MODELING PROFITABILIY OF PRIVATE BANKS IN ETHIOPIA

Abstract

Profitability is the ability to make revenue from the overall business activities. Financial institutions is dominated by the banking industry that results panel data that requires panel model to analyze and explore determinant factors associated with its profitability. In Ethiopia all the financial systems are dominated by the banking industry and there is no foreign bank involvement; the financial markets leave to only domestic state-owned private and public banks. Previously linear regression and static panel model were applied to address the bank profitability determinants. However these methods explain profitability at a point of time and not consider the dynamic nature of profitability. Instead, dynamic panel models reflect dynamic features of profitability coherent with society. The main objective of this study was aimed to model determinants of private banks profitability in Ethiopia during 2012–2021 considering its dynamic nature. Return on assets, return on equity, and net interest margin were used in this study as profitability indicators and analyzed using dynamic panel model estimation methods based on the first differenced and system generalized moment method estimation techniques based on the data extracted from national bank of Ethiopia. The exploratory data analysis result showed the profitability; return on asset was seems stable while return on equity was decreased and net interest margin was increased with decreasing rate. The model specification result showed one-step system generalized moment method estimation was an appropriate estimation technique as model estimation result directs lagged profitability, capital adequacy, asset quality and size of banks have positive significant effect on profitability. Similarly inflation rate and economic growth rate have positively determine private banks profitability on macroeconomic side. Despite to this results liquidity was significant negative bank specific determinant of profitability. The study result recommends consideration on capital adequacy, asset quality, liquidity, branch of banks for the private banks profitability. In addition, this study will call upcoming research to model profitability on return on equity and net interest margin with determinants such as credit risk and non-performing loan with improving the estimation method of panel autoregressive distributed lag models for modeling profitability in Ethiopia.