Diversifications and bank performance of vietnamese commercial banks

Dissertation submitted in partial fulfillment of the Requirement for the MSc in Finance FINANCE DISSERTATION ON DIVERSIFICATIONS AND BANK PERFORMANCE OF VIETNAMESE COMMERCIAL BANKS TRAN THAO LINH ID No: 19046142 Intake Supervisor: Dr Le Hai Trung September 2020 Tai ngay!!! Ban co the xoa dong chu nay!!! 17014126225351000000 Executive Summary The increasing wave of financial liberalization and globalization has reshaped the banking business model Commercial banks have diversified their income streams to non-interest incomes, such as payment services, brokerage activities, business consulting, portfolio management, guarantee, sponsorship, etc…This trend causes interest income sources to decline and increase non-interest income in many major countries and regions over the past three decades (Allen & Santomero, 2001) In the same global trend, the Vietnamese banking business has changed significantly with the noticeable expansion of non-traditional activities Since the integration of the banking industry is taking place strongly, bank diversification is an inevitable and objective trend Theoretically, income diversification can improve the bank's performance by diversifying banking risks However, the empirical evidence is far from consensus as several practical studies find that income diversification can reduce the profitability of banks After the research process, there are very few studies analyzing the impact of diversification on banking in the Vietnamese context Therefore, to fill the gaps in the literature by providing a comprehensive study, this study was conducted to evaluate the impact of income diversification on the performance of commercial banks by using data from audited financial statements and quarterly reports of 13 listed commercial banks in Vietnam from 2010 to 2019 My results aimed at pointing that diversified activities heterogeneously benefit banks While the funding diversification has a positive impact on bank performance and stability, the effect of income diversification in fact faces lower levels of bank performance The analysis provides a framework for evaluating these issues in the Vietnam markets i Acknowledgements I express gratitude to my supervisor Dr Le Hai Trung for his support to perform the laboratory analysis during this project work I am especially sincerely grateful to his providing constructive criticism on my thesis write up and moral support at each phase of the project I am also thankful to Do Thi Ngoc Anh and Dang Tien Dat - University of the West of England students for their ever friendly and always ready support to perform the project Finally, I would like to thank my family for their support, unconditional love and believe in me Tran Thao Linh September 2020 ii Table of Contents Executive Summary i Acknowledgements ii List of tables iv List of figures v Abbreviations vi Introduction Chapter 1: Theoretical Background and Literature Review 1.1 Literature review 1.2 Bank diversification in Vietnam 14 Chapter 2: Data, Methodology and Descriptive statistic 19 2.1 Data Collection 19 2.2 Data analysis 19 2.2.1 Empirical methodology 19 2.2.2 Rationale of variables 20 Chapter 3: Empirical Results and Discussion 27 3.1 Descriptive Statistics 27 3.2 Empirical result 28 3.2.1 Model selection 30 3.2.2 Result discussion 33 Chapter 4: Conclusion and recommendations 38 Appendix 44 Reference 47 iii List of tables Table 1: Variables’ definition and sources used………………………………… 26 Table Descriptive statistics of research variables…………………………… 28 Table Correlation analysis…………………………………… …………… 29 Table The impact of income diversification on performance… ………… 30 Table The impact of funding diversification on performance…… ………… 31 Table Hausman’s test result…………………………………….…………… 32 iv List of figures Fig Trends in income diversification for the period 2010–2019…………… 18 Fig Trends in funding diversification for the period 2010–2019…………… 18 v Abbreviations Return on assets (ROA) Return on equity (ROE) Ordinary Least Squares (OLS) Fixed effects model (FEM) Random effects model (REM) Income diversification (ID) Funding diversification (FD) Variance inflation factor (VIF) vi Introduction The banking system has been playing a key role in the stability and development of the economy, especially for a bank-based financial market as in Vietnam With the increasing integration to the international markets, the structure of the Vietnamese banking system has changed substantially The restructuring of the banking industry through the merger of banks and the increasing competition from foreign banks has increased the competition in the banking system significantly As a result, diversification is an important strategy for Vietnamese commercial banks as well as financial institutions In particular, commercial banks in Vietnam have also gradually shifted from traditional specialized credit activities to non-traditional activities in order to diversify banking risks, generate revenue, and importantly, increase competitive opportunities Since the ultimate goal of commercial banks is to maximize profits, thus, it is important to investigate the role of diversification to the performance of Vietnamese commercial banks Previous literature on the relationship between diversification and bank performance is voluminous On the one hand, several studies advocate bank diversification and argue that this strategy can offer many benefits For example, Laeven and Levine (2007) and Elsas et al (2010) showed that non-interest income contributed to profit growth as non-profit revenue was more stable than interest income activities Besides, diversification in different products or markets will help a bank reduce the risk of bankruptcy because different activities will have different levels of risk and they can help offset the risk of bankruptcy or in other words, banks can take advantage of this opportunity to increase profits (Sanya & Wolfe, 2010) Likewise, Lee et al (2014) and Saghi-Zedek (2016) stated that diversification of operations improves profitability, minimizes fluctuations in income and bankruptcy of these banks Moreover, the diversification of revenue reduces many risks and helps banks increase efficiency On the other hand, there are many views that disagree with the bank's diversification strategy For example, Gamra and Plihon (2011), Stiroh and Rumble (2006) suggested that increasing dependence on non-interest income will affect bank income, which does not lead to higher profits, on the contrary, it also reduces profits and has many potential risks In addition, due to increased fixed costs, financial leverage in banking activities increases in proportion to the decreasing profitability faced by banks (DeJonghe, 2010; Fiordelisi, et al., 2011) By experimental methods such as Baele et al (2007) shows that although diversification in the banking industry has both advantages and disadvantages, it is an inevitable trend because of the urgency that it brings to increased profits and expanded competitiveness in a challenging international integration environment at the moment Most previous researches, however, mainly focus on the US and European markets which have a long history of economic development Recently, the increasing role of emerging markets in Asia in general and Southeast Asia in particular in the global economy has brought much attention to their banking system structure and strategy Empirical studies, however, provide mixed results Trivedi (2015) and Ismail et al (2015) find that diversification of fee and non-interest income sources contributes significantly to increased profits and different noninterest income generating activities will bring different sources of income to set up appropriate strategies This argument is supported by experimental studies such as Nisar et al (2018), Moudud-UI-Huq et al (2018) On the contrary, when researching many aspects of diversification, Nguyen Thi Lam Anh (2018) believed that not all types of diversification bring positive benefits to bank performance and that depending on each country, there will be a different degree of influence In this thesis, I explore the relationship between diversification and bank performance for Vietnamese commercial banks In particular, I add the literature by considering not only income diversification but also the funding diversification Previous studies, such as of Hiep et al (2019), Ngoc (2019), Quynh (2020) and Cuong et al (2020) only focus on income diversification and there are mixed opinions about its effect on the bank performance Thus, my study provides more comprehensive research on the impacts of diversification in both income diversification and funding diversification to the bank performance in Vietnam commercial banks In this thesis, I employ a panel data collected from the audited financial statements and quaterly reports of 13 commercial banks which has been listed in Vietnam in the period 2010-2019 from S&P CapitalIQ To investigate the relationship between diversification and bank performance, I perform a panel data regression with Pooled OLS, fixed effects model (FEM) and random effects model (REM) methods to solve endogenous problems, variance, and autocorrelation in the research model The purpose of this study are: (1) explore the advantages and disadvantages in the process of diversifying the banking system; (2) evaluate the effectiveness of methods of diversifying the banking system in Vietnam in recent years and suggest some policy recommendations to the authorities and banks in order to continue the process of diversifying the banking system effectively in the future