Econometrics

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Browsing Econometrics by Subject "Bank Profitability"

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    Determinants of Profitability in Domestic Banking Markets: - Implications of Foreign Bank Entry.
    (Addis Ababa University, 2008-07) Sabir, Nasir; Tesfaye, Mekuria (PhD)
    A policy of openness of the domestic banking markets to international bank participation is not a universally accepted argument. While arguments in favor of foreign bank entry are argued to be broad based, there exist a set of concerns with regard to the potentially adverse effects of opening to international involvement. But neither side of these arguments is supported by hard evidence. This paper in the first place attempts to investigate what the determinants of profitability in domestic banking markets are. Afterwards, the implications of foreign bank entry to the profitability of the domestic sector will be analyzed based on the lessons taught from the experiences of the selected East African countries. In order to attempt its objectives the paper employs a dynamic econometric model, which captures the extent of barriers to entry on the profitability of the local sector through the coefficient of the lagged dependent variable (lagged profit). The problem of inconsistency and bias of OLS estimators is handled by application of the Arellano and Bover(1995) GMM estimation method. This method exploits the orthogonality condition that exists between lagged levels and differences in the difference equation and that of instruments of lagged differences and the levels in the original equation. Accordingly, it is found that bank specific variables like equity to total assets, customer and short term funding to total assets, and productivity are highly significant determinants of profitability while the credit risk to total loans and overheads to total assets, though not that significant, they do have an inverse relationship with bank profitability. Furthermore, both the industry specific variables and the macro economic variables are found to be significant determinants. The coefficient of the lagged dependent variable also indicates that the Ethiopian Commercial banking market is not characterized by competitive conditions and profits show a tendency to persist from one year to the other. This implies that, entry of foreign banks will reduce the profitability of the local Commercial banks as international banks exploit their competitive advantages and as they internalize the economic benefit of the knowledge they created, possibly subjecting domestic banks to operate at a reduced rate of return where the issue of their survival may be put in to question. Conclusively, since most of these determinants are highly affected by the quality of management either through its direct or indirect influence, it can be suggested that optimal policies to bank management is the right direction to follow in order to spur progress. Keywords; Bank Profitability, Foreign Bank entry, Bank management, Dynamic panel model, GMM.