Determinant of the net interest margin of commercial banks in vietnam

The empirical results show that capital adequacy, operating efficiency, credit risk and bank's growth rate have a positive impact on net profit margin.. Key words: Net interest margin, c

Dissertation submitted in partial fulfillment of the

Requirement for the MSc in Finance

FINANCE DISSERTATION ON

COMMERCIAL BANKS IN VIETNAM

ĐẶNG NGỌC HUYỀN

ID No: 22080934 Intake 6

Supervisor: Dr NGUYEN THANH NHAN

September 2023

Abstract

This study analyzes factors affecting net interest margins of commercial banks in Vietnam The article uses secondary data of 4 banks in the period 2018–2022 and applies panel data regression method The empirical results show that capital adequacy, operating efficiency, credit risk and bank's growth rate have a positive impact on net profit margin After getting the results, almost all relationships were recognized and the results were positive In contrast, credit risk and dummy variable (covid19) has a negative effect on net interest margin A few recommendations for commercial banks in Vietnam are also given to help them monitor and increase NIM, thereby improving bank performance

Key words: Net interest margin, commercial banks, Capital adequacy, credit risk, bank’s growth rate,

operating efficiency

Acknowledgement

First and foremost, I would want to express my heartfelt gratitude to my master thesis supervisor, Dr Nguyen Thanh Nhan, whose advice on thesis writing assisted me in answering the questions in the study paper Her suggestions have helped me make my study more meaningful and valuable Her advice also greatly improved my research skills In addition to the instructor, I would want to thank all of the teachers and friends who contributed helpful knowledge This thesis would not have been possible without their supervision and cooperation

Table of Contents

CHAPTER 1: INTRODUCTION 5

1.1 Research background 5

1.2 Research motivation 5

1.3 Research aims 5

1.4 Research question 5

1.5 Research scope 6

1.6 Research method and data 6

CHAPTER 2: LITERATURE REVIEW 6

2.1 Theoretical basis 6

2.1.1 Capital adequacy 6

2.1.2 Credit risk 7

2.1.3 Operating efficiency 7

2.1.4 Bank’s growth rate 8

2.1.5 Net interest margin 8

2.2 Hypothesis analysis 9

2.3.1 Capital adequacy and NIM 9

2.3.2 Credit risk and NIM 9

2.3.3 Operating efficiency and NIM 10

2.3.4 Bank’s growth rate and NIM 11

2.3.5 The impact of covid-19 on NIM 11

CHAPTER 3: METHODOLOGY 12

3.1 Sample selection and Data Source 12

3.2 Econometric model 13

3.3 Expected result 13

CHAPTER 4: FINDINGS 14

CHAPTER 5: DISCUSSION 19

CHAPTER 6: CONCLUSION 21

CHAPTER 7: RECOMMENDATION 22

References 23

Factors affecting the net interest margin of commercial bank of Ethiopia 29

Appendix 29

CHAPTER 1: INTRODUCTION 1.1 Research background

In most countries, banks provide essential services that facilitate economic growth They lend money to start businesses as well as provide a safe place in which societies can store their wealth For developing countries in particular, improvements in the banking sector can have a significant impact on the allocation

of financial resources as the sector remains the most important source of financing for investment employees, due to underdeveloped financial markets (Sufian & Habibullah, 2010) Banks play an important role in improving economic efficiency by shifting capital from units with excess resources to those with more productive investment opportunities Banks also play an important role in the commerce and payment system by significantly reducing transaction costs and increasing convenience In Vietnam, banks are one

of the factors that govern the financial system, so determining the factors that determine the bank's performance is an important predictor of unfavorable economic conditions stable and can help the bank's management and shareholders to present plans and achieve long-term goals in a professional manner Performance research is important in assessing the health of organizations However, the profitability of the banking sector is particularly important because the health of the industry is closely related to the health of the economy as a whole (Lipunga 2014) Thus, knowledge of the factors involved affecting the net interest margin of commercial banks is not only important but necessary in stabilizing the economy as well as for the benefit of governments, financial authorities and other stakeholders

1.2 Research motivation

In recent years, Vietnam is making efforts to restore and stabilize the economy, more and more businesses and organizations are in need of capital, mainly credits from commercial banks By June 30, 2023, the credit balance of the economy reached over VND 12.4 million billion, an increase of 4.73% compared to the end

of 2022 (Anh, 2023) Accordingly, the State Bank orients credit growth in 2023 to about 14- 15%, with adjustments appropriate to the actual situation However, data from the Vietnam Chamber of Commerce and Industry shows that, in fact, only 33% of businesses have access to credit Therefore, studies on the efficient allocation of capital become important and urgent In which, the ratio of net interest income (NIM)

should be prioritized for consideration

 Primary question: What are the factors impact on net interest margin of commercial

banks in Viet Nam?

 Secondary question:

- What is the relationship between capital adequacy and NIM of commercial banks?

- How credit risk affect to NIM of commercial banks?

- How operating efficiency impact on NIM of commercial banks?

1.5 Research scope

Determinant of the net interest margin of commercial banks in Viet Nam will be the main issue that needs

to be studied in this study The research will provide an in-depth understanding of the impact of various factors that can affect the net interest margin of commercial banks in Vietnam The research will collect data in financial reports from Vietcombank, Vietinbank, Eximbank and VietABank from 2018 to 2022 with dummy variable Covid 19 for analysis

1.6 Research method and data

For the Qualitative research method, analysis and evaluation methodologies are utilised to synthesise the

theoretical basis of the model, regarding the elements impacting NIM, from which the suggested model is drawn The comparative method is often used to assess fluctuations and changes in research variables throughout time and space

For Quantitative research method, the study runs FEM, REM regression economic models, and relevant

tests on the Stata programme based on the specified research model and data sources for observable variables to establish the applicability and amount of impact of various factors on NIM

In terms of data, this study employs panel data, with each factor evaluated to fluctuate across time and space To run the quantitative model, variables evaluated for 5 years from 2018 to 2022 and among 4 commercial banks in Vietnam are gathered

CHAPTER 2: LITERATURE REVIEW 2.1 Theoretical basis

2.1.1 Capital adequacy

Capital adequacy is a pivotal and indispensable notion within the realm of finance, particularly in the domain

of banking, as it serves to guarantee the stability and financial soundness of organisations operating within this sector Blum (2017) asserts that capital sufficiency plays a pivotal role in ensuring financial stability within the banking sector The main aim is to guarantee that banks possess a enough buffer of capital to sustain unforeseen losses (Basel Committee on Banking Supervision, 2004) Furthermore, it is worth noting

that the Basel Accords have played a crucial role in defining the implementation of capital adequacy standards on a global scale The implementation of Basel II and III has resulted in the introduction of more sophisticated risk measuring tools and increased capital requirements (Biswas et al., 2015) Extensive research has been conducted to examine the effects of these rules on the stability of the banking sector (Kashyap & Stein, 2004) In addition, capital adequacy holds significant importance in maintaining financial stability, and there exists a substantial body of scholarly literature that examines its regulatory framework, measurement techniques, factors influencing it, and its impact on bank behaviour

2.1.2 Credit risk

Merton (1974) and Angbazo (1997) describe that credit risk, also known as default risk, is the chance that a borrower may fail to pay their financial obligations, causing the lender to incur losses It is the risk that customers will be unable to repay their debts when they reach maturity Credit risk has a beneficial impact

on banks' interest income Banks that lend out more money incur higher credit risk and must maintain bigger reserves, forcing them to charge higher interest rates on their loans to compensate for the predicted losses, resulting in a positive relationship (Garza-Garca, 2010) Credit risk, also known as default risk, is the chance that a borrower may fail to pay their financial obligations, causing the lender to incur losses (Merton, 1974)

In banks, credit risk is critical because it represents the possibility of borrowers defaulting on loans, which can have a negative impact on their financial health and profitability Credit risk management enables banks

to make educated lending decisions, protect their capital, and preserve overall financial system stability.Credit risk must be understood and managed by financial institutions and investors.Credit risk is often measured using a variety of indicators, including as credit scores, credit spreads, and credit default swaps (CDS) (Jarrow & Turnbull, 1995) Credit rating agencies play an important role in determining an issuer's creditworthiness (Altman & Rijken, 2004) Banks are particularly vulnerable to credit risk as a result

of their lending activity The Basel II and III agreements established regulatory capital requirements that reflected credit risk (Biswas et al., 2015) Credit risk management has become more important as a result of these rules (Mollah et al., 2017)

2.1.3 Operating efficiency

Operating efficiency assesses an organization's capacity to effectively utilise its resources to achieve its goals and objectives (Slack et al., 2019) It is a critical component for businesses seeking to preserve their competitiveness and profitability in today's fast-paced business world.To examine operating efficiency, many metrics and ratios are utilised, including the Efficiency Ratio (ER), which assesses the relationship between operating expenses and revenue (Berger & Hannan, 1998) Also, Data Envelopment Analysis (DEA) is used to compare relative efficiency to peers (Cooper et al., 2007) Among the primary factors impacting efficiency levels are firm size, industry competition, and technological capabilities Operating efficiency and total business performance are inextricably related Efficient firms are more profitable (Sarpong et al., 2014) and have superior financial stability (Parnell et al., 2011) Several studies have been

conducted to investigate the relationship between efficiency and various financial and non-financial performance metrics (Hitt et al., 2007) An & Loan (2017) also defined operational efficiency as the ratio

of operating expenses to total income, which represents the operating costs necessary to generate a single unit of Gross Income Sharma and Gounder (2011) claim that a negative association is anticipated due to the likelihood of high costs eroding net profit margins However, the capacity of an organisation to provide cost benefits to its clients is contingent upon its market strength, hence resulting in a favourable outcome in markets that lack competition

2.1.4 Bank’s growth rate

Bank growth rates are an important indicator of their ability to increase their operations and market presence

It includes several characteristics, such as asset growth, deposit growth, and loan portfolio expansion (Altunbas et al., 2007) Bank expansion is required for financial intermediaries to remain competitive and achieve long-term viability Additionally, analysing a bank's growth rate is an important part of assessing its financial health and success The pace of growth represents the bank's ability to increase its assets, deposits, and loan portfolio during a given time period (Samy, 2003) A strong and sustained growth rate can indicate a healthy and competitive institution, implying an expanding client base and market share However, if not backed by conservative lending and underwriting practises, rapid development may raise concerns about risk management and asset quality (Fungacova and Poghosyan, 2009) A static or declining growth rate, on the other hand, may indicate difficulties in obtaining new consumers or expanding the business To provide a well-rounded assessment of a bank's performance and sustainability in the financial industry, a comprehensive analysis of its growth rate should consider factors such as the economic environment, regulatory constraints, risk management practises, and the bank's overall strategic direction

2.1.5 Net interest margin

The Net Interest Margin is an important indicator of a financial institution's profitability and efficiency It

is defined as the difference between interest revenue and interest expenses as a percentage of total assets (Saunders & Cornett, 2008) Maintaining a strong NIM is critical for the financial stability and competitiveness of a bank According to Calem & Mester, 1995; Maudos & De Guevara, 2004 and Berger

et al., 1995, the size of interest-earning assets and interest-bearing liabilities, macroeconomic conditions and regulatory environment are all important aspects to consider NIM can be influenced by the size and market structure of financial organisations Smaller banks have greater NIMs due to local market strength, according to research (Rhoades, 1993) Market concentration and competitive levels also influence NIM (Boyd et al., 1994) A competitive banking system will increase efficiency and decrease NIM (Rudra & Ghost, 2004) High profit return ratios provide substantial challenges to intermediaries, such as increased savings encouraged by lower borrowing interest rates and limited bank investment opportunities as a result

of higher lending rates (Fungáorvá & Poghosyan, 2011) As a result, banks expect to perform their intermediate role at the lowest possible cost in order to encourage economic growth

2.2 Hypothesis analysis

2.3 1 Capital adequacy and NIM

According to Athanasoglou et al (2005), bank capital serves as a protective measure in the event of unfavourable circumstances The measure of capital is determined by dividing equity by the total value of assets The ratio serves as an indicator of the extent to which a bank's assets are financed by the owners' funds, so providing an estimate of the bank's capital adequacy and its capacity to withstand losses (Ommeren, 2011) The measure of risk aversion in this study is represented by the ratio of equity to total assets A greater ratio signifies an elevated level of risk aversion exhibited by bank managers According to Raja and Sami (2015), the anticipated sign of this variable is uncertain Banks with high levels of capitalization are more financially stable, leading to lower funding costs and ultimately bolstering their profit margins Conversely, a greater inclination towards risk aversion may incentivize banks to allocate their resources towards assets with lower levels of risk, resulting in diminished profit margins

According to Acharya et al (2009), the economic cycle can have an impact on both capital adequacy and NIM Banks may face increased credit losses during economic downturns, forcing regulatory agencies to emphasise the significance of retaining adequate capital The relationship between economic cycles, capital adequacy, and NIM has been studied, notably during financial crises In addition, the degree of capital adequacy has a direct impact on the NIM of a bank Banks must strike a balance between the demand for higher NIM, which frequently entails taking on more risk, and the regulatory necessity for adequate capital buffers to absorb possible losses Banks that retain higher levels of capital, sometimes known as being "well-capitalized," may be better positioned to withstand credit losses during economic downturns, which might benefit NIM (Berger & DeYoung, 2001)

2.3.2 Credit risk and NIM

A number of further research have discovered a positive relationship between credit risk and net interest margin (Maudos & Guevara, 2004; Dolient, 2005; Maudos & Sols, 2009; Kasman et al., 2010; Gounder & Sharma, 2012; Tarus et al., 2012) Banks with higher credit risk may charge higher interest rates to offset potential losses, but this might have a negative impact on NIM (Berger et al., 1995) Altunbas et al (2007) investigated how credit risk management practises affect NIM According to Koffie, Edder, and Anabel Pineda (2014), it is commonly observed that banks utilise loan write-offs, delinquent loan portfolios, or provisions for non-performing loans (NPLs) as indicators to assess default risk As indicated in the existing body of scholarly literature, a notable issue associated with these measures is their tendency to focus on historical data rather than serving as forward-looking indicators of default risk In contrast, the definition of credit risk provided by Raja and Sami (2015) pertains to the proportion of loan loss provisions in relation to gross loans A positive correlation exists between a larger ratio and lower credit quality, indicating an

elevated level of credit risk According to Poghosyan (2012), it is anticipated that banks will necessitate elevated interest margins in order to offset the inherent risks associated with funding ventures that carry a higher degree of risk Additionally, banks are expected to uphold sufficient loan reserves to ensure their financial stability Valverde and Fernandez (2007) propose an alternative perspective wherein a bank might address the issue of elevated credit risk by allocating its investments towards government assets that yield lower returns

According to , there is a trade-off between risk and NIM It refers to the delicate balance that banks must strike between seeking higher NIM through riskier lending practices and adopting a more conservative approach to protect capital This trade-off has significant implications for a bank's profitability and overall financial health (Adrian & Shin, 2010) Banks with more capital may engage in riskier lending practises, thus earning more interest revenue and NIM Such practises, however, subject businesses to higher default risks Banks with stronger capital adequacy, on the other hand, may take a more conservative lending approach to protect their capital, which may result in a lower NIM (Naceur, 2003) When compared to banks adopting riskier lending methods, well-capitalized banks' conservative lending stance often results in a lower NIM This is due to the fact that safer loans and investments tend to provide lower interest income Banks with sufficient capital are frequently ready to accept a lower NIM in exchange for reduced risk exposure and improved stability

2.3.3 Operating efficiency and NIM

Operating efficiency, as measured by the Efficiency Ratio, has a significant impact on a bank's NIM The net interest margin (NIM) is a crucial financial indicator that measures the difference between interest income produced through lending and interest expenses incurred from funding sources such as deposits and borrowings (Fungacova & Poghosyan, 2009) Research, as exemplified by studies like Berger & Humphrey (1997) and Hirtle (1997), has consistently shown that there exists a strong and meaningful link between these two metrics The Efficiency Ratio is a popular metric for determining a bank's operational efficiency

It is computed by dividing a bank's total revenue by its operating expenses A lower ER indicates greater operational efficiency because operating expenses consume a smaller proportion of revenue Berger et al (1997)'s scholarly work gives empirical evidence and insights into the relationship between operating efficiency and NIM in the banking sector According to this study, banks with lower ERs, indicating more operating efficiency, have higher NIM (Porter, 1979) In other words, when a bank manages its expenditures more efficiently, a smaller proportion of its revenue is spent on operating expenses, allowing a larger proportion of interest income to contribute to NIM

When the ER is lower, it signifies that the bank is operating more efficiently, and a smaller portion of its revenue is being consumed by expenses (Kalluci, 2012) This efficiency has a direct and positive impact on NIM Banks that are adept at managing their costs and achieving lower ERs tend to generate higher NIM,

as a greater proportion of interest income from lending activities contributes to NIM (Naceur, 2003) This relationship underscores the critical role of cost management and operating efficiency in shaping a bank's profitability and overall financial health It also emphasizes the importance of the ER as a key tool for assessing a bank's ability to generate income while minimizing expenses, ultimately influencing its NIM, competitiveness, and long-term viability

A higher NIM is often connected with increased bank profitability and financial stability The relationship between operating efficiency and NIM is critical since it has a direct impact on a bank's ability to earn profits and manage costs Higher NIM is associated with lower ER, which indicates higher operating efficiency This is due to the fact that a larger share of interest income earned by lending activities contributes to NIM because it is not eaten by high operating expenditures As a result of efficient management, banks can create higher NIM (Berger & Humphrey, 1997)

2.3.4 Bank’s growth rate and NIM

In their study, Berger et al (2003) made the strategic decision to prioritise maximising profitability above pursuing growth, thereby capitalising on their existing efficiency advantage The selection between these alternatives may be influenced or determined by market structure Under times of intense competition, a bank may be compelled to pursue strategies involving price reductions and expansion In a market marked

by imperfect competition, a bank may possess increased autonomy in selecting profit-maximizing strategies Demirgüç-Kunt and Huizinga (1999) and Carbo and Rodriguez (2007) asserts that as the economic growth rate increases, the NIM will decrease In addition, Abreu and Mendes (2003) and Maria and Agoraki (2010) did not identify any significant relationship between this factor and NIM does, predicting economic growth has a negative effect on the NIM coefficients of the studied banks in Vietnam Vietnam's economy is forecasted to grow by 5-5.2% in 2023 (Nguyen, 2023) The growing economy leads to good market conditions, more positive economic activity, and an improved business environment This helps to reduce the risk of businesses not being able to meet their financial obligations on bank loans When a bank perceives less credit risk, the required risk premium is also lower, and lending rates will also decrease, which in turn reduces the bank's NIM (Maria & Agoraki, 2010)

2.3.5 The impact of covid-19 on NIM

The COVID-19 pandemic outbreak in 2019 has far-reaching implications for global financial markets and economies, introducing considerable uncertainty and problems to a variety of industries, including the banking industry Net Interest Margin (NIM), an important financial statistic for banks, emerged as a focal point of scrutiny and concern in this setting (Naceur, 2003) The difference between interest income received through lending and interest expenses incurred from funding sources such as deposits and borrowings is shown in NIM It is a critical indicator of a bank's financial health since it is a fundamental indicator of

profitability and efficiency (Saunders & Cornett, 2019) The pandemic's disruption produced a range of interconnected difficulties that impacted NIM in financial institutions

According to Rey (2020), to encourage economic activity, central banks around the world implemented aggressive monetary measures, including lowering policy interest rates These interest rate cuts had an immediate and direct influence on banks' NIM Lower policy rates caused loan spreads to contract, potentially lowering NIM (Petersen, 2015) Academic research has looked into how interest rate dynamics affected NIM throughout the pandemic As the pandemic started out, interest rates fluctuated as central banks around the world altered policy rates in response to economic problems These changes impacted NIM directly by influencing the spread between interest income and interest expenses (Shin & Zhao, 2016) Academic research looked into how interest rate volatility affected NIM throughout the epidemic

The pandemic's economic uncertainty had ramifications for credit risk, loan default rates, and loan portfolio quality Banks had to manage credit risk while also trying to sustain NIM levels (Jiménez et al., 2014) Accordingly, the economic consequences of COVID-19 increased credit risk and raised worries about loan portfolio quality As borrowers experienced financial difficulty, banks saw an increase in non-performing loans (NPLs) The loan portfolio quality of a bank is inextricably connected to NIM, as decreasing asset quality can lead to larger provisions for credit losses and lower interest income (Berger et al., 1995) During the epidemic, researchers investigated the relationship between loan portfolio quality and NIM

CHAPTER 3: METHODOLOGY 3.1 Sample selection and Data Source

Data in this study is taken from audited financial statements of Vietnamese commercial banks including Vietcombank, Vietinbank, Eximbank and VietAbank provided for the period from 2018-2022 As of 2023, Vietnam has a total of of 31 commercial banks The final data set obtained after eliminating banks with unclear and transparent data will form a balance sheet of 4 banks covering the most recent 5 years It can be affirmed that those selected banks are suitable to represent commercial banks in Vietnam Moreover, to evaluate the impact of NIM during the Covid 19 pandemic, researchers added dummy variables to the model The dummy variable is equal to 1 when the Covid pandemic occurs, whereas its value is equal to 0 before the Covid pandemic occurs The researchers used panel data for the period from 2018 to 2022 of four commercial banks, which have clear and complete public data Furthermore, the data is collected from the financial statements published by the bank itself, so it is valid and reliable

Capital adequacy Equity over total assets (%) Hamadi & Awdeh (2012),

Hawtrey & Liang (2008)

Credit risk Loan loss provision/total

loans (%)

Kasman et al (2010) Tarus et al (2012)

Operating efficiency Operating expense / total

Covid19 The pandemic has led to

many changes in Vietnam's economy

Tran & Phan (2015); Tran & Truong (2017); Dao (2013)

Net interest margin (Investment income –

Interest expense) / Average Earning assets

Sources: Author, 2023

Researchers examined factors affecting net interest margin from 2018 to 2022, when the Covid 19 era occurred, using OLS model study (Nishiyama, Osada, and Sato, 2008) According to Faridi (2012), factors influencing NIM (independent variables) include capital adequacy, credit risk, operating efficiency, and bank growth rate The goal is to use econometrics to examine the impact of the aforementioned factors on four commercial banks in the context of Covid 19 To assess model correlation, the researchers used random FEM and REM fixed effects

Variable Sign Expected

results

Capital adequacy CAR (+) Credit risk NPLR (-) Operating efficiency OPC (-) Bank’s growth rate MP (+) Covid 19 COVID (+)

CHAPTER 4: FINDINGS

Table 1: Descriptive analysist

Variable | Obs Mean Std Dev Min Max -+ - NIM | 20 .0249 .0062975 0148 0339 NPLR | 20 .8925939 705269 .2665504 2.675994 CAR | 20 104245 .0255933 .081 .155

MP | 20 .0930663 .0800912 .0099404 .1932502 OPC | 20 00531 .0019818 .0032735 .0098887 -+ - COVID | 20 6 .5026247 0 1

Source: (Author, 2023)

As we can see that all variables have 20 observations In term of the dependent variable, NIM ratio has the average value at 0.0249 Regarding to independent variables nonperforming loan ratio and capital adequacy ratio have the average value at 0.89 and 0.1, respectively Additionally, and the average values of marker position and operating efficiency ratio at 0.09 and 0.005, respectively As a regard of the dummy variable, the average value of Covid is 0.6

Table 2: Correlation

| NPLR CAR MP OPC COVID -+ - NPLR | 1.0000

CAR | 0.1002 1.0000