large cash to meet unexpected events. This represents the banking industry is pursuing similar policies as international bank and highlight the positive relationship between the profitability and liquidity.

The study of the external determinants highlights that GDP does not a positive relationship with the profitability of the bank. During the period of the economic boom, the loan rate is lower and during recession period the rate of default is high. When the economy is booming then loan demand increased which helps the bank to generate large interest income and from other sources.

Nevertheless, the economic variability does not have an impact on the profitability of the banks. This shows that GDP have a different effect on the profitability of the banks when compared with developed and developing countries.

5.2 Recommendations

During the literature reviews some good practices and international practices were observed among the banking industry in different countries. Based on the results of the data analysis the following good practices can be used by the commercial banking industry in china.

  • The commercial bank should maintain the capital of 8% which will reduce their dependency on the holding large amount of cash. This will reduce the dependency on holding cash and bank will have low cost source of funding.
  • The NIM is relative low which represented that bank borrowing and lending is not efficient and the investment decisions are optimal to maximise the profits. Bank should consolidate the capital base to avoid holding the cash to meet expenses.
  • The capital structure of the bank should be reviews with more long-term for the bank to reduce interest and generate better return on the assets. The current percentage shows on 50% of the deposit usage for advance this reviewed to achieve better rate of return.
  • The lending and borrowing decision should be based on the economic scenario of the market. This will reduce the risk of bad debts as well as charge the interest rate which helps the bank to cover its cost.
  • The impact of inflation should be reduced continuously. The unanticipated and unexpected level of inflation has significant for eh banks which consequently reduce the profits of the business.

5.3 Future Studies

This research has highlighted several opportunities for the possible future scenario and context. The interesting area would explore the effect of the unanticipated inflation on the banking sector of the china. Moreover, liquidity and risk adverse attitude of the Chinese banks can be studied and how it affects the profitability of the banks.

The size of banks in china is major area of study and how they affect the profitability and tackle comparative advantage of local banks. The balance of the liquidity and capital base of the commercial bank could help to improve profitability and reduce cost in the country. The study of the banking structure and profitability of the smaller commercial banks would highlight the different environment in Chinese context.

 

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