The determinants of profitability of Indian commercial banks: A panel data approach

• Date: 01 January 2019
• Author: Faozi A. Almaqtari,Eissa A. Al‐Homaidi,Mosab I. Tabash,Najib H. Farhan
• DOI: http://doi.org/10.1002/ijfe.1655
• Published date: 01 January 2019

RESEARCH ARTICLE

The determinants of profitability of Indian commercial

banks: A panel data approach

Faozi A. Almaqtari

1

| Eissa A. Al‐Homaidi

2

| Mosab I. Tabash

3

| Najib H. Farhan

2

1

Faculty of Commerce, Aligarh Muslim

University, Aligarh, UP, India, Hodeidah

University, Hodeidah, Yemen

2

Faculty of Commerce, Aligarh Muslim

University, Aligarh, India

3

College of Business, Al Ain University of

Science and Technology, Al Ain, United

Arab Emirates

Correspondence

Mosab I. Tabash, Assistant Professor,

College of Business, Al Ain University of

Science and Technology, Al Ain, United

Arab Emirates.

Email: mosab.tabash@aau.ac.ae

Abstract

The current study examines the determinants of profitability of Indian com-

mercial banks. The analysis is conducted over a period of 10 years in which

the Indian banking sector has gone under different changes such as demone-

tization and issues related to banking sector sustainability and banking sector

frauds. The analysis is based on balanced panel data over a period ranging

from 2008 to 2017 for 69 commercial Indian banks. Profitability of Indian

banks is measured by two proxies, namely, return on assets (ROA) and return

on equity (ROE), whereas bank size, assets quality, capital adequacy, liquidity,

operating efficiency, deposits, leverage, assets management, and the number of

branches are used as bank‐specific factors. Further, a set of macroeconomic

determinants such as gross domestic product, inflation rate, interest rate,

exchange rate, financial crisis, and demonetization are used as independent

variables.

Stationary test along with pooled, fixed, random effect models and panel cor-

rection standard error are used in this study. The results revealed that bank

size, the number of branches, assets management ratio, operational efficiency,

and leverage ratio are the most important bank‐specific determinants that

affect the profitability of Indian commercial banks as measured by ROA. Fur-

thermore, among the bank‐specific determinants, the results revealed that

bank size, assets management ratio, assets quality ratio, and liquidity ratio

are found to have a significant positive impact on ROE. With regard to the

macroeconomic determinants, the results revealed that the inflation rate,

exchange rate, the interest rate, and demonization are found to have a signifi-

cant impact on ROA. However, in the case of ROE, the results show that all

macroeconomic determinants except demonization have a significant impact

on the bank's profitability as measured by ROE.

KEYWORDS

bank‐specific, commercial bank, demonetization, financial crisis, India,profitability

1|INTRODUCTION

The performance of a country's economy to a large extent

depends on the performance of its banking sector. Banks

play a vital and substantial role in the development of any

economy (Menicucci & Paolucci, 2016). Since the 1990s,

India has witnessed a significant liberalization with the

intentions to increase productivity and to enhance the

Received: 20 April 2018 Revised: 9 August 2018 Accepted: 9 September 2018

DOI: 10.1002/ijfe.1655

168 © 2018 John Wiley & Sons, Ltd. Int J Fin Econ. 2019;24:168–185.wileyonlinelibrary.com/journal/ijfe

efficiency of Indian banks (Ghosh, 2016). Following

the liberalization in 1991, the Indian banking sector

has become a fast flourishing industry that has

contributed to the growth of other major industries

(Singh, Sidhu, Joshi, & Kansal, 2016). India is the largest

country in South Asia with a considerable financial

system characterized by diversified financial institutions

(Ghosh, 2016).

The banking system in India composes of 27 public, 26

private, 46 foreign, 56 regional rural, 1,574 urban coopera-

tive, and 93,913 rural cooperative banks. Public sector

banks represent about 70% of the total assets of the Indian

banking system (Shrivastava, Sahu, & Siddiqui, 2018). The

financial system of India is dominated by the commercial

banks. In a competitive, challenging, and regulatory

environment like India, the Indian commercial banks

have to allocate effectively and efficiently their assets and

liabilities to increase the profitability (Viswanathan,

Ranganatham, & Balasubramanian, 2014). As shown in

Figure 1, there is an increasing trend of total liabilities to

assets, deposits to loans, and borrowings for Indian banks

over the period from 2013 to 2017.

Despite the increasing trend of balance sheet indica-

tors, the profitability of Indian banks has decreased over

the period from 2013 to 2017. As shown in Figure 2,

return on asset (ROA) and returns on equity (ROE) have

deteriorated over the period from 2013 to 2017.

In spite of declining the profitability of Indian banks

in the last recent years, some critical questions that may

arise in this regard are “What are the determinants of

the profitability of Indian commercial banks?”And also,

what are the main causes for such kind of decline in

the profitability measures during this period?

The main aim of this paper is to evaluate the impact

of bank‐specific factors and macroeconomic determinants

on profitability of the Indian commercial banks. The cur-

rent study focuses on a major and important sector in an

emerging economy such as India. Taking into consider-

ation some new governmental policies and procedures

such as demonetization process that may affect the

profitability of Indian banks and global financial crisis

2008. Moreover, fraud cases that raised recently in

Feb 2018 when tax department estimated that Indian

banks could take a hit of more than U.S. $3 billion as a

result of Punjab National Bank scam which is the

country's second‐biggest governmental bank. Further-

more, the biannual Financial Stability Report of India's

central bank (Reserve Bank of India [RBI]) was released

on June 30, 2017, which raised some big concerns

about the sustainability of the country banking system.

RBI warned that the sector is under severe stress, with

mounting bad loans and an increase in banking

frauds. All the above policies and measures show the

importance of this study that pushes all policymakers

and researchers to examine the external and internal

factors affecting the profitability of the Indian commer-

cial banks.

This paper is organized as follows: Section 2 provides

the literature review. Section 3 presents the determinants

of profitability of Indian commercial banks. Section 4

shows the data and methodology of the study. Analysis

and results are given in Section 5. Section 6 concludes

the paper and gives recommendations.

2|LITERATURE REVIEW

Bank's profitability has been extensively investigated in

different countries around the world. Although there

are three main common streams in the prior literature

of a bank's profitability, all conducted studies have the

same purposes and outlines. Garcia and Guerreiro

(2016) and Saona (2016) have focused their research on

internal and external factors affecting bank's profitability.

Further, Anbar and Alper (2011), Athanasoglou,

FIGURE 1 Balance sheet operations of Indian banks 2013–2017

[Colour figure can be viewed at wileyonlinelibrary.com]

FIGURE 2 Profitability (ROA and ROE) of the Indian banks

2013–2017. ROA: ratio of bank net profit to total assets; ROE:

ratio of net profit to shareholders equity [Colour figure can be

viewed at wileyonlinelibrary.com]

ALMAQTARI ET AL.169