Internal factors effecting the bank profitability- 123docz.net

CHAPTER 1: THEORETICAL FRAMEWORK AND RESEARCH

1.2. General review of Bank profitability

1.2.3. Internal factors effecting the bank profitability

Non-performing loan, which is commonly referred to as the amount of payment remaining non-performed after maturity (Charles, 2001), is seen a typical h problem in wide range of articles. Therefore, non-performing loan ratio which is taken from ratio of non-performing loan to total loan, should be able to indicate status of credit risks. Maxwell and Peter (2016) claim that the increasing non-performing loan ratio comes with message of probability that the bank would not be able to recover the payment. Consequently, commercial bank encountering higher non-performing loan level would probably see great financial loss and eventually realize lower profit after all.

As a result, there should be negative relationship between bank profitability and non-performing loan rate (Messai&Jouni, 2013); giving sense for bank to drastically control such type of bad debt. Nevertheless, Pasha and Khemraj (2009) oppose this relationship as he argues that the complicated definition of non-performing loan might distort the way this indicator to be recorded.

Therefore, the measurement of non-performing loan might be inconsistent across the countries with different regimes of bad debt recognition. In fact, though calculation of non-performing loan is purely standardized, the complicated definition of overdue term for non-performing loan is the factor of confusion. Particularly, while the standard overdue term in International

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ground set by International Monetary Fund (2005) defines a minimal line of 90 days for credit risks to be recognized, it was found that the term varied significantly across the countries where past studies were conducted.

Specifically, the due for non-performing loan recognition on Russia is defined as just 30 days, compared to 60 days in Estonia and Lithuania (Iuga&Lazea, 2012). Such difference in deadline may significantly contribute to the actual level of non-performing loan. In Vietnam, the standard of non-performing loan is referred as in Decision numbered 493/2005/QĐ-NHNN by Vietnam Central Bank, wherein 90 days overdue is qualified for non-performing loan record. Such compliance to international standard would facilitate the comparison with other studies better

Capital Adequacy Ratio (CAR)

The capital adequacy ratio refers to the level of equity held by the bank to secure it from the risks arise from credit transaction. For its nature, capital adequacy ratio is considered as the reserve which protects depositors and banks from unexpected loss. The capital adequacy ratio originally stems from regulation of Basel Accord, with regulatory minimum of 8%. It is assumed that the reserve would enable bank to prevent financial loss; hence in long term the profitability should be guaranteed at certain level. This is evidenced in the study of Olalekanand Adeyinka (2013) where it was found quite a positive relationship between the capital adequacy ratio and profitability. On the other hand, it is also criticized that the reserve could prevent the bank from fully operating at 100% capital capacity; thus far driving profitability to be lower in short term where higher reserve is required (Gizaw, Kebede&Selvaraj, 2015).

In general term, the inclusion of capital adequacy ratio in batch measuring credit risk is compulsory as long as this variable reflects the true nature of credit risk management practice as well as the regulatory attempt to bring forth

more stable operation of commercial banks in long term. This is therefore essential to be included in the set of variables of this study.

Loan to deposit ratio (LDR)

Loan to deposit ratio is adopted to measure the liquidity of bank in the wake of profit maximization. According to Gizaw, Kebede and Selvaraj (2015), the variable indicates whether commercial bank may withstand when depositor withdraw as well as when bank meet market loan demand via cash asset reduction. The concept of liquidity in relation to credit risk management implies that a more liquid bank should be less likely insolvent before massive credit risks. Especially, it is advocated by Misker (2015) that the systematic credit risks which often derive from financial crises demand would pose real challenge for the bank liquidity. On the other hand, the profitability should not be high in case bank remains too secured. Accordingly, the nature of risk taking and profit maximization make it difficult to determine a sufficient level of liquidity among commercial banks (Misker, 2015).

Loan Loss Provision ratio (LLPR)

While capital adequacy ratio grants protection to depositors against unexpected loss, the loan loss provision reserve gives protection toward anticipated loss (Gizaw, Kebede and Selvaraj, 2015). Considering the essence of loan loss reserve as the contra income account, it literally enables expected loss to be recognized in profit and loss statement. As a result, high loan loss provision ratio should normally indicate lower profit and in report though the inclusion has not certainly reported deduction to the final profit. In normal course, the loan loss provision is treated in quite various ways, including earning management or income soothing (Gizaw, Kebede and Selvaraj, 2015). However, its robust implication should reflect the belief of managers for quality of assets.

Accordingly, loan loss provision should increase when quality of asset drops and vice versa. In this study, the variable Loan Loss Provision would be adopted to

identify expectation for asset quality as a mechanism of credit risk management. LLPR= the loan loss reserve / total loan balance.

Total assets (TA)

It is argued by Misker (2015) that the assets should hold positive relationship with bank profitability. This perspective is in line with the conclusion of Olalekan and Adeyinka (2013) who refers to assets as the mean of profit making. Accordingly, bank with greater value of assets might find it easier to engage in the large investment or large scale financial operation, which in turn should fetch a greater profit to the bank. This point of view, however, is opposed by Iuga and Lazea (2012) as the author advocates that the greater risk in large scale project should cancel out the greater profit that bank may subject to. This argument is developed on the basis that there is always balance between the extent of risk and profit in any size of business.

Therefore, it is invalid to argue that the greater bank should be more effective in profit making

Dividend ratio: (DR)

Nevertheless, Pasha and Khemraj (2009) argue that the dividend paying ration shows clearly how well the firm is making profit. Accordingly, only high profitable firm with positive financial records may offer high dividend paying ratio to stimulate the investors. However, one should also see that a profitable firm is not necessary to pay out high dividend but to retain the dividend payment for achieving further in the long run. For this reason, the dividend paying ration might even drop when bank profitability is high, as long as the opportunities are worth the attention from the bank.

Internal factors effecting the bank profitability

Other external factor effecting the bank profitability

Brief of BIDV profit making performance in 2006-2017