Factors affecting the profitability of commercial banks in vietnam from 2009 2018

Obtained result showed that ROA of commercial banks in Vietnam was affected positively and statistically significant by bank size, equity ratio, loan ratio, deposit ratio, income diversi

MINISTRY OF EDUCATION AND TRAINING STATE BANK OF VIETNAM

BANKING UNIVERSITY HO CHI MINH CITY

NGUYEN THI MINH THU FACTORS AFFECTING THE PROFITABILITY OF

COMMERCIAL BANKS IN VIETNAM

FROM 2009 – 2018

GRADUATE THESIS MAJOR: FINANCE - BANKING

CODE: 52340201

SUPERVISOR MSC VU THI HAI MINH

HO CHI MINH CITY, 2020

MINISTRY OF EDUCATION AND TRAINING STATE BANK OF VIETNAM

BANKING UNIVERSITY HO CHI MINH CITY

NGUYEN THI MINH THU

FACTORS AFFECTING THE PROFITABILITY OF

COMMERCIAL BANKS IN VIETNAM

FROM 2009 – 2018

GRADUATE THESIS MAJOR: FINANCE - BANKING

CODE: 52340201

SUPERVISOR MSC VU THI HAI MINH

HO CHI MINH CITY, 2020

ABSTRACT

The purpose of this thesis is to provide an analysis of factors affecting the profitability of 28 commercial banks in Vietnam from 2009 to 2018 using Pooled OLS, FEM, REM, FGLS methods The scope of the study is to aim at finding and analyzing the degree of impact of specific bank factors, industry-specific factors and macro-economic factors on the profitability of 28 commercial banks in Vietnam The study cannot avoid the limitations because of the selection may not fully reflect the content and the meaning of all factors affect profitability or may not fully represent all commercial banks in Vietnam

Understanding the factors influencing the performance of the bank not only receives much attention from scholars, but also from shareholders, administrators and authorities, because it assists policy makers and administrators in formulating strategies and policies to ensure the stability and sustainability of banking system's operation, as well as to avoid the risk of banking system crisis Assessing the profitability of a commercial bank always raises questions, because of their diversity Many researchers consider that profitability can provide a picture of the bank's business results

Obtained result showed that ROA of commercial banks in Vietnam was affected positively and statistically significant by bank size, equity ratio, loan ratio, deposit ratio, income diversification ratio, credit growth rate and GDP; while non-performing loan, operating cost and exchange rate have negative impact on ROA In contrast, liquidity, credit to GDP and inflation do not affect ROA and are not

statistically significant

Keywords: commercial banks, profitability, ROA, bank size,

non-performing loan, equity ratio, liquidity ratio, loan ratio, deposit ratio, income diversification ratio, operating cost, credit to GDP, credit growth rate, GDP, inflation, exchange rate

SUMMARY

International economic integration is an indispensable trend and an objective requirement for any country in the current development stage However, this process, in addition to creating certain advantages and opportunities for the country participating in the integration, also put these countries before significant difficulties and challenges The roadmap of international economic integration puts enterprises of developing countries in general, the commercial banking system in particular and the new business environment with fierce competition pressures, unbalanced competitors Currently, Vietnam is a member of the United Nations, the World Trade Organization, the International Monetary Fund, the World Bank Group, the Asian Development Bank and the Joint Forum Economic Cooperation Asia-Pacific, ASEAN Vietnam participates in multilateral free trade agreements with ASEAN countries, South Korea, Japan and China Vietnam has also signed with Japan a bilateral economic partnership agreement For banking and monetary system, the integration process is associated with the process of liberalizing financial market, bringing many opportunities, but also many challenges From that practice, this thesis will analyze and introduce factors affecting the efficiency in the operation of Vietnam’s commercial banking system in the current integration period, especially the factors affecting the profitability of commercial banks in Vietnam, from which to give practical recommendations to improve the operational efficiency of commercial banking system, is an urgent issue

This thesis analyses factors affecting the profitability of 28 commercial banks in Vietnam from 2009 to 2018 using regression methods such as Pooled OLS, FEM, REM, FGLS; thereby provide some recommendations to improve the profitability of commercial banks in Vietnam

In order to further analyze the impact of Vietnam's macro environment and banking industry on the profitability of Vietnamese commercial banks, the author decided to consider three more independent variables, namely exchange rate, credit

to GDP and credit growth rate along with two familiar macro factors which are inflation and GDP growth

The table below summarizes related previous studies and theoretical framework of this thesis

Table 0.0.1: Related previous studies and theoretical framework

Theory/Related previous

studies Subjects are mentioned

Previous studies and related law, decree

Commercial banks Definition of commercial banks

- Law: Consolidated documents No

20/2018/VBHN-NHNN, the State Bank of Vietnam

- Previous studies: Getter, (2016), Tariq et al (2014), Tuyishime et al (2015), Kalpana & Rao (2017), Mongid et al (2012), Erina & Lace (2013)

Profitability

Definition of bank profitability

Wang & Wang (2015), Bikker & Vervliet (2017), Iacobelli (2017), Yuksel

et al (2018), Muya & Gathogo (2016), Niresh & Velnampy (2014),

Sehrish, Irshad & Khalid (2010), Pastory &

Marobhe (2015), Kohler (2013)

Measurement Book: Principals of finance, Scott, B &

Eugene, F B (2015)

Market power theory

It explains the profit of firms to be increased from the achievement of more market power

Bain (1951)

Efficiency theory

It explains other aspect of bank profitability which can be generated from better management and business efficiency

Demsetz (1973)

Agency cost theory This theory focuses on the

use of financing structure Jensen & Meckling

of the firms to drive the managers and the investors to solve free cash flow issues

Signaling theory

This theory emphasizes that the firms with profitable condition and high business performance can supply the market and the customers with positive information

Arrow (1972) and Spence

& Noor-Mohamad-Noor, A (2012), Al-Omar, H &

Al-Mutairi, A (2008)

National studies

Nguyen (2018), Nguyen et al (2018), Le et al (2017), Nguyen, D (2017), Phan & Phan (2014), Vo & Batten (2014), Vu & Nahm (2013), Nguyen Thanh Phong

(2015), Phan Thi Hang Nga (2011)

Source: Author’s synthesis

The research model proposed specifically as follows:

Where: βo : constant term

β1, , β14: Regression coefficients for the independent variables i: bank; t: year of observation; μi: error term/ residual term

Dependent variables:

ROA: return on assets (%)

Independent variables (bank-specific factors):

SIZE: bank size (billion VND)

NPL: non-performing loan (%)

LIQ: liquidity ratio (%)

EQR: equity ratio (%)

LOAN: loan ratio (%)

DEP: deposits ratio (%)

IDR: income diversification ratio (%)

OPR: operating cost ratio (%)

Independent variables (industry-specific factors):

CRD: credit to GDP

CGR: credit growth rate

Independent variables (macro-economic specific factors):

INF: inflation

GDP: gross domestic product

ER: exchange rate between VND and USD

The thesis performs: (1) Descriptive statistics; (2) Correlation analysis; (3) Model estimation (Pooled OLS, FEM, REM); (4) Model choice (Between Pooled OLS and FEM, between FEM and REM); (5) Model diagnostics (Autocorrelation diagnostics, multicollinearity diagnostics, heteroskedasticity diagnostics); (6) Model fix; (7) The prediction of residuals; (8) Normality test of residuals

The result of model choice analysis showed that both FEM and REM were more appropriate than Pooled OLS Furthermore, FEM was proven as more appropriate than REM However, the author identified that there was autocorrelation issue in the dataset The result of heteroskedasticity check revealed that FEM model did face up with this issue To fix the model problems, the author conducted FGLS regression technique and here is the result:

However, while some independent variables are in line with the expectations

of the author, there are some independent variables that contrary to the author's

initial expectations Detailed is shown as below:

Table 0.0.2: Expectations and research results of independent variables

Code Description Expected signs Results

(Source: Author’s synthesis)

Based on the research results, the author will provide some recommendations

in chapter 5 to improve commercial banks’ profitability, thereby helping policy

makers to easily control and optimize the profitability of commercial banks

DECLARATION

I hereby declare that the graduate thesis is my original work, written by me under the guidance of Ms Vu Thi Hai Minh and it has not been presented for examination in anywhere else The data and sources cited in the thesis have been duly acknowledged

I take full responsibility for my pledge

Author

Nguyen Thi Minh Thu

ACKNOWLEDGEMENT

It is my radiant sentiment to place on record my best regards, deepest sense

of gratitude to my supervisor at Banking University in Ho Chi Minh City - Ms Vu Thi Hai Minh, for her patience, motivation, enthusiasm, and immense knowledge She has wholeheartedly helped and guided me in the process of writing this thesis I choose this moment to acknowledge her contribution as she has been supportive of

my study and has actively provided me with enormous information to achieve the goal

Also, I would like to thank all of my friends, who always support and help

me through the study together with the inspiration they gave me

Author

Nguyen Thi Minh Thu

ABBREVIATION LIST

FEM Fixed effect model FGLS Feasible Generalized Least Squares GDP Gross domestic product

INF Inflation MARG Net financing margin NIM Net Interest Margin NOVX Non-interest expenses to average total assets Pooled OLS Pooled Ordinary Least Squares

REM Random effect model ROA Return on asset ROCE Return on capital employed ROE Return on equity

Std Dev Standard Deviation VIF Variance Inflation Factors

LIST OF TABLES

Table 0.0.1: Related previous studies and theoretical framework iii

Table 0.0.2: Expectations and research results of independent variables vi

Table 2.1: Summary of studies on the impact of factors affecting bank profitability 22

Table 2.2: Limitation of empirical research 25

Table 3.1: Summary of debt groups 34

Table 3.2: Variables used in the model 39

Table 4.1: Descriptive statistics 46

Table 4.2: Pearson correlation 49

Table 4.3: Pooled OLS output 50

Table 4.4: FEM output 52

Table 4.5: REM output 54

Table 4.6: Model choice between Pooled OLS and FEM 56

Table 4.7: Model choice between FEM and REM 56

Table 4.8: Autocorrelation diagnostics 57

Table 4.9: Multicollinearity diagnostics 57

Table 4.10: Heteroskedasticity diagnostics 58

Table 4.11: Cross-sectional time-series FGLS regression 58

Table 4.12: The prediction of residuals 59

Table 4.13: Normality test of residuals 60

Table 0.1: List of commercial banks selected for the research xxxiii

LIST OF FIGURES Figure 3.1: Research process 31

Figure 3.2: ROA trends of Vietnamese commercial banks during 2009-2018 33

LIST OF PICTURES

Picture 1: Descriptive statistics xlvPicture 2: Correlation analysis xlviPicture 3: Pooled OLS output xlviiPicture 4: FEM output xlviiiPicture 5: REM output xlixPicture 6: Model choice between Pooled OLS and FEM xlixPicture 7: Model choice between FEM and REM lPicture 8: Autocorrelation diagnostics liPicture 9: Collinearity diagnostics liPicture 10: Heteroskedasticity diagnostics liiPicture 11: FGLS output liiPicture 12: The prediction of residuals liiPicture 13: Normality test of residuals lii

TABLE OF CONTENTS

ABSTRACT i

SUMMARY ii

DECLARATION vii

ACKNOWLEDGEMENT viii

ABBREVIATION LIST ix

LIST OF TABLES x

LIST OF FIGURES x

LIST OF PICTURES xi

TABLE OF CONTENTS xii

CHAPTER 1: INTRODUCTION 1

1.1 Background of the study 1

1.2 Objectives of the study 2

1.2.1 General objectives 2

1.2.2 Specific objectives 2

1.3 Research questions 2

1.4 Subject and scope of the study 2

1.4.1 Subject of the study 2

1.4.2 Scope of the study 2

1.5 Research methodology 3

1.6 Significance of the study 3

1.6.1 Scientific significance 3

1.6.2 Practical significance 3

1.7 Structure of the study 4

CHAPTER 2: THEORETICAL BASIS AND LITERATURE REVIEW 5

2.1 Theoretical basis about commercial bank 5

2.2 Theoretical basis about commercial bank profitability 6

2.2.1 Definition of bank profitability 6

2.2.2 The indicators reflect the profitability of commercial banks 7

2.2.2.1 Return on Assets - ROA 8

2.2.2.2 Return on Equity - ROE 9

2.2.2.3 Net Interest Margin - NIM 9

2.2.3 Factors affecting commercial bank profitability 10

2.2.3.1 Internal factors 10

2.2.3.2 External factors 10

2.3 Theoretical framework 10

2.3.1 Market power theory 11

2.3.2 Efficiency theory 11

2.3.3 Agency cost theory 12

2.3.4 Signaling theory 12

2.4 Literature review 13

2.4.1 Foreign studies 13

2.4.2 National studies 18

2.4.3 Previous studies’ gap and summary 22

2.4.3.1 Previous studies’ gap 22

2.4.3.2 Summary 28

CONCLUSION OF CHAPTER 2 29

CHAPTER 3: METHODOLOGY 30

3.1 Data collection 30

3.2 Research process 30

3.3 Research model 32

3.3.1 Dependent variables 32

3.3.2 ROA trends of Vietnamese commercial banks during 2009-2018 32

3.3.3 Independent variable 33

3.3.3.1 Bank size (SIZE) 34

3.3.3.2 Non-performing loan ratio (NPL) 34

3.3.3.3 Liquidity ratio (LIQ) 34

3.3.3.4 Equity ratio (EQR) 35

3.3.3.5 Loan ratio (LOAN) 35

3.3.3.6 Deposit ratio (DEP) 36

3.3.3.7 Income diversification ratio (IDR) 36

3.3.3.8 Operating cost ratio (OPR) 36

3.3.3.9 Credit to GDP ratio (CRD) 37

3.3.3.10 Credit growth rate (CGR) 37

3.3.3.11 Annual GDP growth rate (GDP) 37

3.3.3.12 Inflation rate (INF) 38

3.3.3.13 Foreign exchange rate (ER) 38

3.3.4 Summarize 38

3.3.5 Proposed research model and hypotheses 41

3.4 Research methods 42

3.4.1 Pooled ordinary least square (Pooled OLS) 43

3.4.2 Fixed effect model (FEM) 43

3.4.3 Random effect model (REM) 44

3.4.4 FGLS (Feasible Generalized Least Squares) 45

CONCLUSION OF CHAPTER 3 45

CHAPTER 4: RESULTS AND FINDING 46

4.1 Descriptive Statistics 46

4.2 Correlation analysis 48

4.3 Model estimation 50

4.3.1 Pooled ordinary least square (Pooled OLS) 50

4.3.2 Fixed effect model (FEM) 52

4.3.3 Random effect model (REM) 54

4.4 Model choice 55

4.4.1 Between Pooled OLS and FEM 55

4.4.2 Between FEM and REM 56

4.5 Model diagnostics 56

4.5.1 Autocorrelation diagnostics 57

4.5.2 Multicollinearity diagnostics 57

4.5.3 Heteroskedasticity diagnostics 58

4.6 Model fix 58

4.7 The prediction of residuals 59

4.8 Normality test of residuals 59

4.9 Discuss the research results 60

4.9.1 Bank size (SIZE) 60

4.9.2 Non-performing loan (NPL) 61

4.9.3 Liquidity ratio (LIQ) 61

4.9.4 Equity ratio (EQR) 62

4.9.5 Loan ratio (LOAN) 62

4.9.6 Deposit ratio (DEP) 63

4.9.7 Income diversification ratio (IDR) 63

4.9.8 Operating cost ratio (OPR) 64

4.9.9 Credit to GDP (CRD) 64

4.9.10 Credit growth rate (CGR) 65

4.9.11 Gross domestic product GDP) 65

4.9.12 Inflation rate (INF) 66

4.9.13 Exchange rate (ER) 66

CONCLUSION OF CHAPTER 4 67

CHAPTER 5: CONCLUSION AND RECOMMENDATION 68

5.1 Conclusion 68

5.2 Recommendation 69

5.2.1 Bank size (SIZE) 69

5.2.2 Non-performing loan (NPL) 70

5.2.3 Equity ratio (EQR) 71

5.2.4 Loan ratio (LOAN) 72

5.2.5 Deposit ratio (DEP) 73

5.2.6 Income diversification ratio (IDR) 74

5.2.7 Operating cost ratio (OPR) 75

5.2.8 Credit growth rate (CGR) 76

5.2.9 Gross domestic product (GDP) 76

5.2.10 Exchange rate (ER) 77

5.3 Limitation of the study 78

5.4 Future research directions 78

CONCLUSION OF CHAPTER 5 79

REFERENCES xviii

APPENDIX xxxiii

CHAPTER 1: INTRODUCTION 1.1 Background of the study

Banking sector is the backbone of any economy and it plays a vital role in the operation and development of a country Nowadays, the banking industry in Vietnam is facing competitive pressure as globalization and international integration are increasing This has made the concept of efficiency become more crucial for both financial and nonfinancial institutions, and commercial banks are also part of the financial institutions Efficiency in banking operations is always a top concern for bank administrators because effective banking operations will contribute to creating sustainable profits, increasing stability, promoting development and increasing competitive advantage for Vietnamese banks in the environment of international integration The competitive environment in the financial market in Vietnam is becoming increasingly fierce and fierce, because not only competition between banks but also with financial intermediaries and foreign banks with strong financial potential and strong international experience The general determinants of bank profitability have been thoroughly examined in many previous literatures In addition, profitability is an essential factor for a bank to maintain ongoing activities and it is one of the important criteria to evaluate the performance of banking operations

Therefore, it is important to assess the factors affecting the financial performance or more specifically the profits of these banks, thereby making recommendations for managers to conduct orientation, and restructure business activities

Those are reasoning why the author chose to conduct a research entitled:

“Factors affecting the profitability of commercial banks in Vietnam from 2018”

2009-1.2 Objectives of the study

1.2.1 General objectives

The study aimed at finding and analyzing the degree of impact of specific bank factors on the profitability of 28 commercial banks in Vietnam, as well as providing banks’ managers some solutions and recommendations to develop and improve commercial banks’ profitability

1.2.2 Specific objectives

Specifically, this study addresses the following objectives:

- Measuring the degree of impact of specific bank factors on the profitability

of 28 commercial banks in Vietnam based on the implementation of multivariate regression models

- Identifying factor represents profitability of banks

- Giving some appropriate recommendations to improve the profitability of Vietnamese commercial banks based on research results

1.4 Subject and scope of the study

1.4.1 Subject of the study

The subject of this study is banks’ profitability for the time period of 2009 to

2018 based on annual income reports

1.4.2 Scope of the study

- Time scope: from 2009 to 2018

- Space scope: 28 commercial banks in Vietnam

1.6 Significance of the study

This thesis will propose a research model of factors affecting the profitability

of commercial banks in Vietnam, as well as provide policy makers and bank managers with empirical evidence on the impact factors and the degree of influence

of each microeconomic and macroeconomic determinant on the profitability of commercial banks in Vietnam from 2009 to 2018 Based on the research results, the author proposes some recommendations to improve commercial banks’ profitability Following that, this study will help policy makers to easily control and optimize the profitability of commercial banks

1.7 Structure of the study

There are 5 chapters in this thesis:

Chapter 1: Introduction

Some contents will be mentioned such as overview and problems of research, objectives, research questions, subject and scope of the thesis

Chapter 2: Theoretical basis and Literature review

Chapter 2 includes some main contents such as the theory of profitability and factors affecting the profitability of commercial banks This chapter introduces briefly some of the previous studies, in Vietnam as well as in the world in general, making comparisons of different points of view on the topic Following that, this study reviews and synthesizes previous research models on profitability of commercial banks as the basis for proposing research model

Chapter 3: Methodology

This chapter presents the method used in research, research design, detailed description of the steps taken in the research process, as well as data collection procedures and data analysis This section will specify the regression model used to study, explain variables, calculations, formula and expectation of variables

Chapter 4: Results and Findings

This chapter deals with the empirical results, including the descriptive statistics of regression variables, correlation analysis, model estimation, model choice, model diagnostics, model fix using FGLS to overcome the variance change and autocorrelation, the prediction of residuals and normality test of residuals, finally determine the empirical results of the model

Chapter 5: Conclusion and Recommendation

Chapter 5 presents the results of estimating the panel data model in Chapter

4, summarizes concise key findings and suggests recommendations to improve the profitability of commercial banks in Vietnam Banks can expand non-traditional activities to increase their income and adjust their risks This chapter also states the limitations of the study and future research directions

CHAPTER 2: THEORETICAL BASIS AND LITERATURE REVIEW 2.1 Theoretical basis about commercial bank

Commercial banks are credit institutions that perform all banking activities and other related business activities for profit purposes (Consolidated documents

No 20/2018/VBHN-NHNN, the State Bank of Vietnam)

Commercial bank is a financial institution which are operating under two business scopes: one is to federally insure deposits and to pay interests to the depositors and the second is to use its charter to issue loans, to check cash balance and clearing services, and to underwrite securities (Getter, 2016) Commercial bank plays prominent role in modern economy in circulating financial resources (Tariq et al., 2014) Other definition of commercial bank is a financial intermediary which effectively channel idle funds in the market to those who need credit to invest into valuable production and business opportunities and personal purposes (Tuyishime

et al., 2015) Commercial bank is further divided into public sector bank (the bank with major of stake is hold by the government), private sector bank (the bank with major of stake is hold by private individuals) and foreign bank (the bank with head office located in other countries outside of a nation) (Kalpana & Rao, 2017) Commercial banks establish maladjustment and impediment and contribute to the development of the economy (Mongid et al., 2012) The operation of commercial banks is aligned with monetary policies of a nation and they play the main role of controlling cash flow given to expected rate of returns and emissions (Erina & Lace, 2013)

In summary, the term of commercial bank used in the study is defined as a financial institution which operates in the way of holding deposit, paying interests

to the depositors, issuing credit to different economic sectors and facilitates economic development of a country

2.2 Theoretical basis about commercial bank profitability

2.2.1 Definition of bank profitability

Profitability is determined as one of indicators that reflect efficient banking system, along with high service quality and sufficient funding resources (Wang & Wang, 2015) When the banks earn high profitability, their operations are safe and sound (Bikker & Vervliet, 2017) It is also the indicator to reflect whether the banks are in threating situation (Iacobelli, 2017) It is defined as the difference between the profit extracted from its assets and the expenses incurred in its liabilities (Yuksel et al., 2018) Profitability reflects the efficiency of the management in making benefits from all the business operations of an organization, firm or company (Muya & Gathogo, 2016) Profitability refers to amount of money that a company can produce with the resources it has The goal of most organization is to maximize profitability (Niresh & Velnampy, 2014) One important precondition for any long-term survival and success of a business is profitability Profitability is generally measured using accounting ratios with the commonly used profitability ratio being ROA ROA determines the amount of the profit earned per shilling of assets This reflects the efficiency with which the bank’s managers use bank’s investment resources or assets in generation of income (Sehrish, Irshad & Khalid, 2010) It is also determined as the banks’ ability in compensation of credit losses, capital retention, and the support for future development (Pastory & Marobhe, 2015) Behind of profitability generated from interest income, banks also earn substantial profitability from non-interest income which is collected from the charge

to the customers to use financial services (DeYoung & Rice, 2004) Some discussions related to non-interest income of the banks were discussed by other researchers and this income sources implied for less reliance of the banks to interest income while pertaining the banks’ business and operational stabilization, leveraging risk diversification and the increase of fixed cost to invest into facilities

to deliver banking services to the customers (Kohler, 2013)

Given to the difference understandings of bank profitability, the term of bank profitability used in the thesis is defined as a relative number (a percentage), which expresses the ratio between profit and revenue Commercial bank profitability made during the year represents the capability of making profit, in which profit is expressed through the results of business activities of the bank, such as: mobilizing capital, lending, discounting, guaranteeing, providing financial services and other related activities The time for determining annual profit is made at the end of December 31 when the annual settlement, preparing annual financial statements For the determination of profits to be accurate, the total revenue and expenses of the entire system must be accurately determined during the year

2.2.2 The indicators reflect the profitability of commercial banks

Empirical evidence showed that ROA, ROE and NIM were often chosen by other researchers

There are many proposals to measure bank profitability provided by different researchers Tariq et al (2014) proposed two indicators to measure bank profitability, namely return on equity (ROE) and net-interest margin (NIM) ROE reflects administration capability of the banks in using stakeholders’ investment (Molyneux & Thornton, 1992) and it is measured by an equation in which earning after tax is divided by total equity (Ichsani & Suhardi, 2015) NIM refers to the net income divided by the banks’ total assets values (Memmel & Schertler, 2011) Other indicator which is utilized to measure bank profitability is through return on assets (ROA) It is used to measure the effectiveness of assets utilization (Pastory & Marobhe, 2015) ROA is measured by taking net income divided by the banks’ total assets values (Saragih, 2018)

According to Fredrick Mwaura Mwangi (2014), to measure the effectiveness

of commercial banks, there are some commonly used indicators such as ROA, ROE Similarly, Rose (2002) pointed out that a bank's business performance is measured by return on equity (ROE) and return on total assets (ROA)

Murthy and Sree (2003) defined ROE is a financial indicator that shows the profitability compared to the total equity shown on the balance sheet

Khrawish (2011) defined ROA is the ratio of income to total assets It tells

us how well a company’s management is at using its assets to generate earnings

Through the above studies, most authors use ROA and ROE to measure profitability or profitability ratios used to evaluate the business performance of commercial banks (Nguyen Minh Kieu, 2009)

Each variable is explained further as below:

2.2.2.1 Return on Assets - ROA

ROA is an indicator reflecting the management effectiveness, measuring the ability of the bank's board of management to convert a bank's assets into net income

Source: Principals of finance, Scott, B & Eugene, F B (2015)

In which, net income is the earning after-tax, while assets are formed from equity and loans, so ROA is affected by tax policy and interest expense Earnings after-tax is taken from the income statement and total assets are taken from the balance sheet ROA is a measure of how much profit a business is generating from its capital A high value of ROA shows that the bank is functioning well in making profits by utilizing the assets and performance of the bank is good However, it is necessary to review the bank’s activities if ROA is above the stable level

ROA is calculated from financial report of the firms through an equation of which it is equivalent to net profit after taxes divided by average total assets (Samiloglu et al., 2017) The firms expected that their ROA value to be increased and higher ROA value means higher performance and increasing value of ROA is attractive to the investors (Saragih, 2018)

2.2.2.2 Return on Equity - ROE

ROE is an indicator to measure the percentage of income that a shareholder

of a bank receives from an investment in a bank In other words, return on equity is

an indicator of the efficiency of the equity investment

Source: Principals of finance, Scott, B & Eugene, F B (2015)

ROE is defined as the ability of a firm to generate profit upon on every share

of its capital (Rosikah et al., 2018) ROE is calculated through an equation of which net profit after taxes divided by average total shareholder equity (Kabajeh et al., 2012) Like ROA, the firms always expect higher ROE to attract the investors in the market and ROE valued between 15-20% is generally considered good (Faisal et al., 2018) ROE is a measure of profitability that calculates how many dollars of profit a business generates with each dollar of shareholders’ equity (Rose, 2002), so it always receives great attention from investors If this ratio is positive, the bank is profitable In contrast, if the ratio is negative, the bank is trading at a loss At the same time, higher ROE proves that the bank is balanced in the use of shareholder capital compared to its borrowed capital effectively to generate profits during its operation Therefore, a high value of ROE shows that the bank is functioning well

in managing the shareholders’ equity and generating to revenues to shareholders

2.2.2.3 Net Interest Margin - NIM

NIM is determined as an indicator that reflects how well of the banks as financial intermediaries and it is measured by the lending interests charged to borrowers and the deposit interests paid to the depositors (Obeid & Adeinat, 2017) Other way to calculate NIM is to take the gap between interest income and interest expense before it is divided to total asset (Bikker & Vervliet, 2017) NIM is also

calculated by taking net interest income divided by average earning assets (Soegeng

by total loans) and regulatory capital to risk-weighted assets affect bank profitability (Albulescu, 2015) Other indicators such as bank size, operating efficiency, asset management efficiency and portfolio management also affect bank profitability (Erina & Lace, 2013) Empirical evidence from different researchers explored more internal indicators affecting bank profitability such as management decision and policy objectives set by the banks (Staikouras & Wood, 2004)

2.2.3.2 External factors

Beside internal factors, bank profitability is also under the influence of external factors or macro-economic factors According to Blerta, B (2014), external factors refer to those which are not under the banks’ control such as inflation rate, market share, industry growth and interest rate The contribution of overall banking sector to national gross domestic product (GDP) is also considered as important external factor to the bank profitability (Bezawada & Ranajee, 2018) Economic growth is determined as external factor and its effect on bank profitability is confirmed (Gul et al., 2011; Rehmand et al., 2018)

2.3 Theoretical framework

Several theoretical frameworks have emerged in an attempt to highlight the objective of the bank and how it should manage its profitability This section discusses market power theory, efficiency theory, agency cost theory and signaling theory as the underlying theories to explain the profitability concept

2.3.1 Market power theory

Market power theory was proposed by Bain (1951) and it explained the profit of firms to be increased from the achievement of more market power (Athanasoglou et al., 2005) When the firms gain market power, they are able to control the price setting for products and services that are not always favorable to the customers (Punt & Rooij, 2001) Market power and market concentration are two different concepts While market power refers to the possibility to change the firms’ profits, market concentration refers imperfection side of a market whether the firms focus on specific market due to internal strategies or legislative barriers from the government (Punt & Rooij, 2001) In addition, the firms with high market power are likely to earn monopolistic profits and therefore they have more chance to win the market shares from other competitors (Nkegbe & Yazidu, 2015) Market power theory was applicable to banking industry in which the banks with higher market power can earn extra profits from higher market share and more diversification in their products (Mirzaei, 2012) This theory emphasized that bank profitability depends on bank size and its financial performance (Macharia, 2016) Market power theory represents for the influence of external factors on banks profitability throughout industry structure and market share of the banks (Obamuyi, 2013; Fisseha, 2015)

2.3.2 Efficiency theory

Efficiency theory was developed by Demsetz (1973) It explains other aspect

of bank profitability which can be generated from better management and business efficiency (Macharia, 2016) This theory implies the fact that when the management efficiency of the firms is improved, the firms are likely to achieve higher profits and larger market share (Athanasoglou et al., 2005) Efficiency theory addresses when the firms successfully gain production efficiency through better production practices and higher management efficiency, they can earn higher profit from lower production and operating cost (Birhanu, 2012) Herein, the core of efficiency theory

is economy of scale (Odunga et al., 2013) When the firms achieve economy of

scale, their business efficiency will be improved and therefore they gain higher profitability and market share (Birhanu, 2012; Mirzaei, 2012; Fisseha, 2015) In banking industry, efficiency theory can be applied to explain the reason why large commercial bank earns higher rate of returns in their investment than smaller commercial bank since larger banks are often equipped by better production technologies as well as management expertise (Saona, 2011) In addition, when the banks achieve better efficiency, they can deliver banking services at lower cost than other competitors, leading to higher profits (Onuonga, 2014)

2.3.3 Agency cost theory

Agency cost theory was developed by Jensen & Meckling (1976) This theory focuses on the use of financing structure of the firms to drive the managers and the investors to solve free cash flow issues (Macharia, 2016) Agency theory posits the gap between the professional managers who have low ownership and the investors who hold large ownership, and both have different business objectives, leading to agency problem (Gedajlovic & Shapiro, 2002; Alfadhl & Alabdullah, 2013) In more detail, agency problem is raised when professional managers use the firms’ resources to maximize for their owned benefits instead of bringing more values to their owners (Mian et al., 2012)

2.3.4 Signaling theory

Signaling theory was developed by Arrow (1972) and Spence (1973) This theory emphasizes that the firms with profitable condition and high business performance can supply the market and the customers with positive information (Bini et al., 2011) Signaling theory also explains the relationship between profitability and capital structure (Alkhazaleh & Almsafir, 2014) When the firms achieve optimal capital structure, it is considered as a signal for higher profitability (Adeusi et al., 2014) The application of signaling theory in banking industry is through the increase in capital positively affect the future development of the banks (Alkhazaleh & Almsafir, 2014) Moreover, when the managers of the banks perceive that their banks are better than other banks in the market, they have the

motivation to persuade additional investment from the investors (Macharia, 2016) Signaling theory prevails the information disclosure related to bank performance and it helps to increase the value of the firms, to get more investment fund into banking operation and therefore earning more profit (Muzahem, 2011)

Almaqtari et al (2018) conducted a research about the determinants of profitability of Indian commercial banks Quantitative research method was employed with the data of 69 Indian commercial banks during the period of 2007-

2017 Pooled OLS, fixed effect and random effect were used as data analysis techniques ROA was considered as dependent variables and it depended on bank-specific factors (bank size, capital adequacy, asset quality, liquidity, deposit, asset management, operating efficiency, leverage and number of banks’ branches) and macro-economic factors (annual real GDP, inflation rate, interest rate, exchange rate, financial crisis and demonetization) Obtained result showed that ROA was significantly affected by operational efficiency, number of branches, asset management, bank size, and leverage

Yao et al (2018) conducted a research about profitability determinants of financial institutions in Pakistan The data was collected from 28 commercial banks over the period of 2007-2016 Yao et al utilized quantitative research method with two-step generalized method of movement to be selected A research model was developed in which dependent variables consisted of ROA, ROE and NIM while independent variables included bank-specific factors (bank size, bank solvency, credit quality, liquidity, operational efficiency, financial structure, diversification,

funding cost, operating expenses, labor productivity, and bank type), industry specific factors (industry concentration, banking sector development, and market power), and macro-economic factors (GDP growth rate, inflation rate and government change) Obtained result showed that bank size and bank profitability were related under u-shape curve Yao et al identified that the government change affected bank profitability Moreover, bank profitability was negatively influenced

by inflation rate, industry concentration, banking sector development, credit quality and operational efficiency

Yuksel et al (2018) conducted a study about the determinants of profitability

in banking sector of post-Soviet countries The data was collected from 13 countries which had been influenced by Soviet Union in the period of 1996-2016 Quantitative data analysis with fixed effect and generalized method of movement were both employed A research model was developed in which ROE was dependent variable and there were 8 independent variables, including capital adequacy ratio, total loans to total deposit, total loans to GDP, bank size, non-interest to interest income, interest rate, GDP growth rate and inflation rate Obtained result showed that both GDP growth rate and non-interest to interest income affected positively bank profitability Moreover, Yuksel et al (2018) identified negative effect of loans to GDP on bank profitability in examined countries but stronger GDP growth rate supported higher bank profitability

Kawshala & Panditharathna (2017) conducted a research about the factors effecting on bank profitability Quantitative research method was employed from 12 commercial banks in Sri Lanka Ordinary least square was selected as data analysis technique A research model was developed in which ROA reflected bank profitability and there were four independent variables, namely bank size, capital ratio, deposit ratio and liquidity ratio Obtained result showed that 28.6% of variance of ROA was significant explained by independent variables Moreover, Kawshala & Panditharathna identified that liquidity ratio affected negatively but

insignificantly ROA Positive and significant effects of bank size, capital ratio, and deposit ratio were confirmed after the analysis

Nuhiu et al (2017) conducted a study about the determinants of commercial bank profitability through different financial performance indicators in Kosovo A research model was developed in which ROA, ROE and NIM were commercial bank profitability indicators and the determinants were capital adequacy ratio, asset quality, management efficiency and liquidity Two other macro-economic indicators were accounted, namely inflation rate and yearly GDP growth rate The data was collected during 2010-2015 and quantitative research method was employed Using Ordinary Least Square method, Nuhiu et al identified that these determinants explained for 71.15% of variance of ROE, 71.50% of variance of ROA and 51.01%

of variance of NIM They also identified that liquidity ratio affected negatively ROA, ROE and NIM

Pastory & Marobhe (2015) conducted a research to explore the determinants

of commercial banks profitability in Tanzania Quantitative research method was selected and the data was collected during the period of 2000-2011 There were 18 commercial banks data to be collected Quantitative research method was employed with ordinary least square, fixed effect and cross-selection random effect method Dependent variables were ROE, NIM and non-interest expenses to average total assets (NOVX) Independent variables reflected bank-specific aspects through capital adequacy, liquidity, asset quality, expenditures as well as macro-economic aspects through inflation rate and interest rate Market share of the banks was accounted in the research model Obtained result showed that expenditures were not significantly influencing on NIM, ROE and NOVX Pastory & Marobhe confirmed that bank profitability was strongly responded to capital adequacy, asset quality, liquidity and selected macro-economic factors

Sehrish Gul, Faiza Irshad and Khalid Zaman (2011) analyzed the relationship between bank specific and macro-economic characteristics over bank profitability The study was conducted on a panel data set consisting top fifteen Pakistani

commercial banks over the period 2005-2009 Pooled Ordinary Least Square (Pooled OLS) method was employed to measure the relationship that exists among assets, loans, equity, deposits, economic growth, inflation and market capitalization, which were the independent variables and return on asset (ROA), return on capital employed (ROCE), net interest margin (NIM), which represented banks’ profitability (dependent variables) The study findings reported that both internal and external factors have a strong impact on banks profitability

Abuzar (2013) conducted a study on the determinants of profitability of Islamic banks in Sudan The study used return on assets (ROA) and net financing margin (MARG) as banks’ profitability indicators The results indicated that only the internal factors have important effects on banks' profitability Cost, liquidity and the size of the banks show positive relationship and significant impact with the bank profitability, while external macroeconomic factors have no substantial effects on profitability

Usman, D (2014) examined the profitability of 23 commercial banks operating in Pakistan from 2009 to 2012 The study used management policies, capital ratios, risk management as internal factors or management factors and inflation, government policies as external factors The paper used the ordinary least square (OLS) method to check the impact of cost efficiency, liquidity, capital adequacy, deposits and size of the bank on the profitability (ROA) of the commercial banks The author used the descriptive statistics which include mean, median, minimum, maximum and standard deviation Other methods includes correlation analysis, regression analysis and natural logarithm of total assets technique The results showed that cost efficiency, liquidity and capital adequacy are those variables in the check of management that decide the profitability of commercial banks operating in Pakistan Other statistically significant variables like deposits and size of the bank have no influence on profitability

Khaled, M et.al (2016) identified the bank specific variables that impact the profitability of commercial banks of Bangladesh The research used data from

financial reports of 15 commercial banks for the period 2003-2013 to look into the hit of return on asset as the dependent variable (ROA) and parameters such as capital adequacy ratio, gearing ratio (risk), liquidity, non-performing loan ratio, operating expense ratio and bank size Prais-Winsten correlated panels corrected standard errors (PCSEs) model was used to remove any autocorrelation and heteroskedasticity problem automatically for the panel data The findings reported that size, operating expense, gearing ratio and capital were found to be important variables that affect the bank profitability of Bangladesh More specific, the authors found capital to be positively related to profitability while size, operating expense, gearing ratio were found to be inversely related Other variables like liquidity and non-performing loan ratio did not demonstrate any impact on profitability The authors concluded that adequate capital, low risk, efficient expense management and rightsizing lead to greater performance and profitability for Bangladeshi bank industry

Sufian, F & Noor-Mohamad-Noor, A (2012) examined the relationship between internal and external factors over Indian bank profitability over the period

2000 – 2008 The empirical results have found strong evidence that credit risk, network embeddedness, operating expenses, liquidity and size have statistically significant impact on the profitability of Indian banks However, the impact is not uniform across banks of different nations of origin The same results was observed

by Sufian (2011) in the study about factors affecting profitability of Korean banking sector from 1992 to 2003 Using unbalanced bank level panel data, the results indicated that liquidity level, diversification, credit risk, business cycle, and industry concentration significantly affect banks’ profitability

Al-Omar, H & Al-Mutairi, A (2008) found a direct relationship between equity, total assets and return on assets (ROA) The research aimed at investigating into the effect of bank-specific characteristics on profitability in Kuwaiti banking sector over the period 1993 – 2005 from the collected seven national commercial banks Their findings showed that equity ratio, loan‐ assets ratio, operating

expenses ratio, and total assets explain about 67% of the variation in return on assets (ROA) However, the effect of loan‐ assets ratio and operating expenses ratio

on profitability are statistically insignificant Accordingly, the results emphasize the need for improving capital adequacy and reducing the ratio of non‐ interest assets

as a solution to increase profitability Also, the study revealed that bank size is positive related to bank profitability, which means banks have potential for higher profits as the size of these banks increases

2.4.2 National studies

In Vietnam, there were numerous empirical evidences which were developed

by Vietnamese researchers to explore the determinants of commercial bank profitability In this section, national studies are collected in order to explore how previous researchers studied about this topic Key results, data collection and data methodology and the limitation of these researchers will be highlighted

Nguyen (2018) conducted a study about factors affecting Vietnamese banks’ profitability Nguyen used quantitative research method to analyze data of 25 commercial banks during 2005-2013 ROA was used as bank profitability indicators Explanatory variables were combined between internal and external factors Obtained result showed that bank profitability was significantly and positively explained by the diversification of the banks’ income and total liabilities ratio Otherwise, banks’ profitability was significantly and negatively affected by non-performing loan ratio and total equity to total asset Nguyen, however, did not find significant effect of macro-economic factors on Vietnamese banks’ profitability In addition, Nguyen confirmed that the banks with higher income diversification level earned more profit that the banks with lower income diversification The main limitation of this study is that it did not cover all commercial banks in Vietnam

Nguyen et al (2018) conducted a study about the determinants of profitability of Vietnam commercial banks The data was collected in 13 commercial banks in Vietnam during 2006-2015 and quantitative research method

was employed with pooled ordinary least square, fixed effect and random effect A research model was developed in which bank profitability was measured through ROA, ROE and NIM and these indicators were affected by several internal factors, including bank size, capital ratio, credit risk, ownership structure, liquidity, banking efficiency These indicators were also affected by economic cycle and inflation rate

as two external indicators Empirical evidence showed that bank profitability was significantly and negatively influenced by foreign ownership, credit risk and capital ratio They also identified that bank profitability was not statistically influenced by bank size, state ownership, GDP and inflation rate Other factors had different or mixed effects on bank profitability The main limitation of this study is that it did not cover all commercial banks in Vietnam

Le et al (2017) conducted a research about the determinants of bank profitability among listed banks in Vietnam’s Stock Exchange The data was collected for the period of 2007-2013 with 9 listed commercial banks Dependent variables were ROA, ROE and NIM Independent variables consisted of internal variables (bank size, total asset growth rate, management expenses, capital, credit risk and other risks) and external variables (GDP growth rate, inflation, population growth rate and interest rate) Fixed effect and random effect were data analysis techniques and obtained result showed that credit risk was not significantly affecting ROA in fixed effect and NIM in random effect Management expense insignificantly affected ROE in fixed effect Inflation rate insignificantly affected ROA in random effect and ROE in fixed effect Interest rate insignificantly affected NIM in fixed effect GDP growth rate insignificantly affected ROA and NIM under fixed effect Population growth insignificantly affected ROE and NIM under fixed effect Otherwise, chosen variables affected significantly ROA, ROE and NIM and the sign of effect was mixed in different models The main limitation of this research referred to the choice of listed banks, leading to the findings might not be

in unlisted banks

Nguyen, D (2017) conducted a study about the determinants of profitability

in commercial banks in Vietnam The data was collected for 16 largest commercial banks during 2007-2016 and quantitative method was employed with fixed effect A research model was developed in which internal factors (asset structure, asset quality, capitalization, financing structure, operating efficiency, bank size and income diversification) and external factors (annual GDP growth rate, inflation rate and market concentration) affected bank profitability (ROA) Obtained result showed that bank profitability was significantly affected by asset quality, capitalization, financing structure, operating efficiency and inflation rate Overall R-square was 64% for the model The main limitation of this study is that it did not cover all commercial banks in Vietnam

Phan & Phan (2014) conducted a study to analyze the factors affecting performance of Vietnamese commercial banks They collected the data during 2005-2012 from 28 Vietnamese commercial banks A research model was developed in which ROA was dependent variable Independent and other variables were market concentration, total deposit of top four largest banks to total deposit in banking system, market share, bank size, liquidity risk, bank loans to total assets, ownership type, and inflation rate Obtained result showed that market concentration, ownership and inflation rate affected significantly ROA Bank size have no impact on ROA while liquidity risk affected ROA significantly The main limitation of the study was that Phan & Phan (2014) only took into account inflation rate as single macro-economic factors In fact, there are many other macro-economic indicators, but they were not used by these researchers

Vo & Batten (2014) conducted a research about the determinants of bank profitability in Vietnam They collected the data during 2006-2014 for 35 commercial banks and performed quantitative data analysis with fixed effect and generalized method of movement Dependent variables were ROA, ROE and NIM Independent variables were bank size, capital adequacy, bank risk, bank operational cost, bank productivity, Herfindahl - Hirschman concentration index, inflation rate

and GDP growth rate Under fixed effect, NIM was significantly affected by all factors, except GDP growth rate while bank risk, GDP growth rate and inflation rate did not affect significantly ROA In addition, bank risk, concentration index and inflation rate were not significantly explained for ROE under fixed effect Similarly,

a mixed estimation result was found when generalized method of movement was applied In more detail, bank size, bank operational cost and bank productivity significantly affected ROA, ROE and NIM Concentration index and inflation rate significantly affected ROE while only concentration index affected significantly ROE NIM was significantly affected by concentration index and GDP growth rate

A major limitation of this research was that it did not explore the effect of crisis since Vietnam banking system faced up with a downturn cycle in the period of 2008-2012

Vu & Nahm (2013) used data of Vietnamese commercial banks during

1998-2004 The results of this study are similar to Gardener et al (2011) on the impact of bank capital, but difference in the impact of bank size and inflation index In addition, Vu & Nahm (2013) also found that bank management ability and the average growth rate of total product per capita have a positive impact, but bad debt has a negative impact on the performance of Vietnam commercial banks

Nguyen Thanh Phong (2015) used panel data and regression model with the dependent variable was profit (ROA) and independent variables were bank size, loans, equity, credit risk, liquidity, operating costs, economic growth and inflation The study indicated that factors such as loans, credit risk, liquidity and operating expenses had a negative impact on bank profitability, while inflation had a positive impact on the economy The results also showed that bank size, equity ratio and economic growth do not really affect the profitability of joint stock commercial banks on Vietnam's stock market This result was similar to the results of Lieu Thanh Truc and Vo Thanh Danh (2012)

Phan Thi Hang Nga (2011) studied the determinants of the profitability of listed banks during 2005-2010 The author used ROA to represent the bank