Determinants of Bank Profitability

Examining the determinants of the banks profitability is very important in any economy as these foundations perform key financial functions. In Turkey it is even more important considering the fact that the stock market is heavily dominated by the banks. See here, here and here for more about the bank-intensive style of Turkish financial markets.

Lately we noted that on historical basis profitability indicator ratios of Turkish banks have been dramatically declining despite the relatively high valuations. We observed those bank stocks losing momentum and the benchmark equity index evaporation right after, a harbinger for what might happen remainder of the year.

At this stage we find it important to find out what the industry-specific and macroeconomic determinants of Turkish banks’ profitability are because of its strong impact on the characteristics of stock market. To be more accurate I narrow the scope of this research and used the data of the commercial banks only -which is compiled by Turkish Banking Watchdog (BRSA)-.

Below is a list of possible determinants of Turkish commercial banks’ profitability.

  • Total Assets (log)
  • Capital Adequacy Standard Ratio
  • Loans to Assets
  • Non-performing Loans Ratio
  • Liquid asset to assets
  • Deposit to Assets
  • Loan to Deposit
  • Net Interest Margin
  • Non-interest Income
  • Annual Real GDP Growth
  • Annual Inflation
  • Real Interest Rates

After collecting the data over the time period between 2003 and 2014 I calculate the correlation between the variables listed above which is as follows:

Turkey - Determinants of Banks Profitability - Table 1

As a profitability measure again we use the return on equity (RoE) ratio. Following that, this next table demonstrates the relationship between the profitability of Turkish commercial banks and the given independent variables through a regression analysis.

Turkey - Determinants of Banks Profitability - Table 2

The results suggest that the relationship between the banks’ profitability and the selected macroeconomic variables is significantly weak. On the other hand we find out that the banks can improve their profitability through increasing their capital adequacy and decreasing their loan/asset or loans/deposit ratio. Our main deduction from the latter finding is that to improve their profitability the commercial banks in the country need pay more attention to being well-capitalized and having a more liquid financial position with lower loan/deposit ratio.

For the issue of declining capital adequacy ratios in Turkish banks read this.

and this is for the increasing risks around loan/deposit spreads.

Considering the above-mentioned developments it would not be surprising to see banks posting lower income figures in the upcoming quarters.