There have been several studies looking into the impacts of monetary policy on bank profitability, but because this is a rarely studied area e.g., Flannery, 1981; Hancock, 1985; Samuelso
INTRODUCTION
Rationale
Monetary policy plays a vital role in influencing a nation's financial environment, significantly affecting sectors such as banking The relationship between monetary policy and bank profitability has become a focal point for researchers and policymakers (Borio et al., 2017; Zimmermann, 2019; Garcia, 2020), especially in light of the challenges posed by the COVID-19 pandemic.
19 pandemic, which has presented unprecedented challenges to economies worldwide, including Vietnam
Vietnam, like many countries, faces significant economic challenges due to the pandemic, leading to disrupted financial markets and strained bank health In response, policymakers have introduced monetary policy measures aimed at supporting economic recovery It is essential to evaluate the effectiveness of these measures in maintaining bank profitability in Vietnam.
Researching monetary policy transmission in Vietnam is complicated due to the intricate nature of its banking system and the limited availability of high-quality financial data This lack of detailed information creates methodological challenges for researchers, resulting in a scarcity of academic literature on the topic Despite its importance for policymakers and bank managers, understanding the broader implications of monetary policy decisions in Vietnam remains underexplored Further investigation in this area could yield valuable insights that would contribute to the ongoing development and stability of the Vietnamese banking sector.
Numerous studies have explored the effects of monetary policy on bank profitability, yet a clear consensus remains elusive, with varying conclusions on its impact (Flannery, 1981; Hancock, 1985; Samuelson, 1945; Kumar, Acharya, and Ho, 2020) Research specifically addressing this topic in Vietnam is scarce (Nguyen et al., 2017; Dang, 2022), largely due to the country's rapidly growing yet still developing banking sector, which is undergoing significant structural changes Most existing studies on the Vietnamese banking industry have concentrated on fundamental issues, such as the implications of banking sector reforms (Nguyen et al., 2020) and the influence of state-owned banks (Farrell and Quang).
2019), and the challenges of financial inclusion (Hoang and Hoffman, 2020)
This research aims to enhance the existing literature by offering empirical evidence on the impact of monetary policy on bank profitability in Vietnam, particularly during the challenges posed by the COVID-19 pandemic The findings are expected to inform policymakers in developing effective monetary policy measures that support bank profitability and contribute to overall economic stability in Vietnam.
Research objectives
This study aims to analyze the influence of monetary policy on the profitability of Vietnamese banks, focusing on the periods before and during the COVID-19 pandemic The research will utilize annual data from 13 joint-stock commercial banks in Vietnam, covering a decade from 2014 to 2023.
2023 The specific aims of the study are as follows:
● Analyze the relationship between monetary policy variables, including lending interest rates and money supply, and bank profitability indicators, specifically return on assets (ROA)
This article evaluates the influence of monetary policy on bank profitability in Vietnam prior to the COVID-19 pandemic, focusing on the stability and performance of banks in a relatively stable economic climate It also explores how the relationship between monetary policy and bank profitability has transformed during the pandemic, highlighting the distinct challenges and disruptions encountered by the banking sector during this unprecedented time.
● Identify any significant differences in the effects of monetary policy on bank profitability between the pre-pandemic and pandemic periods, considering ban-specific factors and overall economic conditions
This research provides empirical evidence and insights into the relationship between monetary policy and bank profitability in Vietnam The findings will inform recommendations for policymakers and banks, aiming to foster effective measures that enhance bank profitability and promote overall financial stability in the country.
This study explores the impact of monetary policy on bank profitability in Vietnam, particularly in the context of the COVID-19 pandemic It aims to deliver a comprehensive understanding of how monetary policy affects bank profitability during both stable and crisis periods The research will include an in-depth analysis and recommendations to enhance the central bank's monetary policy implementation and improve operational strategies for commercial banks.
Research questions
● What is the nature of the effects of monetary policy on bank profitability in Vietnam?
● To what degree has the influence of monetary policy on bank profitability in Vietnam been?
● To what extent did the COVID-19 pandemic impact the relationship between monetary policy and bank profitability in Vietnam?
● What recommendations are necessary to enhance the effectiveness of monetary policy implementation by the central bank and operational policies by commercial banks in Vietnam?
Scope of research
The thesis investigates the micro and macroeconomic factors affecting 13 out of the 14 major joint-stock commercial banks in Vietnam for the year 2024, in accordance with Decision 538/QĐ-NHNN from the State Bank of Vietnam Agribank has been excluded from this analysis due to its unique status as a state-owned commercial bank and its absence from the stock exchange, resulting in limited publicly available information that does not meet the research objectives.
This thesis analyzes annual data from various banks over a decade, spanning from 2014 to 2023 The extensive temporal scope allows for a thorough examination of the research topic, providing insights into the effects of the COVID-19 pandemic in Vietnam while maintaining an unbiased perspective across different phases.
Methodology
The qualitative method utilizes statistical techniques to analyze the impact of monetary policies on bank profitability, offering a comprehensive overview of the effects and examining the underlying dependencies, ultimately leading to actionable recommendations.
This study employs a quantitative approach utilizing a regression model for panel data to analyze the effects of monetary policies on bank profitability Additionally, it evaluates the Random Effects Model (REM) and Fixed Effects Model (FEM), alongside the Hausman test, to assess the significance of the relationship between dependent and independent variables, ultimately identifying the most appropriate model for the research.
Thesis structure
CHAPTER 1: INTRODUCTION - Introducing a brief background of the thesis, research objectives and research questions, the scope of research and research methodology
CHAPTER 2: LITERATURE REVIEW - Overviewing the concept, measurements as well as the determinants of bank profitability and monetary policy Subsequently, summarizing the results of previous research papers on the collaborative outcome of these indicators
CHAPTER 3: DATA AND METHODOLOGY - Mentioning the sources of data collection and the research method of the thesis
CHAPTER 4: EMPIRICAL RESULTS - Presenting the estimation results, performing tests to achieve the most accurate results and interpreting it
CHAPTER 5: CONCLUSION - Concluding the thesis and confirming the research objectives.
LITERATURE REVIEW
Theoretical Framework
Bank profitability serves as a key indicator of performance, reflecting the effectiveness of management within the operational environment Sustainable and robust profitability is essential for ensuring stability in the banking sector, as highlighted by Garcia-Herrero et al (2009).
Bank profitability is crucial in the financial sector as it is closely linked to the stability of the banking system, highlighting a causal relationship By monitoring bank profitability, stakeholders can better predict financial crises and promote a sustainable banking environment (Zheng and Jean-Petit, 2022).
Bikker and Bos (2008) highlight the importance of assessing bank profitability through various indices and efficiency ratios obtained from financial statements These metrics provide crucial insights into a bank's resource utilization for profit generation By analyzing financial documents such as income statements and balance sheets, analysts can calculate key indicators like return on assets (ROA), return on equity (ROE), net interest margin (NIM), and efficiency ratios.
Return on Assets (ROA) is a key indicator of a bank's profitability in relation to its total assets, reflecting the efficiency with which it generates profits from its asset base A higher ROA signifies effective utilization of assets and strong income generation capabilities.
ROE assesses a bank's profitability in relation to shareholders' equity, reflecting the return earned on shareholder investments A higher ROE signifies increased returns for shareholders (Manoppo, 2016; Pongtiku and Salim, 2021; Nuarika, 2022)
Net Interest Margin (NIM) measures the disparity between interest income generated from loans and investments and the interest paid on deposits and borrowings, reflecting a bank's fundamental profitability in its lending and borrowing operations A higher NIM signifies increased earnings from interest-earning assets relative to interest expenses, indicating stronger financial performance.
Efficiency ratios assess a bank's cost-effectiveness and operational efficiency by measuring its revenue generation and expense control Key efficiency ratios include the expense-to-income ratio, cost-to-income ratio, and operating income-to-total assets ratio A lower ratio signifies better efficiency and superior cost management (McCune, 2007; Lagoe and Lagoe, 2019).
Understanding the drivers of bank profitability is essential for regulators, policymakers, and banks, as it encompasses factors such as interest rate spread, loan quality, operating efficiency, capital adequacy, market conditions, regulatory environment, and technological innovation This insight is vital for identifying vulnerabilities, promoting financial stability, attracting investment, and managing risks effectively For instance, recognizing the impact of market conditions aids in developing measures to mitigate economic fluctuations, while understanding the link between capital adequacy and profitability is crucial for establishing appropriate requirements that ensure a stable banking system.
Bank profitability is more than just a performance metric; it is crucial for the success and stability of the banking industry and can help predict crises (Xu et al., 2019) It affects a bank's competitiveness (Istudor, 2022), enhances the effectiveness of monetary policy transmission (Altavilla, 2019), and acts as a key indicator of institutional health and stability (Xe et al., 2019).
The profitability of banks is explained through various theoretical models that consider factors such as risk, efficiency, and market conditions Notable examples include the profit-maximizing bank model, which highlights the trade-offs between risk and return (Malafeyev and Awasthi, 2015; Siew et al., 2021; Sun et al., 2022), and the charter value model, which focuses on long-term profitability expectations (Bakkar et al., 2016; Schenck and Thornton, 2016; Daher et al., 2019).
Researchers analyze real-world data to validate theoretical models, examining bank-specific characteristics, macroeconomic factors, and regulatory changes Empirical studies help identify significant determinants influencing bank profitability.
Monetary policy (MP) involves the strategies implemented by central banks to affect the availability and cost of money in an economy, as outlined by the European Central Bank This topic garners considerable interest and scrutiny from nations and researchers alike.
Milton Friedman's 2001 research on the US economy highlighted that monetary policy (MP) involves regulating the money supply through interest rate adjustments and other measures to influence excess reserves held by financial institutions at the central bank The Federal Reserve defines MP as a strategy used by a country's monetary management agency, usually the central bank, to control inflation, stabilize prices, preserve the value of the currency, and maintain public confidence in legal tender.
Central bank MP has three basic objectives: ultimate objectives, intermediate objectives, and operational objectives (Mishkin, 2019)
Ultimate objectives in monetary policy (MP) are consistent across nations and are reflected through five key indicators: price stability, economic growth, financial market stability, stable interest rates, and high employment stability These objectives are generally interconnected, as low unemployment and stable prices typically accompany economic growth, while stable interest rates contribute to financial market stability However, in the short term, conflicts may arise among these goals, necessitating central banks to navigate trade-offs between various macroeconomic objectives.
Monetary policy tools are actions taken by central banks to influence money supply and interest rates, which are essential for achieving monetary policy objectives These tools play a vital role in regulating the economy's money supply and interest rates.
There are two groups of MP tools: conventional monetary policy tools and unconventional monetary policy tools
Conventional monetary policy utilizes both direct and indirect tools to influence the money supply and interest rates Direct tools, applicable in regulated financial systems, encompass credit ceilings, interest rate caps, and exchange rate controls In contrast, indirect tools operate through market mechanisms, targeting intermediate variables such as the money supply and interest rates.
Unconventional monetary policy is employed by central banks to address unusual economic challenges when standard tools fail This approach includes strategies like policy guidance, liquidity support, quantitative easing, and the use of negative interest rates to stimulate the economy.
● Theoretical Basis on the effect of MP on Bank Profitability
According to the neoclassical monetary theory developed by Samuelson
Factors affecting bank profitability
According to Sritharan (2015), bank size refers to the total net assets, client cash deposits, and the amount of capital held by the bank Ramezani and Alan
Bank size, as defined in 2014, refers to the total revenues generated by a bank, encompassing both interest and non-interest revenues This size is significant as it influences production costs and enhances the bank's capacity to leverage economies of scale effectively.
Schildbach (2017) discusses several main indicators of bank size, each with their own strengths and limitations
Total assets are a key indicator of a bank's size and overall activity, providing a comprehensive view of its balance sheet that includes loans, investments, cash, and other holdings (Mrvaljevic et al., 2022) This standardized measure is essential for regulatory frameworks to establish prudential requirements and thresholds, ensuring transparency and ease of regulation Larger banks, reflected by higher total assets, are often perceived as more stable, enhancing market perception and investor confidence (Fariyanti, 2018; Chernykh, 2019) Moreover, measuring bank size through total assets promotes market transparency and supports international comparisons, as endorsed by the International Accounting Standards Board's Conceptual Framework for Financial Reporting (Arnold, 2013) This facilitates cross-country analyses and assessments of global banking trends and systemic risks.
Furthermore, Market capitalization reflects a bank's current value and is not distorted by different measurement rules However, it primarily quantifies success rather than pure size
Revenues serve as a holistic metric that reflects the diverse activities of banks, including commercial and transaction banking, investment banking, and asset management As cash flow-based figures, they offer a more dependable assessment that remains unaffected by varying business models and financial structures.
Revenues serve as the most effective indicator of a bank's size, while equity capital reflects the bank's book value and remains relatively stable, minimizing measurement issues and fluctuations in business models Nonetheless, equity capital may not accurately represent the current business volume of a bank when compared to revenue figures.
Other measures such as risk-weighted assets, net income, or the number of customers offer a more limited perspective on bank size and are therefore less useful for comprehensive assessments
- Theoretical Basis on the effect of Bank Size on Bank Profitability
According to the theoretical perspective known as Economies of Scale by McGee (2014), larger banks can enjoy advantages that enhance their profitability
Larger banks achieve lower average costs per unit of output by spreading fixed costs over a broader asset base, which is facilitated by their centralized operations, enhanced bargaining power with suppliers, and significant investments in technology and infrastructure This phenomenon, known as economies of scale, significantly contributes to the higher profitability of these institutions Research by Owualah (2016) and Navaretti et al (2019) supports the notion that larger banks can effectively lower their average costs through this strategic distribution of fixed costs.
The theoretical perspective of Diversification and Risk Management by Uddin (2022) underscores the importance of bank size in effective risk management Larger banks typically have more diverse loan portfolios and a broader geographic presence, which allows them to spread risks across various borrowers and markets, ultimately reducing their overall risk exposure This diversification enhances their capacity to manage credit, market, and liquidity risks, leading to improved profitability through loss mitigation and better financial performance Supporting this view, Bogonko (2023) found that effective risk management practices positively influence financial performance in commercial banks listed on the Nairobi Securities Exchange, demonstrating a reduction in losses and an increase in profitability Additionally, Kishanrao (2023) confirmed that such practices are crucial for both public and private sector banks, as they contribute to increased profitability by minimizing losses and enhancing overall financial outcomes.
The relationship between bank size, as measured by total assets, and profitability has been extensively studied in the banking literature
Numerous studies indicate a positive correlation between total assets and bank profitability Tee (2017) explored asset and liability management's effect on the profitability of listed banks in Ghana, finding that both total assets and liabilities positively influence profitability, measured by return on assets (ROA) Additionally, economic factors like GDP and interest rates were considered, with robust panel regression analysis confirming that total assets significantly contribute to profitability Similarly, Budhathoki et al (2020) assessed Nepalese commercial banks, revealing that total assets enhance profitability, as shown by improved ROA, ROE, and net interest margin (NIM) metrics Their findings suggest that larger banks experience greater profitability Furthermore, Charmler et al (2018) analyzed bank liquidity trends in Ghana over a decade, concluding that total assets positively impact the profitability of commercial banks.
The study also identified a significant relationship between liquidity and ROA, suggesting the importance of maintaining an optimal level of liquid assets for enhanced profitability
Numerous studies indicate a negative correlation between total assets and bank profitability For instance, Ali (2016) utilized a balanced panel data regression model to analyze the profitability of banks in Pakistan following the 2008 financial crisis, revealing that total assets negatively impact bank profitability, as measured by Return on Assets (ROA) and Return on Equity (ROE).
A 2023 study examined the connection between non-performing loans (NPLs) and bank profitability in Bangladesh, revealing that larger bank size, indicated by total assets, inversely affects profitability, particularly reducing return on assets (ROA) Similarly, Rajagukguk et al (2021) explored the effects of liquidity and total assets on the profitability of pharmaceutical companies on the Indonesia Stock Exchange, finding that total assets negatively influence profitability (ROA) within this sector.
Capital adequacy refers to the minimum capital that banks and financial institutions must maintain to absorb losses and ensure operational continuity during financial challenges (Tamplin, 2023) This concept is crucial for the banking sector, as it ensures the stability and financial health of institutions, reduces the risk of bank failures, and promotes overall economic stability.
The Capital Adequacy Ratio (CAR) is a crucial metric for evaluating a bank's financial strength and stability, serving as an indicator of its capacity to absorb potential losses A higher CAR reflects a larger capital base in relation to risk exposure, thereby bolstering the bank's ability to endure adverse events and maintain overall financial stability.
Regulatory authorities establish minimum Capital Adequacy Ratio (CAR) requirements for banks to ensure financial system stability, often aligning with international standards such as the Basel Accords Adhering to these requirements is essential for banks to operate legally and uphold the trust of depositors, investors, and counterparties, thereby preserving the integrity of the banking sector.
Banks with higher Capital Adequacy Ratios (CARs) are viewed as more creditworthy, which enhances their reputation and reliability in interbank and counterparty relationships This favorable perception boosts their competitiveness in the interbank lending market and attracts counterparties for various financial transactions As a result, CAR measurement significantly impacts the willingness of other banks and market participants to form business relationships with a particular bank, as supported by research from Matthews et al (1996), Weic et al (2011), and Kalifa et al (2018).
- Theoretical Basis on the effect of Capital Adequacy on Bank Profitability
The Modigliani-Miller theory (1959) asserts that, without taxes, transaction costs, and market imperfections, a firm's capital structure, including banks, does not affect its profitability, as its value is determined solely by its assets and cash flows However, in the banking sector, regulatory capital requirements and market discipline impose constraints on capital decisions Banks must adhere to capital adequacy regulations, such as those in the Basel Accords, which set minimum capital levels based on asset risk These regulations aim to enhance banking stability and protect stakeholders Non-compliance with capital adequacy standards can lead to severe consequences for banks, including penalties, activity restrictions, or loss of operating licenses, ultimately impacting their profitability and financial health.
Recent studies underscore the critical role of capital adequacy in the banking sector Victor (2022) found that non-compliance with capital adequacy requirements negatively impacts the sustainability and profitability of deposit money banks in Nigeria over a 32-year period This highlights the need for regulatory compliance and effective risk management Similarly, Sobieri (2022) emphasized that capital requirements in the Polish banking sector enhance loan portfolio quality and mitigate systemic risk, with non-compliance potentially leading to bank failures Amissan (2023) further explored the effects of capital adequacy on the profitability of banks listed on the Ghana Stock Exchange, reinforcing the importance of maintaining robust risk management practices to ensure financial stability.
Empirical Studies Review
Research indicates that the relationship between monetary policy and bank profitability is inconsistent Cruz-García et al (2017) found that expansionary monetary policies negatively impacted net interest margins and overall bank profitability Their analysis revealed a nonlinear and concave relationship involving interest rates, the yield curve's slope, and profitability Specifically, lower interest rates and a flattened yield curve had a more significant adverse effect, implying that normalizing monetary policy could potentially restore banking margins and enhance profitability.
Borio et al (2017) found a positive relationship between net interest income and short-term interest rates, with a more pronounced effect at lower rates They also highlighted that higher interest rates tend to decrease non-interest income while positively influencing loss reserves Similarly, Tuna and Almahadin (2021) identified significant impacts of monetary policy interest rates on banking indicators in developing countries, emphasizing a stronger connection at lower interest rates, which suggests heightened vulnerability to policy interest rate risks.
Kumar, Acharya, and Ho (2020) discovered that short-term interest rates positively impact bank profitability in New Zealand, whereas long-term interest rates have a negative effect Additionally, Dang and Huynh (2022) found that banks that diversify their income sources and increase non-interest income can mitigate the adverse effects of monetary policy on their overall performance.
The significance of monetary policy on bank profitability appears to vary depending on banks' reliance on traditional interest income segments Dzeha et al
A 2022 study revealed that in Ghana, raising monetary policy interest rates leads to decreased net interest margins and profitability for banks, while lower rates improve profitability Higher interest rates indicate a tighter monetary policy, causing increased loan costs and reduced lending, which can result in short-term profit declines However, banks can mitigate long-term profitability decreases by adjusting their deposit and credit interest rates accordingly.
A study by Nguyen et al (2017) in Vietnam established a significant positive relationship between monetary policy and the performance of commercial banks, consistent with earlier findings The research highlighted that credit growth and liquidity are key internal factors driving banking profitability, while macroeconomic elements, including economic growth and inflation, play a crucial role in influencing the overall performance of the banking sector.
The COVID-19 pandemic significantly influenced monetary policy and its effects on bank profitability, as highlighted in a 2023 analysis by the Azerbaijan High Technical Educational Institution The study examined the responses of the Japanese government, Bank of England, and Federal Reserve, concluding that adjustments in monetary policy during the pandemic notably impacted bank profitability Prior to the pandemic, monetary policies primarily targeted inflation control, whereas post-pandemic strategies shifted towards economic recovery, emphasizing asset purchases.
Boungou (2023) examined the impact of COVID-19 vaccination on bank profitability, analyzing data from 5,474 banks across 23 OECD countries between 2019Q2 and 2022Q1 The findings revealed that the pandemic negatively affected bank profitability, particularly in the early stages Although COVID-19 vaccination contributed positively to bank profitability, it was insufficient to entirely offset the initial financial losses incurred during the pandemic.
The pandemic intensified the influence of monetary policy on bank profitability, with expansionary measures enhancing both performance and risk A study by Nguyen et al (2022) utilized the dynamic two-step system generalized method of moments (S-GMM) estimator to analyze commercial banks in Vietnam, revealing that the effects of monetary policy on bank performance and risk differ before and after COVID-19 Notably, during the pandemic, monetary policy expansion led to increased bank performance and risk, with variations depending on specific bank characteristics and the overall impact of COVID-19.
Ramlall (2023) examined the effects of COVID-19 on the profitability of leading banks worldwide, utilizing an extensive array of bank-specific ratios The findings revealed that asset utilization's positive influence on profitability diminished during the pandemic, while the crisis resulted in a higher cost-to-income ratio affecting return on equity (ROE).
Table 2.1: Summary of the effects of bank-specific and macroeconomic factors on bank profitability from previous literature
Factors Measure Effects Based study
Bank size Total assets +/- Tee (2017);
Budhathoki et al (2020) ; Charmler et al (2018); Ali (2016);
Karim et al (2023); Rajagukguk et al (2021)
Nguyen and Tang (2023); Kurniawati and Bagana (2022); Noman et al (2015)
Liquidity LDR +/- Pasaribu and Riyadi (2022);
Yulyanti et al (2022); Fanny et al (2020); Rusiyati (2018)
Asset quality NPL - Karim et al (2023);
Economic growth Annual GDP growth
Inflation CPI +/- Jeevitha et al (2019);
Batsinda and Sukla (2019); Dogan and Yildiz (2023)
Credit growth Credit growth rate +/- Wijayanti and Mardiana (2020);
Mery and Dony (2021); Rossi et al (2019);
Monetary supply M2 growth rate + Tolley et al (1957);
Lending rate Lending interest rate
Windsor et al (2023); Bikker et al (2017); Nurfadillah et al (2023)