Finance dissertation on determinants of bank profitability – empirical evidence from vietnam banking sector

Consequently, the factors influencing the performance of banks have garnered the attention of researchers, bank executives, financial markets, and regulatory authorities alike.. A stable

Dissertation submitted in partial fulfillment of the

Requirement for the MSc in Finance

Supervisor: Prof Dr Chu Khanh Lan

September 2023

Table of content

I INTRODUCTION 4

II LITERATURE REVIEW 7

2.1 B ANK PROFITABILITY 7

2.2 I NTERNAL FACTORS 8

2.2.1.BANK SIZE 8

BANK CAPITALIZATION 8

2.2.2 8

2.2.3.CREDIT RISK 9

2.2.4.LIQUIDITY RISK 10

2.2.5.COST MANAGEMENT 11

2.2.6.CONCENTRATION 11

2.2.7.OWNERSHIP 12

2.3 M ACROECONOMIC FACTORS 13

2.3.1.GDP 13

2.3.2.INFLATION 14

2.3.3.MONEY SUPPLY 14

III MODEL SPECIFICATION AND DATA 15

3.1 B ACKGROUND 15

3.2 D ETERMINANTS 18

3.2.1.INTERNAL FACTORS 18

3.2.2.EXTERNAL FACTORS 21

3.3 M ODEL 22

D ATA 23

3.4 23

IV EMPIRICAL RESULTS 24

4.1 E CONOMETRIC APPROACH 24

V RESULT AND DISCUSSION 28

5.1 I NTERNAL FACTORS 28

5.2 E XTERNAL FACTORS 31

VI CONCLUSION AND RECOMMENDATION 32

VII REFERENCES 35

VIII APPENDIX 38

List of graph

Graph 1_Total assets by bank structure Source: author’s calculation 16

List of table Table 1_ROA and ROE of state-owned and privately-owned banks Source: Author’s calculation 16

Table 2_Dependent and independent variables 23

Table 3_Correlation matrix Source: Stata analysis results 26

Table 4_Model 1, model 2 regression summary Source: Stata analysis results 29

Table 5_OLS regression Source: Stata analysis results 38

Table 6_Model 1 heteroskedasticity and autocorrelation test Source: Stata analysis results 39

Table 7_Model 1 FE vs RE Source: Stata analysis results 39

Table 8_Model 1 FE regression Source: Stata analysis results 40

Table 9_Model 1 GLS regression Source: Stata analysis results 40

Table 10_Model 2 FE vs RE Source: Stata analysis results 40

Table 11_Model 2 GLS regression Source: Stata analysis results 41

I Introduction

Over the past twenty years, the global banking industry has undergone significant changes in how it operates Various factors, both from within the industry and from the broader economic landscape, have influenced how banks are structured and how well they perform Despite the growing trend of reduced reliance on banks in many countries, they still play a central role in financing economic activities across different market segments A healthy and profitable banking sector is more resilient to adverse events and plays a crucial role in maintaining financial system stability Consequently, the factors influencing the performance of banks have garnered the attention of researchers, bank executives, financial markets, and regulatory authorities alike The present banking system in Vietnam consists of several major banks under government control, alongside a significantly larger number of smaller privately-owned and foreign banks This highly segmented market lacks institutional complexity and primarily operates through intermediation It provides an ideal environment for testing theories regarding the role of banking

in an emerging economy and how changes in regulatory structures affect competition and bank profitability Given the limited influence of stock and bond markets, financial intermediation remains essential for the provision of credit Another pressing concern tied to this segmented market is the undercapitalization of the Vietnamese banking system, exacerbated by a challenging environment marked by sluggish loan demand Banks are grappling with the need to counteract credit-related expenses and enhance their internal capital generation in this context

Decision No 689/2022/QD-TTg, which endorsed the project “Restructuring the system of credit institutions associated with bad debt settlement for the period 2021 – 2025,” was officially released on June 8, 2022 Consequently, this marks the third project sanctioned since 2012, following the prior approval of two projects, namely “Restructuring the system of credit institutions” as per Decision No 254/2012/QD -TTg (for the period 2011-2015) and Decision No 1058/2016/QD-TTg (for the period 2016-2020) The restructuring process for the banking system spanning the years 2011-2020 achieved notable successes, including the absence of bank failures, ensured liquidity, and enhanced order and discipline in banking operations Nevertheless, the fundamental objectives of the restructuring, such as the conclusive resolution of bad debts and the establishment of a genuinely healthy banking system in line with international standards, featuring

a diversified ownership structure founded on advanced technology, have remained largely unresolved(SBV,2022) However, the Vietnamese banking system still encounters several challenges in implementing this project, attributed to the following reasons Firstly, there are

limitations in the restructuring tools, exemplified by state-owned banks facing difficulties in terms

of financial resources to handle bad debts and a lack of specific legal frameworks, especially in the restructuring process Secondly, as the primary objective of restructuring the Vietnamese banking system is to maintain stability, the issue of bankruptcy or bank closures is not explicitly addressed Even the restructuring solutions still maintain a high level of “directionality,” such as the “mandatory mergers/consolidations” proposed in the 2016-2020 phase of the project, which diminishes the market-oriented aspect of merger and acquisition solutions However, this approach has been modified in the 2021-2025 phase of the restructuring project, which now encourages voluntary mergers and acquisitions among credit institutions Thirdly, among the restructuring contents of the Vietnamese banking system, a strong emphasis is placed on improving bank management This sets it apart from developed countries around the world where market orientation in banking activities is ensured, and corporate governance issues have been widely applied in banking operations(Tung, 2023) Thus, in order to achieve success in accordance with Decision No 689/2022/QD-TTg, the Vietnamese banking system requires further in-depth research to formulate measures aimed at enhancing the efficiency of the industry's operations

One significant motivation behind this article stems from the ongoing challenges within the Vietnamese banking system A stable and robust banking sector is crucial for maintaining the stability of the financial system and for effectively managing adverse economic shocks (Athanasoglou, 2008) Consequently, the factors influencing the profitability of banks have garnered significant attention from researchers, particularly in emerging economies like Vietnam Over the past decade, the Vietnamese banking industry has undergone substantial restructuring to adapt to the opportunities and challenges within its operating environment The presence of foreign banks and the requirement to adhere to Basel II standards have compelled Vietnamese banks to consolidate and bolster their financial resilience One of the primary concerns related to Vietnamese banks is the high level of non-performing loans, which has had a detrimental impact

on their performance(Batten, 2019) Another issue relates to the frequency of reporting standards,

as detailed information regarding bank profitability is typically only available on a quarterly basis for larger banks(Albertazzi, 2009) Furthermore, banks with low profits often have stronger incentives to engage in riskier non-traditional banking activities(Edwards, 1995) Conversely, bank-specific factors may be subject to more frequent observation due to legal requirements and accounting standards Therefore, a comprehensive analysis of the factors influencing bank

profitability within the Vietnamese context offers valuable insights for maintaining a stable financial system

This research aims to empirically analyze a comprehensive range of factors, comprising bank-specific, industry-specific, and macroeconomic determinants, with a specific focus on their impact on the profitability of banks within the Vietnamese banking sector The dataset employed

in this analysis encompasses 32 Vietnam banks during the time span from 2010 to 2022 Our principal aim is to discern the pivotal factor that wields the most significant influence on bank profitability in this particular context In addition, we hope to uncover any unique patterns that show how these ownership types affect bank profits in Vietnam as a part of the academic

conversation in our field

To attain these objectives, we undertake a series of procedures Firstly, we conduct a comprehensive review of existing literature, with a specific focus on factors related to individual bank risk and market power, as they are recognized as key influencers of bank returns Additionally, given the contemporary research highlighting the significance of macroeconomic elements in influencing bank risk, we incorporate a range of macroeconomic variables into our regression analyses Secondly, we examine our dataset for issues related to stationarity or any other potential concerns Thirdly, we employ regression analysis to uncover and understand the relationships between various variables, comparing our findings with the established literature Finally, we execute various tests aimed at evaluating the model's robustness and validity

Our primary contribution to the body of literature is the execution of an extensive empirical analysis of this matter within the Vietnamese context Specifically, we offer deeper insights into the determinants of bank profitability in emerging markets Our comprehensive dataset, encompassing detailed attributes of commercial banks, alongside various industry and macroeconomic factors, allows us to achieve this objective Additionally, understanding the factors influencing bank profitability serves as a valuable tool for regulatory authorities in their prudential analysis

This paper is organized as follow: In Section 2, we examine the existing literature and outline our research hypotheses Section 3 provides an overview of key characteristics of the Vietnamese banking system Section 4 provides an overview of our research methodology and the data origins employed in this study Section 5 analyzes the empirical findings, and finally, Section 6 presents our concluding remarks

II Literature review

Literally, the profitability of banks is commonly elucidated as an outcome stemming from a combination of internal and external factors Internal factors stem from a bank's own financial statements, such as balance sheets and profit and loss accounts, and can be referred to as micro or bank-specific determinants of profitability Conversely, external determinants refer to elements that exist outside of bank management's control but are shaped by the larger economic and legal context These external factors have an effect on the operations and effectiveness of financial institutions Various explanatory variables have been put forth for both of these categories, customized to the specific nature and objectives of each research study

Numerous prior studies have explored the subject of bank profitability from various angles within the existing body of literature Pioneering works by authors like Short(1979) and Bourke (1989) were among the first to delve into the factors influencing bank profitability, utilizing cross-country datasets Since then, a multitude of research articles have been published, investigating this subject using cross-country datasets such as Barth(2004), and Flamini(2009) Additionally, many other studies have employed datasets specific to individual countries to examine the determinants of bank profitability(Hirindu Kawshala, 2017, Kosmidou, 2008)

Within the context of the Vietnamese financial markets, the existing literature on the factors influencing the profitability of Vietnamese banks remains notably scarce Previous research has been hindered by variations in sample sizes and measurement techniques, leading to a lack of clarity in establishing the relationships between bank size, credit risk, and bank profitability

2.1 Bank profitability

Bank profitability refers to the ability of a bank to generate earnings or profits from its financial operations and activities It is a measure of how efficiently and effectively a bank can use its assets, manage its liabilities, and conduct various financial services to generate income while covering its operating expenses and risks Bank profitability is a critical metric for assessing the financial health and sustainability of a bank It is closely monitored by regulators, investors, and analysts as it reflects the bank's ability to create value for shareholders while maintaining financial stability In markets where competition is strong, any extraordinary profits are not expected to last, as they would inevitably attract new competitors(Le, 2017) On the other hand, the sustained existence of profits is tied to the presence of barriers that hinder competition, potentially allowing for the emergence of market dominance

2.2 Internal factors

2.2.1 Bank size

The examination of the correlation between bank size and profitability aims to assess potential advantages or disadvantages related to the scale of operations within the banking industry In line with contemporary intermediation theory, it is suggested that larger banks frequently embark on diversifying their business operations, a move that may bring about concerns related to agency problems and less-than-optimal corporate governance This, in turn, can potentially lead to systemic risk, as indicated by Boyd (1993) Large banks can harness the benefits of scale by diversifying their product offerings, attracting a broader customer base, and subsequently reducing information costs and asymmetric information challenges(Short, 1979) Furthermore, the expanded scale empowers banks to reduce transaction expenses and engage in lucrative financing endeavors, thus enhancing their overall profitability, as highlighted by Boyd (1993) In this context, the positive correlation between size and profitability illustrates significant economies of scale This theory finds empirical support in studies conducted by Flamini(2009), Kosmidou(2008), and Staikouras(2004) As banks expand in size, they can achieve cost savings

at the margin, particularly as markets mature(Akhavein, 1997, Molyneux, 1992)

Nevertheless, a negative correlation can emerge in the case of extremely large banks, suggesting diseconomies of scale This phenomenon is attributed to potential challenges such as liquidity constraints and other associated risks that very large banks might encounter Large banks may find it challenging to benefit from diversification due to agency problems and flawed corporate governance(Le, 2020, Sufian, 2008) Diversification can introduce revenue fluctuations, indicating heightened risks associated with these activities, which, in turn, can lead to an adverse impact on bank profitability(Sufian, 2008) Large and extensively diversified banks are more likely to experience diminished revenues, whereas smaller, specialized banks can effectively mitigate asymmetric information issues tied to lending activities(Hanh, 2018)

2.2.2 Bank capitalization

Capital represents an initial step taken to restructure the existing capital framework of banks, safeguarding the banking industry from extensive turmoil Furthermore, capital offers the potential to establish higher benchmarks for any business enterprise, fostering increased business initiatives and driving improved performance(Abdullahi, 2013) Consequently, capital facilitates recapitalization, satisfying the requirements of individual banks by augmenting their minimum

paid-up capital, enabling them to enhance their operations and deliver greater efficiency in serving their customers

Several research studies have documented a positive correlation between capitalization and bank profitability Goddard(2004), Hanh(2018), Sufian(2008) This relationship can be explained through two complementary arguments The first argument is the expected bankruptcy costs hypothesis, which suggests that banks will boost their capital levels when external factors that increase expected bankruptcy costs are significant Additionally, the signaling hypothesis proposes that banks may use their capital levels to communicate information to the market regarding their future prospects and ability to generate profits Consequently, a signaling equilibrium may arise, where banks anticipating better future performance maintain higher capital levels(Pervan, 2015) Recent investigations conducted by Dan (2019), have revealed that the capital adequacy of Vietnamese banks holds a significant role in sustaining bank profitability, particularly in terms of return on assets Additionally, a preliminary examination conducted by

Vu and Nahm (2013) has indicated that specific bank attributes, such as larger size and enhanced management capabilities, alongside macroeconomic factors like robust per capita GDP growth and low inflation rates, exert a substantial influence on the efficiency of profit generation by Vietnamese banks

In contrast, the agency cost hypothesis suggests that high leverage reduces the agency costs associated with external equity and enhances firm value by incentivizing managers to align their actions more closely with shareholders' interests Some studies argue that a bank with an excessively high capital ratio may operate too cautiously, potentially overlooking opportunities for profitable growth and thus increasing the opportunity costs of capital(Sharma, 2013) 2.2.3 Credit Risk

The necessity of risk management within the banking industry is an intrinsic aspect of the banking profession Bank failures predominantly result from poor asset quality and insufficient liquidity During periods of increased uncertainty, financial institutions may choose to diversify their portfolios or enhance their liquid assets to mitigate risks(Molyneux, 1992) This risk management effort involves addressing both credit risk as well as liquidity risk

Credit risk, in banking, refers to the potential financial loss that a bank may face when a borrower fails to repay a loan either partially or in full Essentially, it signifies the risk that arises when borrowers do not meet their repayment obligations, which can lead to financial difficulties

or even bankruptcy for the bank if not handled properly The ongoing presence of non-performing

loans is a major issue in the banking sector and can pose significant challenges.In many cases, a bank's survival depends on its ability to manage various risks effectively, including credit risk(Saleh, 2020) However, some bank managers may prioritize personal interests over sound risk management practices To address this concern, implementing robust risk management strategies becomes crucial Such strategies help banks anticipate and mitigate the negative consequences associated with credit risk Developing a comprehensive and robust credit risk management framework is essential for the long-term viability and improved performance of banks It is important to note that the impact of credit risk on a bank's profitability can vary significantly within the banking industry, depending on various factors and circumstances Several studies highlight that an increased exposure to credit risk is associated with reduced profitability(Athanasoglou, 2006, Kosmidou, 2008) However, other studies argue that banks holding riskier assets may require higher profits to compensate for the elevated risk of default(Figlewski, 2012) This argument may hold particularly true in emerging markets, where macroeconomic volatility tends to be higher than in developed markets, potentially causing bank spreads to rise in response to heightened default risk(Gelos, 2009) In the context of Vietnam, previous research indicates that credit risk has no impact on bank performance (Le, 2020) 2.2.4 Liquidity risk

Banks are highly vulnerable to liquidity risk, a situation where there is a significant outflow

of funds as customers withdraw their deposits This has a detrimental impact on the bank's operations as it discourages potential clients and manageable buyers from engaging with the bank(Arif, 2012) Consequently, the bank's overall effectiveness declines significantly, leading to

a critical reduction in profits In simple terms, liquidity risk arises when a bank lacks the required funds to meet its short-term obligations and faces unexpected outflows of cash The availability

or shortage of cash plays a crucial role in determining the level of liquidity risk faced by a bank

Several studies argue that banks with higher levels of liquid assets tend to achieve lower profits (Katusiime, 2021, Kosmidou, 2008) This is because cash or cash equivalents typically yield lower returns compared to other types of assets, which can, in turn, diminish the liquidity premium in return However, according to the expected bankruptcy cost hypothesis, an increase

in a bank's relative holdings of liquid assets is predicted to reduce its likelihood of default, thus enhancing bank profitability(Bourke, 1989) In the context of Vietnam, (Le, 2017, Le, 2020) suggest that a higher proportion of liquid assets can actually improve bank margins, as banks offset the additional costs associated with holding liquid assets by charging higher margins

Consistent with the existing literature, Vietnamese banks with lower liquidity risk are expected to demonstrate greater profitability

2.2.6 Concentration

Considerable effort has been dedicated to investigating the connection between the structure of the banking industry and its performance Numerous studies within the banking and broader industrial organization literature have identified a positive correlation between profitability and various measures of market structure, such as concentration or market share Two contrasting hypotheses regarding the relationship between market structure and performance are the traditional Structure-Conduct-Performance (SCP) hypothesis and the Efficiency-Structure (EFS) hypothesis Both of these hypotheses have been employed in international studies on bank performance Authors like Short(1979), and Molyneux(1993) have utilized multiple independent variables, encompassing both internal and external factors related to bank operations, to clarify the determinants of bank profitability, either on a global or European scale

The conventional Structure-Conduct-Performance (SCP) hypothesis posits that in concentrated markets, banks have the ability to extract monopolistic rents by offering lower deposit rates and charging higher loan rates A correlated concept is the Relative Market Power (RMP) theory, which posits that only companies possessing significant market shares and unique product differentiations have the ability to exert influence over pricing for such products

Consequently, they can achieve above-average profits(Berger, 1995) Staikouras(2004) provides evidence supporting the SCP hypothesis for 685 European banks in the period 1994-1998 According to Molyneux(1993) aggregated country-level estimates reveal that, from 1986 to 1989, collusive profits were observed in the banking markets of Belgium, France, Italy, the Netherlands, and Spain His estimates also indicate that collusive profits did not seem to materialize in non-European Community (EC) banking markets

An alternative perspective challenging this interpretation is the Efficient-Structure (EFS) hypothesis It asserts that market concentration is not a random occurrence but rather a consequence of certain firms within an industry demonstrating superior efficiency In line with this hypothesis, proficient enterprises expand both in terms of scale and market share due to their ability to generate increased profits, resulting in an elevation of market concentration To distinguish between these two theories, prior researchers have integrated market share as an independent variable A typically positive coefficient in favor of the Efficient Firm Size (EFS) hypothesis is observed (Smirlock, 1985) Smirlock formulated a model that establishes a connection between bank profitability and multiple factors, including market share, concentration,

an interaction variable involving market share and concentration, along with a range of control variables This extensive analysis encompassed over 2,700 unit state banks The favorable association between profits and concentration is ascribed to cost reductions realized through superior management or production processes

However, it's important to highlight that this collusion scenario, where larger banks hold sway in the market, could possibly lead to adverse consequences for the profitability of smaller banks, especially when they are faced with intensified competition resulting from this monopolistic setting Conversely, if the heightened industry concentration stems from increased competition among banks themselves, it may have a negative impact on the overall market structure, illustrating the intricate relationship between competition, concentration, and its effects

on bank profitability(Moutsianas, 2016, Zheng, 2017)

2.2.7 Ownership

During its sixth National Congress in December 1986, the Communist Party of Vietnam took a momentous decision to depart from central planning and transition towards a socialist market-oriented framework This transformative shift was coined as 'Doi Moi' or 'renovation,'(Beresford, 2008, Le, 2019) As a part of this transformation, the previously existing mono-bank system, exclusively catering to the needs of the state sector, underwent a significant

reformation It was replaced by a two-tier banking system, with the State Bank of Vietnam (SBV) assuming a pivotal role as the central bank on one tier, while state-owned commercial banks (SOCBs) took on the role of lenders on the other tier This groundbreaking transition also allowed for the entry of private banks in the form of joint-stock banks (JSBs) and a controlled participation

of foreign investors in joint-venture banks

An intriguing question revolves around whether a bank's ownership status is connected to its level of profitability Nevertheless, there is limited evidence to substantiate the notion that privately-owned institutions will consistently yield higher economic profits Le(2019) research outcomes highlight that privatized banks exhibited superior performance compared to other banks, regardless of whether we evaluate their operational efficiency or their role in financial intermediation In essence, the privatization of state-owned banks resulted in enhancements in both their service quality and operational efficiency, even though they continued to have a substantial level of state ownership

Short(1979) , and Flamini(2009) stand as one of the few studies presenting cross-country evidence demonstrating a significant inverse correlation between government ownership and bank profitability More recently, Barth(2004) assert that government ownership of banks is indeed linked to lower bank efficiency This occurs because, given its predominant ownership stake, the state consistently holds substantial influence over the bank's operations, thus diminishing the probability of alterations in corporate governance methodologies Kraft et al (2006) further find out that an extensive privatization of state-owned banks, in the absence of substantial managerial modifications, may lead to a decline in the overall performance of the banking sector Conversely, Bourke(1989) find that ownership status does not play a significant role in explaining profitability 2.3 Macroeconomic factors

2.3.1 GDP

Gross Domestic Product (GDP) stands out as one of the frequently utilized macroeconomic metrics to evaluate a country's overall economic performance It is expected that GDP can have an impact on several aspects associated with the provision and demand for loans and deposits, as noted by Sufian (2008) When GDP growth slows down, especially during economic recessions, it typically leads to a deterioration in credit quality, an increase in loan defaults, and consequently, a reduction in bank returns However, Hoggarth(1998) conclude that the behavior of real GDP fails to account for the greater variability in banking sector profits observed in the UK compared to Germany They do not assert that GDP variability does not

impact profits; rather, they state that it cannot be used to explain the differing performance of UK and German banks If this variable is not statistically significant in explaining profitability, it bolsters the authors’ conclusions Otherwise, the expected relationship should be positive like in the study of Tran(2020), and Hanh(2018) , and as higher economic growth implies a reduced likelihood of both individual and corporate defaults and easier access to credit(Rumler, 2016) 2.3.2 Inflation

The last set of factors that affect profitability pertains to macroeconomic control variables, often including variables such as the inflation rate, the long-term interest rate, and the growth rate

of the money supply J.Revell(1979) addresses the interplay between bank profitability and inflation, highlighting that the impact of inflation on bank profitability hinges on whether a bank's wages and other operational expenditures increase at a faster pace than inflation The key consideration is the level of economic maturity, which enables accurate forecasting of future inflation, allowing banks to manage their operational costs accordingly Perry(1992) also suggests that the impact of inflation on bank profitability relies on the complete anticipation of inflation expectations If a bank's management fully anticipates the inflation rate, this implies that banks can make appropriate adjustments to interest rates to boost their revenues at a rate surpassing their costs, resulting in higher economic profits Most studies, including those conducted by Athanasoglou(1008), and Hanh(2018) have demonstrated a positive relationship between either inflation or long-term interest rates and profitability

2.3.3 Money supply

Money supply changes can lead to fluctuations in the overall price level While the central bank's policies primarily determine the money supply, it can also be impacted by the behavior of households and the actions of banks Monetary policy refers to a government's strategy concerning the management of money within an economy It involves a purposeful adjustment of the cost and availability of money and credit by the government to influence economic activities Monetary policy can take two primary forms: expansionary or contractionary When monetary policy is eased, it involves reducing the cost of borrowing money and increasing its availability This approach, known as expansionary monetary policy, leads to heightened economic activities and a rise in the overall price level Conversely, a tightened monetary policy entails increasing the cost

of borrowing money and reducing its availability This strategy, known as contractionary monetary policy, results in a decrease in economic activities, a decline in the general price level, and impacts

the profitability of firms(Aburime, 2008) In line with prior research, including Kosmidou(2008) , this study incorporates the Money Supply Growth (MSG) as a key variable In Mamatzakis' study conducted in 2003, the money supply was employed as a measure of market size, and the findings indicated a noteworthy influence of this variable on the profitability of banks

There is a considerable body of research on bank profitability conducted at a global level and within well-developed economies However, in the context of Vietnam, both the quantity and breadth of such studies are somewhat limited For instance, Batten and Vo (2019) conducted an investigation into the determinants of profitability for Vietnamese banks during the period spanning from 2006 to 2014 Similarly, Hanh (2018) examined this issue using data from nine banks covering the years 2009 to 2016, while Le's research in 2020 analyzed a dataset encompassing 40 Vietnamese banks, spanning the period from 2005 to 2015 These studies focused on assessing the influence of both external and internal factors on bank profitability, which show various in results However, it's important to note that the Vietnamese economy has undergone significant fluctuations in recent years Consequently, there is a pressing need for research that utilizes the most up-to-date data Furthermore, to gain a more comprehensive understanding of the subject, future studies should consider a broader scope of analysis This should include an exploration of not only internal and external influencing factors but also a thorough examination of different categories of banks with varying ownership structures Such an approach will provide deeper insights, especially when considering the restructuring and liberalization processes within the Vietnamese banking sector

III Model specification and data

3.1 Background

The expansion of the Vietnamese banking system has been actively encouraged by the government, as outlined in the "Restructuring of the Financial System of Credit Institutions for the 2011 - 2015 Period" project, according to Decision No 254/QD-TTg This initiative has since been further emphasized in the "Restructuring of the Financial System of Credit Institutions Associated with Non-Performing Loan Resolution for the 2021 - 2025 Period," as per Decision

No 689/QD-TTg dated June 8, 2022, by the Prime Minister These efforts have propelled banks

to operate more efficiently and increase their profitability

Consequently, there has been a determined effort to implement the restructuring plan for credit institutions involved in non-performing loan resolution for the 2021 - 2025 period The

objective is to develop a robust, high-quality, efficient, transparent, and publicly accountable credit institution system that meets the safety standards required by banking laws and aligns with international best practices The goal is to strive towards achieving the level of development seen

in the leading group of ASEAN countries by 2025(Chi, 2022)

A major focus is placed on designing, approving, and implementing restructuring projects for weak banks By 2025, the aim is to fundamentally address the issues of weak banks and credit institutions, with particular emphasis on preventing the emergence of new weak institutions

Graph 1_Total assets by bank structure Source: author’s calculation

Table 1_ROA and ROE of state-owned and privately-owned banks Source: Author’s calculation.

By the end of 2022, the total assets of the entire credit institution system in Vietnam reached 15.3 quadrillion VND, a 14.5% increase compared to 2021 Among these, the total assets of the

four state-owned banks accounted for 48.33%, with BIDV having the largest asset scale at 2.1 quadrillion VND, a 20.41% increase from 2021

However, when it comes to asset utilization efficiency, despite being the largest in terms of total assets, the banks in this group have not achieved high efficiency Even though the total assets

of each bank have surpassed the 1 quadrillion VND mark, their efficiency remains relatively low Vietcombank had the highest asset utilization efficiency at 1.65% in 2022 On the other hand, private joint-stock commercial banks, although they have much smaller total assets, are gaining an advantage in resource utilization In terms of capital utilization efficiency, Vietcombank also stands out as the bank with the highest Return on Equity (ROE) in 2022, reaching 22.06% This means that the bank earned 22.06 VND for every 100 VND of capital invested in its business.In contrast, when we examine banks with smaller asset and equity levels, such as private banks like MBB, we observe that they achieve higher returns in comparison to their state-owned counterparts, recording

a noteworthy 2.49% return on assets (ROA) and an impressive 22.8% return on equity (ROE) in the year 2022 These figures suggest that private banks are presently operating efficiently, actively harnessing their available resources to maximize profitability

A low Return on Assets (ROA) can result from inefficient investment or lending policies

or rapidly increasing operating costs Conversely, a high ROA reflects a bank's use of a sound asset structure, effective business and investment policies, and efficient asset utilization (Hung, 2023) In order to comprehensively implement the objectives, tasks, and solutions outlined in the Project, Credit Institutions need to identify the difficulties, challenges, existing issues, limitations requiring resolution, and restructuring solutions related to the handling of non-performing loans (NPLs) in the 2021-2025 period(SBV,2022b) NPLs have always been of particular concern to Credit Institutions as they significantly impact business efficiency In recent times, with the guidance of the National Assembly, the Government, and the State Bank of Vietnam, the NPL ratio has decreased significantly, and the handling of NPLs by the Credit Institution system has become more profound and effective Since the beginning of 2020, especially during the fourth wave of the pandemic in our country, the Covid-19 pandemic has had a negative impact on the business activities of Credit Institutions (Nguyet, 2021)

After the Governor of the State Bank of Vietnam issued a Directive to support customers affected by the Covid-19 pandemic, the NPLs in Credit Institutions, in general, had decreased and were reasonably well-managed However, NPLs still had an impact on reducing business

efficiency As a result, by the end of August 2022, the on-balance sheet NPL ratio remained at a safe level of 1.9%; the NPL ratio, including NPLs sold to the Vietnam Asset Management Company (VAMC) and potential NPLs within the Credit Institution system, stood at 4.99% (compared to 6.3% at the end of 2021)(Hung, 2023)." These transformations, combined with the integration of modern technology and enhancements in infrastructure, have played a pivotal role

in enhancing the profitability of banks This study delves into the financial performance of commercial banks in Vietnam from 2010 to 2022 Detailed information about the data sources is provided in the following section

3.2 Determinants

The variables used in this study are listed in Table 2 The profitability metric is represented using two alternative measures: The return on assets (ROA), representing profits relative to assets, and the return on equity (ROE), representing profits relative to equity, are both considered In essence, ROA gauges a bank's management efficiency in generating profits from its assets, although it may be influenced by off-balance-sheet activities On the other hand, ROE signifies the return to shareholders on their equity and is calculated as ROA multiplied by the total assets-to-equity ratio This ratio is often referred to as the bank's equity multiplier, which quantifies financial leverage Banks that bear low level of leverage but high level of equity typically show higher ROA but relatively modest ROE Given that an analysis of ROE does not take into account the increased risks associated with high leverage, and financial leverage is frequently dictated by regulations, ROA emerges as the primary metric for assessing bank profitability(Gul, 2011) 3.2.1 Internal factors

Size (SIZE): One of the central questions in formulating banking policies revolves around identifying the ideal size for maximizing bank profitability In broad terms, it's been established that the impact of expanding in size tends to enhance profitability up to a certain threshold This

is utilized to capture the idea that larger banks have a competitive advantage over smaller banks when it comes to benefiting from economies of scale in transactions, which typically leads to higher profitability As a result, a positive correlation is anticipated between size and profits in researches of Molyneux(1992), and Flamini(2009) However, if greater diversification results in reduced credit risk and hence lower returns, a negative association between the two was discovered in the Sufian (2008), and Afandi(2019) study The natural logarithm of total assets is used for bank size measurement as in Flamini (2009) research which then forecast a positive effect

on firm performance

H1: Bank size has positive impact on profitability

Capital (EA): We calculate capital as the ratio of equity capital to total assets as suggests

by Hirindu (2017) What's noteworthy is that a higher capital level tends to lead to greater profitability This is because having more capital enables a bank to comfortably meet regulatory capital requirements, allowing the excess capital to be extended as loans Capital essentially functions as a reserve of funds to sustain a bank's operations, providing a safety net in case of unfavorable situations Furthermore, the anticipated positive connection between capital and earnings can be further strengthened when new banks enter the market Consequently, banks with expectations of better performance can effectively signal this by maintaining higher levels of capital

H2: Bank capital has positive impact on profitability

Credit risk (CR): As proposed by Athana (2008), credit risk can be assessed by examining loan-loss provisions relative to loans, as central banks establish specific standards for the required level of loan-loss provisions within the country's banking system Adhering to these standards, bank management adjusts the provisions allocated for loan losses at the outset of each period Consequently, credit risk is typically treated as a predetermined variable However, in this study,

we employ the non-performing loans (NPL) to total credit exposure ratio as a proxy for this variable, as it provides a more accurate representation of each bank's actual situation during each period as suggested by Katusiime(2021) According to theory, a higher exposure to credit risk typically corresponds to lower profitability for a firm Consequently, we anticipate a negative correlation between ROA (ROE) and NPL Therefore, banks can enhance their profitability by implementing more effective screening and monitoring of credit risk These strategies entail the prediction of future risk levels

H3: Credit risk has negative impact on profitability

Liquidity risk (LIQ): Liquidity risk, arising from the potential inability of a bank to support asset growth or meet obligations, is considered a significant factor influencing a bank's profitability The loan market is typically seen as riskier but offers higher returns to investors when compared to other assets like government securities As a result, one might anticipate a positive correlation between liquidity and profitability (Ramadan, 2011) However, it is

conceivable that profitability could increase when there are fewer assets allocated to liquid investments (Athanasoglou, 2006) We use the ratio of liquid assets to total assets as a proxy for liquidity risk, following the approach in Athanasoglou's research in 2006, and Slaeh’s in 2012 with a negative expectation

H4: Liquidity risk has negative impact on profitability

Cost managements (CM): The overall expenses incurred by a bank (excluding interest payments) can be divided into two categories: operating costs and other expenditures (such as taxes, depreciation, and other cots) Of these factors, it is only the operating expenses that can be ascribed to the decisions made by the bank's management We anticipate a negative correlation between the ratio of these expenses to profitability, as better management of these expenses enhances efficiency and, consequently, leads to higher profits(Aziz, 2019, Sun, 2017) Hence, we use the natural logarithm of overhead costs as a proxy for expense management

H5: Cost management has positive impact on profitability

Ownership (PRIVATE): There could be a potential connection between bank profitability and ownership, driven by the potential spillover effects of privately-owned banks outperforming their state-owned counterparts, which may not always prioritize profit maximization However,

as the literature review suggests, there is no conclusive empirical evidence to support this perspective In the Vietnamese banking sector, the historical mono-bank system, exclusively serving the state sector's needs and demands, underwent a transformation into a two-tier banking system after the "Doi Moi" (renovation) in the late 1980s(Beresford, 2008) This new system designates the State Bank of Vietnam (SBV) as the central bank on one tier, while state-owned commercial banks (SOCBs) function as lenders on the other Additionally, it permits the entry of private banks in the form of joint-stock banks (JSBs) and allows for a limited presence of overseas investors in joint-venture banks To examine this hypothesis, we employ a dummy variable, following the approach recommended in the literature of Athanasoglou(2008) This dummy variable is assigned a value of 1 for privately-owned banks and 0 for all others

H6: Do private banks generate more profit than state ones?

Concentration (HH): This study utilizes the Herfindahl-Hirschman index, calculated based

on a bank's total loans relative to the total loan exposure of the entire system for a specific year,