Determinants of Profit Ability in Domestic Banking Markets: - Implications of Foreign Bank Entry.
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Date
2008-07
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A.A.U
Abstract
A policy of openness of the domestic banking markets to international bank pm1icipation
is not a universally accepted argument. While arguments in favor of foreign bank entry
are argued to be broad based, there exist a se t of concerns with regard to the potentially
adverse effects of opening to international involvement. But neither side of the se
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 less on s taught from
the experiences of the selected East African countries.
in order to attempt it s objectives the paper employs a dynamic econometric model, which
captures the extent of barriers to entry on the profitability of the local sector thro ugh the
coefficient of the lagged dependent variable (lagged pro fit ). The problem of
inconsistency and bi as of OLS estimators is handled by application of the Arellano and
Bover(J 995) 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 fi.ll1din g to total assets, and productivity are highly significant
determinants of profitability while the credit risk to total loans and overheads to total
assets, though no t that significant, they d o 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 variableals indicates that the Ethiopian commercial banking market is not
characterized by competitive conditions and profits show a tendency to persist from on e
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 advantage s
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 in direct influence, it c ml be suggested that
optimal policies to bank management is the right direction to follow in order to spur
progress .
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Keywords
Bank Profitability, Foreign bank entry, Bank management, Dynamic panel model,, GMM