Determinants of bank’s profitability: role of poor asset quality in Asia

The purpose of this paper is to study the determinants of Asian banks’ profitability with particular focus on the role of asset quality. This concern has been particularly important as the Basel III imposed more stringent requirements in banking regulation.

The paper uses fixed effect estimation for the panel data of the sample that consists of 947 banks from 12 Asian economies over the period of 2001-2015.

The authors find that poor asset quality (measured as impaired loans over gross loans) has a significant negative impact on banks’ profitability. Other bank-specific variables – capital adequacy, income diversification and operating inefficiency – are also important determinants. With regard to macroeconomic factors – real gross domestic product growth has most significant influence on the performance of banks.

The authors also find that the banks operating in non-advanced economies enjoy higher profit margin than banks operating in advanced economies.

Although the average asset quality in Asian banks improved over the years, governments could promote more competition, particularly in non-advanced economies. Banks in the region are recommended to diversify their income by avoiding over reliance on interest income.

Although there are prior studies that looked into asset quality, in particular with regard to the European and US experience, to the best of the authors’ knowledge there is no such study that explores cross-country Asian countries. In addition, the other primary determinants of Asian banks’ profitability are investigated. Further, the authors also looked in depth at the performance of the banks in advanced and non-advanced Asian economies.