The Determinants of Bank Profitability: Empirical Evidence from India

Abstract

The banking sector in India has undergone numerous structural changes, affecting the banking industry in particular and the economy as a whole. In this paper, the internal and external determinants of profitability of commercial banks in India after financial reforms are studied. Panel data techniques with the linear model of Bourke (1989), the methodology employed by Demirgüç-Kunt and Huizinga (1999), and Dietrich and Wanzenried (2011) are used in order to address the issues. Profitability of Indian banks is considered as a dependent variable, which can be measured variedly. However, four important variables, namely, Return on Assets (ROA), Return on Equity (ROE), Net Interest Margin (NIM) and Liquidity (LIQ), are examined. A set of independent variables such as bank-specific factors, namely, Bank Size (SIZ), Operating Efficiency (EFF), Concentration (CON), Risk Index (RI), Capital Average Ratio or Average Capitalization Ratio (CAR), Privatization (PVT) and Quote (QUT) on the stock exchanges, and macroeconomic variables, namely, Gross Domestic Product (GDP) and inflation rate are taken into account. The selected 14 Indian commercial banks during the study period, have the influence of bank-specific determinants, except EFF, and macroeconomic determinants, except GDP, on banks’ profitability. Indian commercial banks’ profitability as measured by ROE, ROA and NIM has a negative relationship with regressors like SIZ, CAR, CON, and GDP. Fixed effect model is found to be the best fit under ROE, ROA and NIM.