research proposal the determinants of profitibility ofvietnamese commercial banks

FOREIGN TRADE UNIVERSITYFACULTY OF FINANCE AND BANKING MIDTERM ASSIGNMENT RESEARCH PAPER ***** RESEARCH PROPOSAL: THE DETERMINANTS OF PROFITIBILITY OF VIETNAMESE COMMERCIAL BANKS... Retu

FOREIGN TRADE UNIVERSITY

FACULTY OF FINANCE AND BANKING

MIDTERM ASSIGNMENT RESEARCH PAPER

*****

RESEARCH PROPOSAL:

THE DETERMINANTS OF PROFITIBILITY OF VIETNAMESE COMMERCIAL BANKS

The current research focuses on the factors that influence the profitability of Vietnamese commercial banks The analysis is carried out during a 13-year period during which the Vietnamese banking sector has seen various changes such as demonetization and difficulties concerning banking sector sustainability and banking sector frauds The study is based on balanced panel data from 26 commercial Vietnamese banks for the years 2007 to 2019 Return on assets (ROA) and return on equity (ROE) are used as proxies to quantify the profitability of Vietnamese commercial banks, whereas bank size, credit risk, capital equity, liquidity, operational expense, and deposits are utilized as bank-specific indicators As independent variables, a collection of macroeconomic drivers such as banking concentration, economic growth, inflation rate, and exchange rate are used

Keywords: profitability, determinants, commercial banks, Vietnamese

1 Literature review

Around the world, bank profitability has been intensively researched from different countries Although there are three primary popular streams in the past literature dealing with bank profitability, all the research undertaken share the same purpose and outline Garcia and Guerreiro (2016) and Saona (2016) have focused their research on elements in banking operations and macro issues affecting bank profitability Furthermore, A Singh and Sharma (2016) and Zampara, Giannopoulos and Koufopoulos (2017) evaluated bank-specific and macroeconomic determinants affecting bank profitability Menicucci and Paolucci (2016), Naeem, Baloch and Khan (2017), Ongore and Kusa (2013), Pasiouras and Kosmidou (2007) and Petria, Capraru and Ihnatov (2015) have researched significant elements and implications

to bank profitability in different countries and from diverse locations Thus, profitability is one of the measures representing the stability of banks, as well as the financial system of banks Therefore, finding out what factors truly affect the profitability of banks has long been

a matter of significant interest among both academics and bank administrators

Moreover, the efficiency aspect of operational organizations (such as firms, banks ) has also gotten a lot of attention from researchers, but it seems to be mostly undertaken inside the scope of corporation Meanwhile, within the commercial banking business, although many themes have been explored in Vietnam, it seems that the studies have not been updated in time and have not been adapted to the changeable state of the economy Specifically, foreign studies use both internal and external factors, especially using the factor of industry concentration (Demirguc – Kunt and Huizinga, 1999; Aboagye et al., 2008) ; Curak et al., 2012; Jara – Bertin et al., 2014) and exchange rates (Al — Homaidi et al., 2018; Almaqtari et al., 2019) It shows that the domestic research studies seem to focus only on the

characteristics of banking expertise, as well as the basic factors of macroeconomics, but have not paid attention to the concentration of market share (based on total assets of the bank) of each type of bank in the economy and foreign exchange activities

That is the reason why the author chose to perform a research on the topic “The determinants

of profitability of Vietnamese commercial banks" using updated data in the period from 2007

- 2019 so that the regression findings are adequate more relevant in the current context, in

order to make recommendations in banking activities, as well as appropriate policies of the State to increase efficiency for commercial banks in the near future

2 Research Aims and Objectives

The overal aim of this research is to investigate the factors influencing Vietnamese

commercial bank profitability in order to make recommendations to help bank administrators and policymakers improve profitability in the near future In this respect, the research objectives that emanated from the review of literature is to:

 Determine factors that affect the profitability of commercial banks in Vietnam Measure the extent and direction of the influence of these factors on the profitability of Vietnamese commercial banks

 Suggest recommendations to help bank administrators and policy makers in Vietnam improve the profitability of commercial banks in the near future

3 Research Questions

Question 1: What are the factors that affect the profitability of commercial banks?

Question 2: How do these factors affect the profitability of Vietnamese commercial banks? Question 3: What are the recommendations to improve profitability of Vietnamese

commercial banks in the future? What are the factors that affect the profitability of

commercial banks?

4 Overview of factors affecting bank profitability

4.1 Bank internal factors

Total assets are used to quantify bank size in bank profitability studies As a result, bank size

is related to diversification and can affect the bank's risk and product portfolio Large banks' economies of scale will cut income and information processing costs, hence bank size will have a beneficial effect on profitability However, some research imply that the association between bank size and profitability may be negative, because larger banks are more difficult

to manage, which may generate problems As a result, operating costs will increase As a result, these banks' profits will most likely be smaller than those of other banks

Equity is considered as the amount of money owned by the bank itself and utilized to finance the activities of the bank Moreover, equity is often employed as a bank's protection in case the business climate evolves in a negative direction Increased equity is needed to ensure bank liquidity because bank deposits are very susceptible to withdrawals from banks when the bank's depositors with the same demand for capital feel the desire to withdraw money However, some other academics suggest that equity can have a negative effect on the profitability of banks in their analyses

The bad debt-to-lending ratio measures changes in the health of a bank's loan portfolio and credit risk Therefore, this ratio can also be considered as an indicator to analyze the credit quality of the bank Credit risk can have a rippling impact, which in turn can lead to insolvency Therefore, the bigger the ratio of bad debt provision on loans, the higher the credit risk In addition, the present value of assets will decline, consequently reducing the bank's solvency At the same time, the risk-return hypothesis also implies that the bigger the risk, the higher the return, which means that there is a positive correlation between credit risk and bank profitability

Liquidity is the main concern of the bank’s board of director and a lack of liquidity can cause problems for banks The Banking Supervisory Authority also considers liquidity as a primary concern This is because banks do not have adequate liquidity to meet the demand of depositors when they take money from the bank Holding highly liquid assets tends to impair earnings since liquid assets are associated with a significantly lower rate of return Therefore,

it can be shown that liquidity and bank profitability will have a negative link with each other

In the course of business activities, banks have to bear some non-business activities Accordingly, these expenses include lending and mobilizing charges, pay and bonus expenses for the bank's staff, only assets, only for public administration operations, only for public service activitie for deposit insurance of customers Therefore, it can be seen that this indicator can be used as an indicator related to the ability of management to control costs and

is expected to have a negative relationship with the profitability of banks since improved (inexpensive) management of these costs can increase the bank's efficiency and thus increase the profit

The income of commercial banks generally depends on the mobilization sources that the bank has from customers For payment deposits, or demand deposits, the bank will not pay interest

to customers when maintaining money in the account or paying a very low interest rate Therefore, consumers can withdraw at any moment they are in need of capital Meanwhile, time deposit or savings account does not enable consumers to withdraw money until the original negotiated maturity date, thus customers might obtain a greater deposit rate in case of this Therefore, it can be observed that customer deposits will be able to directly affect the profitability of banks through net interest income

4.2 Bank external factors

The level of banking industry concentration is proposed by two theories to have a substantial effect on bank profitability The SCP hypothesis says that the more concentrated an industry

is, the more likely it is to have better bank profitability since there will be collusion between banks with enormous market dominance In contrast, the efficiency-structure theory claims that better-managed banks or more cost-effective banks can acquire bigger market shares and lead to a higher degree of industry concentration

GDP growth is the annual change in GDP when the port economy improves, the credit demand of all sectors of the economy will increase substantially and thus will enhance interest income for banks, as well as bank profits will be improved Moreover, when the growth rate of the port economy is high, it will be able to help other sectors of the economy boost their incomes and also raise their ability to repay debts Therefore, it will aid to minimizing credit risk for banks Therefore, it can be observed that economic expansion will have a considerable and favorable impact on the profitability of banks

The effect of inflation on bank profitability relies on whether wages and other non-operating operations of the bank increase faster than inflation Therefore, the relationship between inflation and profit depends on whether inflation is predictable or not In the first situation, if inflation is foreseeable, banks can alter interest rates in time, resulting in a bank's net interest revenue expanding faster than the rise in expenses from inflation, so then inflation will have a positive association with bank profitability Under the second circumstance when inflation is unpredictable, banks will be reluctant to adjust their interest rates and as a result, the increase

in the bank's expenses will be faster than in net interest revenue of the bank

Exchange rates can affect bank profitability by influencing the bank's VND and USD swap costs as well as affecting the liquidity position of USD and VND on the bank's balance sheet consequently changing various choices of the bank When the exchange rate changes, banks with USD positions that are in debt to their partners will likely incur the additional cost from the change in the exchange rate and will increase the bank's interest expenses, lower the net interest income and decrease the bank's profit

Therefore, the issue provides a study model that influences the profitability of banks depending on two categories of components; factors inside the bank and factors outside the bank

5 Methodology

5.1 Theoretical framework

In this section, the topic presents the theoretical bases related to explaining banks' profitability

1 Structure - Conduct - Performance (SCP) theory

The theory of Structure - Conduct - Performance (SCP) was first proposed by Bain (1951) The SCP approach argues that the performance of the banking industry depends on the behavior of banks and, next, on the structure The concentration of the market can determine the profitability of commercial banks.

2 Structural efficiency theory

The structural efficiency theory emerged from the criticism of the Structure Conduct -Performance (SCP) theory of Demsetz (1973) and Peltzman (1977) The structural efficiency

theory holds that the bank's efficiency determines the relationship between market structure and the performance of any bank Banks with superior management skills and advanced technology are rewarded with lower fees and higher profits Structural efficiency

theory is based on the fact that efficient banks typically have lower costs, which leads to higher profits

5.2 Sample collecting method

The research purpose of the topic is to evaluate the influence of factors on profitability of commercial banks operating in Vietnam To solve this research purpose, we collect financial data of commercial banks operating in Vietnam from the financial statements of Vietnamese banks in the period from 2007 - 2019 In this, the financial statements of the banks are collected and aggregated by Vietstock At the same time, the information linked to

macroeconomics will be collected by the author on the database of the World Bank

(WorldBank) as well as of the SBV

In addition, in order to achieve the final research sample that does not deviate much from commercial banks operating normally, we can exclude according to the following

criteria:

 First, commercial banks do not have continuous data available from 2007 to 2019

or banks do not publish financial statements for the financial year

 Second, commercial banks have performed poorly in recent times, specifically commercial banks that are operating in Vietnam but are under special control or have been acquired for 0 dong by the State Bank or other banks was merged into other commercial banks (such as Dong A Commercial Joint Stock Bank, Phuong Nam Commercial Joint Stock Bank, Ocean Commercial Joint Stock Bank )

Therefore, the final sample of the study included 26 commercial banks operating in Vietnam

in the period 2007 – 2019 that are listed in appendix 1

5.3 Analysis method

The research method chosen in this study iss quantitative research The author offers regression models for panel data such as fixed effect (FE), random effect (RE), to choose the right model, conduct Hausman test and least squares estimate feasible generalizations (FGLS) to overcome the errors in the research model Accordingly, the study employs a regression equation to identify the drivers of bank profitability based on the original work

"The determinants of profitability of Indian commercial banks: A panel data approach" by Al-Homaidi (2018)

At the same time, in order to be able to calculate these variables, the author collects the raw data of banks based on audited main load statements published by banks on Vietstock.vn At the same time, the information connected to macroeconomics, the author will collect data on the Database of the World Bank as well as of the SBV

Besides, in order to evaluate the effect of elements inside and outside the bank, the study indicates that the FGLS approach should be utilized to estimate equation Because FGLS can enable the author to handle the difficulties of autocorrelation and variance in the study model

5.4 Research design

= + * + * + * + * + * + * + * + * + * * + +

In which:

i = 1, 2, …, n are the banks in the sample

t = 1, 2, …, n where t is the financial year in the sample

is the bank's profit, caculated by ROA/ROE

is the bank size, caculated by ln of total asset

is the equity, caculated by total equity/total assets

is the credit risk, caculated by provisions for credit risk/total loan

is the bank liquidity, calculated by liquid assets/total assets

is the customer deposit, calculated ratio of customer deposits/total assets

is the operating expenses, calculated byoperating expenses/taxes

is the concentration of Vietnamese banks, caculated by the total market share of the three banks with the largest market share each year

is the economic growth, calculated by growth rate in GDP

is the inflation, calculated by growth rate in CPI

is the average USD-VND exchange rate

is the model error

5.5 Research method

With tabular data (banks over the years), the study also uses the tabular regression method that previous studies have used such as the OLS method Accordingly, this method is relatively easy to use and used by many studies, however, this method requires to satisfy some constraints when regression

Constraint 1: The independent variables are not highly correlated with each other

Constraint 2: The error of the research model has no variance

Constraint 3: Error of the research model without autocorrelation

When one of them believes that this constraint is violated, the results obtained from the OLS regression method will be unreliable At that time, econometricians also suggested that using FGLS regression with tabular data could help solve the problems of autocorrelation and variable variance

Accordingly, in order to know whether the 1 is violated or not, we can use the VIF coefficient for the purpose of detecting whether multicollinearity exists or not At the same time, for constraints 2 and 3, we will use two tests, Breusch and Pagan and Wooldridge, respectively,

to test the problem of variable variance and autocorrelation Accordingly, the Lower hypothesis of these two tests is: No variable variance/no autocorrelation

About data description: First, the author estimates the regression coefficient for model by using estimation methods for panel data such as fixed effects (Fixed Effects), random effects (Random Effects), Feasible General Least Square (FGLS) estimation to overcome variable variance orautocorrelation The results of empirical research on factors affecting profitability

of commercial banks using STATA software give the data equal to 334 observations (n=334)

of 26 Vietnamese commercial banks in the period from 2007 to 2019

5.6 Hypothesis

6 Timescale of the research

2 Collecting and reading domestic and foreign

documents: books, research articles, articles in

domestic and foreign media related to ownership

structure and banking performance

08/2022 – 09/2022

4 Researching on profittibility of Vietnamese commercial

bank

09/2022 – 11/2022

5 Research on the factors affecting the profitibility of

commercial banks

7 Selection of variables related to bank profitibility,

macroeconomics

8 Collecting data related to internal factors of profitibility

of commercial banks

11/2022 – 01/2023

9 Collecting data related to macroeconomics factors

13 Editing, supplementing and perfecting the research 03/2023-04/2023

14 Finalize the official version