Relative Importance of Profitability Drivers of Indian Banks: A Preference Decomposition Approach

Abstract:     
The Asset Liability Management (ALM) process in a bank is multidimensional in nature. The best possible trade off solution for profitability will have to strike an appropriate balance among the key drivers viz., advances, investments, deposits and other income (non-interest income), while simultaneously taking care of the regulatory and other constraints. The objective of this paper is to estimate, in a robust manner, the relative importance of advances, investments, deposits and other income in predicting profits. A comparative assessment is made of the two methods: Ordinary Least Square (OLS) and Robust Regression based on Least Absolute Deviation (LAD) in order to select the one that is appropriate in this situation. The results show that the robust regression outperforms OLS in terms of predictive accuracy, particularly in the context characterized by outliers and non-normal distribution with longer tails. Elasticity coefficients have been computed using the estimated slopes of the robust regression as inputs for arriving at the percentage relative importance of each driver of profitability. For this study, data filtering for inconsistencies warranted exclusion of some banks. Secondly, the focus is mainly on predictive accuracy and not hypothesis testing where OLS may still prove to be more useful. These are the two limitations of the study.

Accepted Paper Series