The Determinant Factors of Bank Profitability in Indonesia

Abstract

Indonesian financial system is a bank based, where the banking system carries a vital role in the economy. That makes the profitability and the stability of the banking industry is essential to preserve economic growth. Therefore, it is critical to understand the determinant factors of bank profitability. The purpose of this study is to analyse the internal bank, external bank, as well as industry-specific determinant on bank profitability, that is measured using Return on Asset (ROA) and Return on Equity (ROE). The study will use a balanced panel data from 93 banks over the period 2015-2019 and utilize Fixed Effect-Generalised Least Square model to examine the relationship.

This study finds that different factors affect banks’ ROA and ROE. It found that capital strength has a significant and positive correlation with ROA, but it does not have a significant correlation with ROE. Cost efficiency, as expected, has a substantial and negative correlation with both ROA and ROE. As for GDP growth, it has a significant and negative correlation with ROA, but it does not have a significant correlation with ROE. That likely caused by the increasing competition from the entry of foreign banks along with economic development. Finally, inflation has a significant and positive correlation with both ROA and ROE. Surprisingly, bank size and bank ownership do not have substantial correlation either with ROA or ROE. These results suggest that banks in Indonesia can enhance their profitability by increasing capital strength and improve cost efficiency.

Keywords: Bank profitability, Indonesia, competition, capital, cost-efficiency

JEL Classification: G20, G21