Based on the above-mentioned issues, based on the situation of banks in the period from 2015-2022 along with what was learned during the internship at the Headquarters of Prosperity Comm
Literature overview
International research
Antonio Trujillo-Ponce conducted a study on the profitability factors of Spanish banks from 1999 to 2009, analyzing data from 697 banks using the Generalized Method of Moments Estimation and a regression model with ROA and ROE as dependent variables Key independent variables included Loan/Total Assets, Non-performing Loans, Equity/Total Assets, and various economic indicators such as GDP growth and inflation rates The findings revealed that banks with higher asset quality and capitalization positively influenced ROA, while a higher equity-to-assets ratio negatively impacted ROE Additionally, income diversification did not significantly affect ROE and ROA, and commercial banks exhibited better profitability than savings banks, albeit with greater income risk.
A study by M Mostak Ahamed et al (2017) analyzed 107 Indian banks, representing 95% of the country's total banking assets from 1998 to 2014, to determine if transitioning to non-interest income sources enhances profitability Utilizing a regression model with Return on Assets (ROA) as the dependent variable, the research incorporated asset quality indicators and the Herfindahl-Hirschman index to assess income source diversification The findings indicate that banks can improve their profitability by diversifying their income streams.
4 diversification In addition, the study also shows that diversification of income sources has a more positive impact on banks with low asset quality
Ali Osman GĩRBĩZ et al conducted a study on 26 Turkish banks from 2005 to 2011, utilizing the Generalized Method of Moments Estimation with independent variables ROA, ROE, and the Herfindahl-Hirschman Index Their findings indicate that income diversification significantly enhances banks' operating efficiency while simultaneously increasing risk The authors also suggest that the period under study was not the peak of diversification for the Turkish banking system.
Domestic research
With the use of the Feasible generalized least squares (FGLS) method, Dr Thuy
A study on the impact of diversification on Vietnam's commercial banking system reveals that income diversification negatively affects business risks among 25 banks from 2010 to 2020, analyzed using simple logistic regression The findings indicate two groups of influencing factors: those that reduce risks, including liquidity risk, deposits to total assets, GDP growth, and inflation, and those that increase risks, such as bank size and loan-to-total asset ratio However, the study does not provide a detailed evaluation of diversification's effect on the banks' overall business performance.
A study conducted by Nguyen Dang Thao Huyen in 2022 closely aligns with the author's focus on evaluating the effects of diversification on the profitability of Vietnamese commercial goods This research analyzed a sample of 32 Vietnamese commercial banks, employing quantitative research methods over the period from 2011 to 2022.
A 2018 study analyzed the impact of income diversification on the profitability of Vietnamese commercial banks using the GMM estimation method, which effectively addresses issues of self-correlation, variance of change error, and endogenous phenomena The quantitative results, measured by ROAA and ROAE, indicate that income diversification positively affects bank profits and is statistically significant This finding confirms that increasing income diversification enables commercial banks to enhance their profitability, providing bank administrators with a solid foundation to reduce reliance on interest income and boost non-interest income.
Research objectives
The main purpose of the paper is to address two main issues including:
This article examines the impact of income source diversification on the profitability of Vietnam's commercial banking system from 2015 to 2022 It aims to determine whether this diversification significantly influences profitability and to analyze how this effect compares to other contributing factors during the specified period.
Second, propose recommendations and solutions to improve the diversification of income sources of Vietnamese commercial banks in the future to achieve the common goals of the whole banking industry.
Scope of the study
Subjects of study: profitability, diversification and other factors affecting profitability of 24 listed commercial banks in Vietnam
Scope of study: The secondary study collected data from audited annual consolidated financial statements of 24 listed commercial banks in Vietnam for the period 2015-2022.
Methodology
The author developed a computational regression model utilizing quantitative methods, drawing on financial statements from commercial banks relevant to the study Employing the Generalized Method of Moments (GMM) Estimation, the research results were rigorously evaluated using Stata software Furthermore, the thesis incorporates data and insights from various public sources, including websites and scholarly articles, both domestically and internationally, to enhance the accuracy and comprehensiveness of the research.
Practical implications of research
This research aims to analyze the impact of income source diversification on the profitability of Vietnam's commercial banking system, comparing it with key factors such as bank size, asset quality, operating costs, and macroeconomic influences By examining the period from 2015 to 2022, the study seeks to highlight the significance of income diversification and offer actionable recommendations to enhance its effectiveness within Vietnamese banks Utilizing data from 24 banks, the research provides a comprehensive overview of the current state of income diversification in the Vietnamese banking sector.
Research structure
The essay is divided into four chapters as follows:
Chapter I: Research Background of diversifying income sources of Vietnamese commercial banks
Chapter II: Current situation of diversifying income sources at Vietnamese commercial banks
Chapter III: Analysis of model results measuring the impact of diversification of income sources of Vietnamese commercial banks
Chapter IV : Recommendation for Vietnamese commercial banks diversification in income sources.
Research Background of diversifying income sources of Vietnamese
Introduction to commercial banking activities
1.1.1 Definition and functions of commercial banks
A bank is defined as a financial intermediary that provides essential services such as loans, deposits, and payment processing, according to the second edition of "Introduction to Bank" by Barbara Casu and her colleagues, utilized at the Banking Academy.
By carrying out the intermediation function, banks collect surplus funds from savers and allocate them to those (both people and companies) with a deficit of funds (borrowers)
In doing so, they channel funds from savers to borrowers, thereby increasing economic efficiency by promoting a better allocation of resources.”
Commercial banks serve as the primary financial intermediaries in an economy, providing essential credit to households and businesses while facilitating payment mechanisms Typically structured as joint stock companies, these banks can be publicly traded or privately owned, catering to both retail and corporate clients With diversified deposit and lending portfolios, they offer a comprehensive range of financial services Prominent examples of commercial banks include well-known institutions like Citibank, HSBC, Deutsche Bank, and Barclays, which dominate the banking landscape in various countries While their core functions revolve around deposit-taking and lending, the significance of commercial banks in the financial system remains paramount.
9 commercial banks also engage in investment banking, insurance and other financial services areas They are also the key operators in most countries’ retail banking markets
According to the second edition of "Introduction to Bank" by Barbara Casu et al., utilized at the Banking Academy, commercial banks perform three primary functions: facilitating transaction sizes, enabling maturity transformation, and managing risk transformation.
Savers typically lend smaller amounts than what borrowers need, highlighting the disparity between personal savings and larger financial requirements, such as purchasing a home Banks play a crucial role by collecting small deposits from savers and converting these into larger loans for borrowers This size-transformation function allows banks to leverage economies of scale, as they have access to a broader base of depositors compared to individual borrowers.
Banks engage in the practice of transforming short-term funds into medium- and long-term loans, exemplified by converting demand deposits into 25-year residential mortgages While banks’ liabilities consist primarily of funds from savers that are repayable on demand or at short notice, their assets, which are loans to borrowers, typically have medium to long-term repayment schedules This leads to a 'borrowing short and lending long' strategy, resulting in a mismatch between assets and liabilities Such a mismatch poses liquidity risks, as banks may struggle to maintain sufficient liquid funds to meet their obligations.
Individual borrowers face credit risk, which is the possibility of failing to repay their loans To mitigate this risk, savers prioritize the safety of their funds Banks can reduce the risk associated with individual loans through strategies such as diversifying investments, pooling risks, thoroughly screening and monitoring borrowers, and maintaining capital reserves to absorb unexpected losses.
1.1.2 Main business activities of commercial banks
Capital mobilization involves acquiring temporary idle funds from organizations and individuals to establish a bank's operational capital Commercial banks utilize various methods for capital mobilization, including accepting deposits, issuing securities, and obtaining loans from other financial institutions and the State Bank of Vietnam (SBV).
Credit granting activities involve the utilization of commercial banks' capital to distribute mobilized funds to various entities within the economy These activities encompass a range of products and services, including lending, discounting, re-discounting, financial leasing, factoring, and bank guarantees Among these, lending stands out as the primary product, generating the highest profits for banks.
Payment services offered by banks are essential service activities that do not utilize bank funds, while simultaneously generating a significant capital source through the payment process These services encompass various means of payment, including check payments, payment orders, payment authorizations, collections, letters of credit, and bank card services, along with other approved payment solutions By providing these payment services, commercial banks not only earn fees but also enhance their competitiveness in the market.
Commercial banks engage in financial investment activities alongside their primary credit operations, enhancing profitability and risk diversification This involves utilizing bank capital to invest in financial assets such as government securities, corporate stocks, and derivative instruments The main objectives of these investments are to generate profits, diversify assets to mitigate risks, improve liquidity, and broaden the banks' business activities.
While profit remains the primary objective for commercial banks, ensuring safety and minimizing risks in their operations is equally crucial To achieve this, banks are expanding their range of services beyond traditional credit and payment activities They are increasingly focusing on innovative solutions that cater to customer needs, thereby maximizing profits with reduced risk exposure Their diverse offerings include insurance services, foreign exchange trading, gold trading in compliance with SBV regulations, trust services, and consulting services, among others.
Commercial banks offer a variety of services beyond traditional banking, including treasury management and safe rental To meet customer demands and enhance profitability, these banks are diversifying their operations by investing in advanced technology and equipment This shift aims to transform them into modern, multifunctional banks that provide a comprehensive range of products and services tailored to customer needs.
Sources of income of commercial banks
Interest income refers to the earnings generated from a bank's assets, including loans, securities, and deposits lent to various borrowers Conversely, interest expense encompasses the total interest paid on interest-bearing liabilities, such as deposit accounts, CDs, and both short-term and long-term borrowings The net interest income (NII) is derived from the difference between interest income and interest expenses This definition is provided by Barbara Casu and her colleagues in the second edition of "Introduction to Banking," a textbook utilized by the Banking Academy.
Non-interest income refers to revenue generated from fees, commissions, and trading activities, and has gained significance in recent years It encompasses various sources, including service charges for deposits, fees for safe deposit boxes, commissions from insurance sales, and gains or losses from trading securities Additionally, it includes profits or losses from foreign transactions and other off-balance-sheet activities, such as securities underwriting, as defined by Barbara Casu and her colleagues.
13 in the second edition book "Introduction to Banking" used by the Banking Academy as a textbook.
Profitability of commercial banks
Profitability measures monetary efficiency and is essential for achieving financial balance, although it alone is not enough Evaluating profitability requires a reference period, and it is relevant across all economic activities that utilize material, human, and financial resources, reflecting outcomes based on these inputs Profitability can be assessed for individual assets or a group of assets.
According to Le Mong Linh (2016), profitability is derived from the effective utilization of physical and financial assets, which represent the economic capital of banks in generating profits This is measured through key financial indicators such as return on equity, return on total assets, and return on revenue Profitability serves as a reflection of a bank's operational success and overall business efficiency, indicating its development level For commercial banks, high profitability enables significant capital accumulation and investment in technology, enhancing service quality to attract customers Conversely, for investors and depositors, a bank's profitability signals safety and risk mitigation, influencing their decision to engage in financial transactions.
According to Nguyen Thi Thu Hien (2017), profitability is a crucial metric for assessing the financial performance of commercial banks, as it reflects the relationship between business outcomes and the resources utilized This financial health is essential for banks to innovate and diversify their product offerings, ultimately enhancing their operational effectiveness.
Therefore, assessing the profitability of banks as well as considering influencing factors is not a new topic, but is always interested by researchers, administrators and executives of banking activities
Profitability is a crucial financial indicator for assessing the performance of commercial banks in today's highly competitive market Bank managers strive to enhance profits, which not only facilitates business expansion but also boosts shareholder income through higher dividends, thereby increasing the bank's market value and enhancing its brand reputation Furthermore, rising profits contribute to employee welfare and retention, fostering a stable workforce To achieve these profit increases, banks must focus on risk management, balance their credit activities with diversified services, and optimize management costs related to public affairs and assets.
Profitability in banking is assessed through key metrics like return on total assets (ROA) and return on equity (ROE) To enhance profitability, banks should focus on increasing income, managing operating costs efficiently, and implementing effective risk management policies This approach not only safeguards individual banks but also strengthens the overall stability of the banking system.
Income Diversification
According to Duong Thuy Ha (2021), income diversification in the banking sector often entails an increase in expenses as well as non-interest income in the operating
The income structure of a bank significantly influences its performance and profitability, with income diversification playing a crucial role Financial theory suggests that diversifying income sources can enhance a bank's efficiency by mitigating risk This diversification is rooted in the characteristics of income and assets, with a bank's operating income typically categorized into interest income and non-interest income Non-interest income, which refers to revenue generated outside of traditional profit-making activities, becomes increasingly important as banks shift their focus from interest income to non-interest income activities.
Ali Osman GĩRBĩZ et al (2013); M Mostak Ahamed et al (2017) uses the Herfindahl–Hirschman index for measurement HHI is calculated as follows:
The income source structure of a bank, represented by S1 to Sn, is crucial for understanding its total operating income (TOI) The Herfindahl-Hirschman Index (HHI) ranges from 0 to 1, indicating that a value of 1 signifies complete reliance on a single income source, while a lower value reflects greater diversification among multiple income sources Research by Stiroh and Rumble (2006), Goddard et al (2008), and Delpachitra and Lester (2013) introduces the Adjusted Herfindahl-Hirschman Index (AHHI) as a metric for measuring this diversification.
The AHHI index evaluates the impact of various components of net income, emphasizing the non-linear relationship identified by Stiroh and Rumble (2006) Key elements include net interest income (NII), which refers to the income generated from interest, and delinquent debt (NON), which encompasses both the delinquent amount and accrued interest Additionally, net operating income (NOI) is calculated as the income derived from all assets minus total expenses.
The AHHI index, ranging from 0.0 to 0.5, assesses income diversification, with a value of 0 indicating minimal diversification from a single income source Conversely, a value of 0.5 signifies complete income diversification Unlike the HHI, a higher AHHI value reflects a more varied income mix, highlighting the importance of diversification in financial stability.
Chapter I focuses on the theoretical basis as well as the authors' research in the previous period as well as in other countries on the impact and impact of income diversification on the profitability of commercial banks According to most of the above results, diversification brings positive impacts on the profitability of banks but also comes with risks.
Current situation of diversifying income sources at Vietnamese
Profitability and diversification of income sources at Vietnamese
commercial banks in the period of 2015 to 2022
Figure 1: Average ROEA of Vietnam's commercial banking system
From 2015 to 2022, the profitability of Vietnam's commercial banking system has shown a clear upward trend in Return on Equity Assets (ROEA), particularly among private banks, which have seen their ROEA increase more than threefold in just eight years Despite this impressive growth, state-contributed banks maintain a higher and more stable ROEA compared to their private counterparts However, the gap in average ROEA between these two groups is narrowing, especially during the COVID-19 pandemic.
ROEA of commercial bank in Vietnam during 2015 2022
Industry Average ROEA Average ROEA of state-contributed banks Private Bank Average ROEA
In 2022, private commercial banks demonstrated significant technological advantages and business flexibility, achieving a return on equity assets (ROEA) nearly comparable to state-owned banks Notably, several private banks maintained exceptional performance, with ROEA exceeding 20%.
6 banks exceeding this milestone, including banks with higher ROEA than VCB such as MBB, VIB or ACB
Figure 2: ROE of commercial banks in Vietnam
ROEA of commercial banks in Vietnam in 2022
Figure 3: HHI of income sources of Vietnam commercial banks during 2015 - 2022
Before the Covid-19 pandemic, Vietnamese commercial banks experienced significant diversification of income sources, particularly among private banks, while state-owned banks showed minimal changes This aligns with the theory that banks with strong asset quality, like state-owned banks, tend to avoid income source diversification However, in 2022, the high interest rate environment caused both private and state-owned banks to see a resurgence in their Herfindahl-Hirschman Index (HHI), as interest income began to dominate the overall operating income of the banking sector.
HHI of income sources commercial banks during 2015 -2022
Industry Average HHI Average HHI of state-contributed banks Private Bank Average HHI
Assessing the impact of diversification of income sources on profitability
This study utilizes audited annual consolidated financial statements from 24 commercial banks listed on Ho Chi Minh, Hanoi, or UPCOM stock exchanges as of Q4 2022 The data spans from 2015 to 2022, with the macroeconomic variable, GDP growth rate, sourced from the official website of the General Statistics Office.
As a first step, the secondary data will be synthesized through Microsoft Excel software After summarizing all the data, a number of independent variables will be calculated through the collected data
In the second step, the organized data will be inputted into Stata software for comprehensive analysis This process includes conducting descriptive statistics, performing OLS regression, and executing linear multi-additive testing Additionally, it involves error variance testing, autocorrelation testing, and applying FEM and REM regression techniques To ensure the appropriate model selection, the Hausman test will be utilized, culminating in the application of the generalized method of moments to address any defects and generate final results.
The data will be organized into tables using Microsoft Excel, and the author will utilize several analytical models, including Generalized Least Squares (GLS), Fixed Effect Model (FEM), Random Effect Model (REM), and Generalized Method of Moments (GMM) These models are widely recognized in both domestic and international research for analyzing factors influencing bank profitability.
The author builds upon the regression model developed by Ali Osman GĩRBĩZ et al for the Turkish commercial banking system (2005-2011), introducing key modifications Notably, the author's model utilizes average return on assets (ROAA) and average return on equity (ROEA) as dependent variables Furthermore, the independent variables are more financially oriented, derived from financial statement data To enhance relevance for developing countries such as Vietnam, the author incorporates GDP growth rate as a macroeconomic variable.
From there, the author establishes the following overview research model
Y = β1 + β2 HHI(it) + β3 LogTA(it) + β4 LAR(it) + β5 CIR(it) + β6.TE/TA(it) + β7 GDPR(t) + β8 NPL(it) + e(it)
- Y are dependent variables representing the profitability of banks including ROEA
- β are the coefficients of vectors
The model incorporates subjective independent variables from banks, such as HHI, LogTA, LAR, CIR, TE/TA, and NPL, alongside the macro objective factor of GDPR.
2.2.3 Variables in the research model
Return on average equity (ROEA)
ROEA = Net Income / Average of total equity
Return on Average Equity (ROEA) is a key metric for assessing business performance, particularly in banks, as it reflects the effectiveness of investor and owner capital utilization Unlike Return on Average Assets (ROAA), ROEA is preferred due to its focus on capital trading, offering a more accurate representation of a bank's operational performance A higher ROEA signifies improved operational and capital efficiency, while a lower ROEA indicates potential inefficiencies in capital use This makes ROEA a vital dependent variable for analyzing the factors influencing banks' capital efficiency.
HHI: The Herfindahl–Hirschman index calculates the concentration of income structure at banks
HHI is an index used or referred to by Ali Osman GĩRBĩZ (2013) and M Mostak Ahamed (2017) as an indicator to show diversification in a bank's income
The Herfindahl-Hirschman Index (HHI) is a key metric for assessing market monopolization, with values ranging from 0 to 1 An HHI of 1 indicates that a bank's income is entirely derived from a single source, while a value close to 0 signifies a diverse income structure A lower HHI suggests effective income diversification, whereas a higher HHI reflects reliance on insignificant income sources Research by Ali Osman GĩRBĩZ indicates that as banks, including the State Bank and commercial banks in Vietnam, diversify their income streams, profitability is expected to improve, with HHI negatively impacting the Return on Equity Assets (ROEA) In Vietnam, commercial banks' operating income is categorized into seven key components: net interest income, net fee and commission income, foreign currency and gold trading income, trading securities income, investment securities income, income from capital contributions and long-term investments, and other income, which are utilized to compute the HHI in the study.
Total assets reflect the overall size of a bank and play a crucial role in its profitability Research by Nguyen Thanh Binh (2021) and Mashayekhi and Bazaz (2008) indicates that higher total assets positively influence the profitability of commercial banks However, contrary findings by Klapper and Love suggest a more complex relationship.
Research indicates that total assets negatively affect a bank's profitability (2004), while Ong & Teh (2013) found that bank size does not influence profitability Consequently, the author will not anticipate any impact from the LogTA variable in the model.
The Loan on Asset Ratio (LAR) is a crucial metric for evaluating the proportion of loans relative to total assets Research by Alper & Anbar indicates that a higher LAR can negatively impact profitability, particularly when banks lack effective risk management and skilled teams Excessive loan scales may restrict banks' ability to maintain minimum liquidity, forcing them to seek costly capital sources Conversely, Tan (2016) argues that a significant lending volume can yield substantial profits for banks engaged in traditional lending Given that Vietnam's commercial banking system heavily relies on lending activities, it is anticipated that LAR will influence business efficiency in a similar manner.
CIR : Operating expenses / Total operating income
Controlling costs is crucial for evaluating business performance across various industries, particularly in banking The cost-to-income ratio (CIR) serves as a key indicator of a bank's cost management efficiency As noted by Nguyen Thi Nguyet Dung and Nguyen Manh Cuong (2020), understanding this metric is essential for assessing financial health and operational effectiveness.
A high Cost-to-Income Ratio (CIR) indicates poor cost control within a bank, leading to detrimental effects on its overall business performance Consequently, this relationship suggests that an elevated CIR is likely to negatively influence the bank's profitability.
TE/TA : Total Equity / Total Asset
The capital structure of a bank significantly influences its profitability, as a higher equity ratio typically leads to increased costs compared to banks with lower equity ratios Given that the cost of equity often surpasses the cost of loans, it is anticipated that the total equity to total assets (TE/TA) ratio will negatively affect the profitability of Vietnamese commercial banks.
GDPR : Vietnam's Gross Domestic Product growth rate in year t
In a developing country like Vietnam, a high GDP growth rate signifies significant economic output The banking sector thrives in such a dynamic environment, as businesses continuously seek capital and banking services to sustain and expand their operations Consequently, it is anticipated that the independent variable GDPR will positively influence the performance of banks.
NPL : Total bad debt / Total credit balance
Research indicates that the non-performing loan (NPL) ratio has a complex effect on bank profitability Specifically, a study by Nguyen Thu Nga (2017) revealed that NPLs adversely impacted the performance of 31 Vietnamese commercial banks from 2009 to 2015 The findings suggest that a high NPL ratio results in significant provisions and a loss of interest revenue, ultimately harming the banks' overall business performance.
Research results
Model results
3.1.1 Descriptive statistics of research data
The descriptive statistics table below is intended to list only the characteristics of the data collected
Figure 4: Descriptive statistics for the whole sample period 2015-2022
The descriptive statistics table reveals that each variable has 192 observations, ensuring consistency across the dataset Furthermore, the standard deviations for all variables are lower than their respective means, indicating that both dependent and independent variables meet the criteria for inclusion in the regression model.
Figure 5: Pearson's pairwise correlation matrix
In terms of autocorrelation between independent variables, no value is greater than 0.8 or less than -0.8, demonstrating a relatively small pairwise correlation among the explanatory variables
Figure 6: Variance inflation factor (VIF)
The author employs the Variance Inflation Factors (VIF) method to assess linear multi-addition for all fluctuations The results indicate that the average VIF is 1.5, which is well below the threshold of 10, and no independent variable's VIF coefficient exceeds 10 Therefore, it can be concluded that multicollinearity is not a concern in the usage model.
F test Prob>F = 0.0000 < 0.05: Between FEM and OLS, FEM is choosen Breusch and Pagan test
Prob>Chibar2 = 0.0000 < 0.05: Between REM and OLS, REM is choosen
Note: The standard errors are reported in parentheses The bold coefficients denote the statistically significant values Asterisks indicate the significance at the 1 percent (*), 5 percent (**) and 10 percent (***) level
The author employs the Hausman test (1978) to determine the suitable regression model for the study, comparing the Fixed Effect Model (FEM) and the Random Effect Model (REM) To assess the appropriateness of instrument variables in the GMM model, the Sargan test (or Hansen test) is utilized, with the null hypothesis (H0) asserting that exogenous instrumental variables are uncorrelated with the error term, aiming for a high P-value Additionally, the Arellano-Bond test is conducted to identify self-correlation in the most differentiated errors, where the first-order self-correlation (AR1) results are disregarded, and the quadratic autocorrelation (AR2) is examined The Hansen test values and AR2 results, presented in Table 5, show P-values exceeding 5%, indicating that the models employed by the author are appropriate and that the estimates derived from the System GMM method are reliable.
The author uses a hypothesis pair for the Hausman test:
+ H0: The REM model is preferable
+ H1: The FEM model is preferable
With a value of Prob>F = 0.0000 < 5%, the FEM model will be more suitable Therefore, the author will use the FEM regression model for the ROEA dependent variable
Figure 8: Variable variance test result
Heteroscedasticity can adversely affect the efficiency of model estimations and compromise the reliability of coefficients To identify this issue, the author employed the Wald test (1973) using the imtest command, specifically the white test, to assess the model's performance.
The analysis indicates that the model for the Return on Equity (ROE) dependent variable demonstrates a significant relationship, with a P-value of 0.0000, which is below the 5% significance threshold This suggests the presence of variable error variance within the model.
3.1.5 Testing the phenomenon of autocorrelation
Autocorrelation is a phenomenon that leads to errors in the variance of estimation coefficients, ultimately diminishing the accuracy of the model To assess autocorrelation within the model, the author employs two sets of hypotheses for testing.
+ H1: The model has autocorrelation phenomenon
Figure 9: Test results of autocorrelation phenomenon
According to the data analyzed using Stata software, the p-value of 0.0000 is significantly lower than the 5% significance level, indicating the presence of first-order autocorrelation in the model.
The author uses the Generalized method of moments (GMM) model to overcome defects to give more reliable estimation results
Figure 10: GMM model regression result
The GMM model has addressed the limitations of earlier models, and this research paper focuses exclusively on analyzing the results derived from the GMM model to interpret the significance of the variables.
The best representation equation of the research model is:
ROEA = 0.711 - 8.388 x HHIit* - 3.643 x LogTAit** - 5.103 x LARit* - 24.19 x CIRit*** + 0.225 x GDPRit*** - 0.524 x TETAit*** - 0.715 x NPLit** + eit
The regression model indicates that the profitability measured by the ROEA dependent variable is significantly affected by all selected independent variables The forthcoming section will detail the results and implications of this model.
Analysis of model results
The income diversification factor (HHI) has an adverse effect on profitability and is statistically significant at 10%
Experimental findings indicate that diversifying income sources significantly enhances the profitability of commercial banks in Vietnam from 2015 to 2022 This aligns with Ali Osman GĩRBĩZ's (2013) conclusions, demonstrating that a 1% decrease in the Herfindahl-Hirschman Index (HHI) correlates with an 8.388% increase in Return on Equity (ROEA) The trend reflects the ongoing efforts of Vietnamese banks to expand income streams, particularly through fee income Among the independent variables analyzed, HHI stands out as the second most influential factor affecting profitability.
The bank size factor (LogTA) has the opposite effect on profitability and is statistically significant at 5%
The model results indicate that larger bank sizes negatively affect profitability, as evidenced by the increase in total assets This finding aligns with Klapper & Love (2004), highlighting that while absolute returns may rise with asset growth, profitability measured by ROEA declines if profit growth does not keep pace with asset growth Specifically, a 1% increase in the logarithm of total assets leads to a 5.103% reduction in bank profitability, which is less significant than the 8.388% decrease observed with income diversification.
The LAR loan size factor has an adverse effect on profitability and is statistically significant at 10%
The model's findings indicate that a 1% increase in the ratio of borrowing capital to total assets leads to a significant 5.103% decrease in profitability, aligning with the results of the Alper & Anbar study While a larger loan size may boost absolute interest income, it complicates management and reduces relative profitability Furthermore, although the impact of income source diversification remains less significant than that of total asset size, the gap has narrowed This trend is particularly relevant for Vietnam's banking system, which continues to depend heavily on net interest income.
The operating expense factor CIR has an inverse effect on profitability and is statistically significant at 1%
The model results indicate that a 1% increase in operating expenses for Vietnamese commercial banks leads to a significant decline in profitability, with ROEA decreasing by 24.19% for every 1% rise in the Cost-to-Income Ratio (CIR) This finding aligns with previous studies by Nguyen Thi Nguyet Dung and Nguyen Manh Cuong (2020) and Tan & Floros (2012) Between 2015 and 2022, banks have largely optimized their operating costs, particularly during the challenging times of the Covid-19 pandemic Rather than focusing on digital transformation, banks prioritized cutting labor costs, which contributed to their relative success during this period Notably, the CIR factor has a more substantial impact on profitability compared to the HHI income diversification factor.
The structural factor of capital has an adverse effect on the profitability of the bank and is statistically significant of 1%
The model findings indicate that a 1% increase in the TETA capital structure factor results in a 0.524% decrease in bank profitability This supports the author's hypothesis that the cost of borrowed capital typically exceeds the cost of equity, particularly in the banking sector, which relies heavily on borrowed funds Additionally, the influence of capital structure changes on profitability is relatively minor when compared to the significant effects of income source diversification.
The NPL ratio factor has an adverse effect on the bank's profitability and is statistically significant at 5%
The model indicates that a 1% increase in the Non-Performing Loan (NPL) ratio leads to a 0.715% decrease in bank profitability, aligning with Nguyen Thu Nga's (2017) findings During the study period, strict adherence to provisioning regulations and timely interventions by the State Bank of Vietnam, such as Circular 01/2020 during the pandemic, mitigated the impact of NPLs on bank profitability In contrast, a 1% change in the Herfindahl-Hirschman Index (HHI) diversification factor has a significantly greater effect than a similar change in bad debt levels.
The findings indicate that income diversification positively influences the profitability of Vietnam's commercial banking system, demonstrating a significant effect compared to other factors However, this impact is notably less than that of the cost-to-income ratio The author will further discuss the practical implications of this model in Chapter IV.
Chapter IV: Recommendation for Vietnamese commercial banks diversification in income sources
In light of the findings from Chapter III and the current landscape of income diversification among commercial banks in Vietnam, this article proposes strategic solutions and recommendations aimed at enhancing the effectiveness of income source diversification within the Vietnamese commercial banking sector.
The author's research indicates that diversifying income sources significantly enhances profitability for commercial banks in Vietnam Therefore, banks should continue to implement strategies that reduce reliance on interest income, aligning with the guidelines of the State Bank of Vietnam Emphasis should be placed on increasing fee income, particularly from non-traditional services like asset management and commercial account offerings, such as letter of credit issuance and underwriting In light of changing customer behaviors due to the Covid-19 pandemic, banks must adapt to market demands by developing high-tech products and pursuing digital transformation strategies that align with the e-banking model to boost fee income Additionally, while maintaining foreign exchange and securities trading activities, banks must closely monitor potentially risky trading to ensure overall stability.
In Vietnam, commercial banks must prioritize diversifying their income sources while also considering other influencing factors This diversification process demands significant investment and operational costs, which can increase the banks' overall operating expenses The model's findings suggest that if the pressure on the Cost-to-Income Ratio (CIR) becomes excessive due to income diversification efforts, banks should reassess their strategies to maintain financial stability.
42 reconsider the strategy for this process, specifically for every 1% change of the maximum CIR is only exchanged in exchange for 3% of the change of HHI
Banks should prioritize the effective management and stability of interest income, as it will remain the primary source of revenue in the banking system for the foreseeable future A stable interest income stream not only serves as a financial cushion but also aids in diversifying income sources, ultimately enhancing bank profitability.
In Vietnam, financial regulators play a vital role in shaping the operations and outcomes of income diversification while managing associated risks Policymakers must understand the evolving landscape of banking, particularly in the wake of the Covid-19 pandemic To foster healthy financial markets, collaboration with international investors is essential to develop effective strategies for income diversification Additionally, regulations should be accompanied by clear guidance on emerging banking services, such as digital banking and financial consulting, to enhance the legal framework and support the growth of the commercial banking sector Finally, ongoing oversight and timely intervention by regulators are crucial to address any legal violations or instabilities that may arise during the income diversification process.
Investors must closely analyze trends in the banking industry, particularly the impact of income source diversification on their investments The trend of diversifying income sources significantly influences the profitability of commercial banks, making it essential for investors to stay informed and adapt their strategies accordingly.
43 choose banks that seriously pursue this goal as well as have the ability to manage risks and grasp trends well
The author provides recommendations for commercial banks and management to enhance the stability and efficiency of income diversification Accelerating income diversification is crucial for improving profitability while maintaining a strong focus on risk management Policymakers should implement timely and appropriate policies to support this diversification process effectively Additionally, investors are encouraged to monitor and capitalize on opportunities with banks successfully navigating the trend of income source diversification.
The Statement Bank of Vietnam has recently implemented a strategy to diversify income sources, particularly emphasizing non-interest-dependent revenue streams This approach highlights the urgent need to analyze how diversification affects profitability for individual banks By understanding this impact, banks can develop effective preparation steps and solutions aimed at achieving both diversification and enhanced profitability.