Internal Factors Influencing the Profitability of Commercial Banks in Bangladesh

The profitability of commercial banks is influenced by a number of internal and external factors. This paper attempts to identify the internal factors which significantly influence the profitability of commercial banks in Bangladesh. In this study, profitability is measured by ROA and ROE which may be significantly influenced by the internal factors such as IRS, NIM, CAR, CR, DG, LD, CTI and SIZE of the bank. Data are collected from published annual reports during 2014-2018 of 23 commercial banks. Using simple regression model, it is found that CR has significant effect on the profitability and CAR has significant influence on ROA only. In addition to this, DG has significant effects on PCBs’ profitability (ROE only) where as IRS and CTI have significant influence on profitability (ROA only) of ICBs. Further, none of these variables have significant effects on the profitability of SCBs but CAR and CR are correlated with profitability (ROA only) and the causes may be the nature of services provided by SCBs to its clients. The internal policy makers should manage the influential internal factors of the banks in order to increase their profitability so that they can meet stakeholders’ expectations.


Introduction
Banking industry is the vital part in any economy because it plays an important role in mobilizing savings from surplus to deficit unit to stream economic activities of the country which propel its economic growth. Stable, healthy and competitive banking industry of a country can significantly contribute to economic growth and development of a country (Bawumia et al., 2005). Further, Mujeri and Younus (2009) asserted that for enhancing economic growth, an important prerequisite is to ensure the required flow of saving into productive investments which depends on the development of appropriate financial institutions particularly banks that are capable of generating adequate quantity and quality of investment. To provide financial services to the economy formal financial institutions specifically banks are established which offer various financial services to its clients including deposit collection and credit disbursement, in order to achieve its primary objective i.e. profitability. Obidike et al. (2015), asserted that financial institutions are established to provide financial services with a view to make profit. The banking industry is managed by the central bank of the country. The central bank monitors all the activities of the commercial banks (Kalsoom et al., 2016). In this regard, Bangladesh bank (BB) monitors, regulates, promotes, directs and controls the activities of commercial banks in Bangladesh. The commercial banks started to provide banking services in Bangladesh thorough nationalizing twelve pre-independent commercial banks in 1972. To make the industry effective and efficient as well as to provide better financial service to the citizen, a number of commercial banks licensed time to time which are operating according to the bank company act 1991. Hossain and Ahamed (2015) stated that increased competition due to frequent entrants ultimately affect the banking profitability. At present, the industry has exaggerate number of banks and sometimes these numbers may affect profitability and cause to be over competitive even inefficient the industry as Mexico has only 47 commercial banks with 7.4 times larger GDP and 13.2 time larger surface area of Bangladesh in 2016 (Khatun et al., 2018).
In Bangladesh, the banking industry comprises sixty scheduled commercial banks of which six are state owned commercial banks (SCBs), three specialized banks, thirty one private commercial banks (PCBs), eleven Islamic shariah-based commercial banks (ICBs), and nine foreign commercial banks (FCBs). Generally, the bank primarily, as an intermediary, collects money from depositors and lends those to borrowers because it has no money and difference between the lending and borrowing price contribute its profitability. Profitability is ability of a company to use its resources to generate revenues in excess of its expenses i.e. company's capability of generating profits from its operation. It is influenced by various factors such as internal, industry specific, economic specific, etc. Olweny and Shipho (2011) concluded that the bank-specific factors were more significant factors influencing the profitability of commercial banks in Kenya than market factors. The study also revealed that profitable commercial banks were strive to improve their capital bases, reduce operational costs, improves assets quality by reducing the rate of non-performing loans, employs revenue diversification strategies as opposed to focused strategies and kept the right amount of liquid assets. Further, Ramadan et al. (2011) investigated the nature of the relationship between the profitability of banks and the characteristics of internal and external factors on 10 banks of Jordan. They found that profitability tends to be associated with well capitalized banks, high lending activities, low credit risk, and the efficiency of cost management. San and Heng (2013), investigated the impact of bank-specific characteristics and macroeconomic conditions on Malaysian commercial banks financial performance. They found that equity assets ratio and liquidity ratio had significant positive relationship with return on assets, bank size had positive significant relationship with return on equity loan loss reserves to gross loans ratio had negative significant relationship with return on assets and net interest margin. In order to assess the definite area of the industry, this study deals with internal factors of the banks that usually contribute to the banks' profitability.
Therefore, the specific objectives of this study are to identify bank-specific internal factors that significantly influence the scheduled commercial banks' profitability and assess whether these influential factors may vary among different segment of commercial banks. Further, time dimension changes from earlier studies may change these factors to influence its profitability. The outcome of this study will help stakeholders to make appropriate policy or pay close attention to manage internal factors efficiently to improve the profitability/commitment of the organization to the society.

Literature Review
There are numerous studies on the profitability of this high competitive industry in every country and most of the studies dealt with profitability. The factors influencing the profitability also vary from countries to countries or time to time and the influential factors are considered from wider areas. Dietrich and Wanzenried (2011), concluded that equity to total assets ratio, cost to income ratio, deposit growth rate, funding cost, interest income, effective tax rate and ownership structure negatively affect banking profitability in Switzerland. Khan et al. (2011), studied the determinants of bank profitability in Pakistan and found that bank size, loan growth, deposits to asset ratio, deposit to loan ratio had significant positive relation where net interest margin, tax and overhead expenses had negative significant relation with profitability. Oladele et al. (2012), found that operating expense; relationship between cost and income, and equity to total assets significantly affected the performance of banks in Nigeria. Ongore and Kusa (2013), found that bank specific factors (capital adequacy, management efficiency, liquidity management) significantly affect the performance of commercial banks in Kenya, except for liquidity variable. Further, Poudel (2012) concluded that default rate (DR) and capital adequacy ratio (CAR) have negative association with ROA where as cost per loan asset (CLA) also has an inverse relationship with banks' profitability measured by return on assets (ROA) in Nepal. Chavarin (2014), analyzed on the determinants of 45 commercial bank profitability in Mexico and found that the profitability of commercial banking is persistent by control of operating expenses, the charging of commissions and fees, and the level of capital and also found that market entry barriers and obstacles to competition as a relatively high persistence of profitability. There are also a number of studies on bank-specific are conducted in Bangladesh such as Samad (2015) identified a few bank specific factors such as loan-deposit ratio, loan-loss provision to total assets, equity capital to total assets, and operating expenses to total assets and the researcher finds that they significantly impact the performance of commercial banks. Mahmud et al. (2016) incorporated several bank specific factors in determining the profitability of commercial banks in Bangladesh. The study indicated that capital adequacy ratio, bank size, and total debt to total equity have significant impact on bank performance. , found that capital ratio, total loan as a percentage of total assets and staff expenditure as a percentage of total assets are highly correlated with profitability whereas total expenditure as a percentage of total assets and cost income ratio are highly negatively correlated with profitability. The study also suggests that bank size, operating efficiency; savings deposits as a percentage of total assets, branch, liquidity ratio, and assets management have no significant relationship with profitability. A number of recent studies in Bangladesh relating to this study are chronologically presented in Table 1. CRAR and cost-to-income are negatively correlated, and liquidity is positively correlated to bank profitability. On the other hand, estimation shows a negative correlation between bank size and profitability. Moreover, NPI is found to be positively correlated to ROA.
From above discussion, Return on Assets, Return on Equity, Interest Rate Spread, Net Interest Margin, Capital Adequacy Ratio, Non-performing Loan to Total Loan, Deposit Growth, Lending Deposit Ratio, Cost to Income Ratio and Bank Size are used as variables in order to achieve the objectives of this study because these are the most commonly identified variables in the earlier studies which significantly influence the performance of the industry.

Population
The population of this study is 60 scheduled commercial banks which are divided into State owned commercial banks (SCBs), Specialized banks (SBs), Private commercial banks (PCBs), Islamic shariah-based commercial banks (ICBs), and Foreign commercial banks (FCBs).

Sampling and Sample
Quota sampling procedure is used to select four SCBs, fifteen PCBs, four ICBs for this study (appendix-A). SBs and FCBs are excluded in this study due to the special nature of service provision and the complexity of available structural data respectively.

Variables
The variables of this study are divided into dependent and independent which are described as follows:

Dependent Variables
The banks' performance can be explained in different ways and one of traditional approach is to look at the profit and loss account of banks which can be considered as microeconomic approach. On the other hand, the performance can be considered by considering the commercial banks' aggregate total assets and liability statement in an economy which can be regarded as macroeconomic approach. Beyond these, Return on Asset (ROA) and Return on Equity (ROE) are two of the important accounting measures of bank profitability. These are considered as depended variable in this study and explained as follows: Return on asset (ROA): It is a broad measure of overall bank performance which explains management's ability to produce income by using assets where high ROA indicates better performance in using assets. Alternatively, it measures the efficiency of using resources to earn income (Ally, 2013;Zopounidis and Kosmidou, 2008). It is measured as net income before tax divided by total assets.
Return on equity (ROE): One of the innermost measures of banking performance for allocating capital among divisions that can be as the ratio of pre-tax profit to equity is ROE. High ROE indicates high managerial performance (Moussu and Petit-Romec, 2014). It is measured as net income after tax divided by total equity. Musah

Independent Variables
The performance of the banks is influenced by numerous internal factors which are considered as independent variables of the study. A brief description of the independent variables used in this study is given below: Interest Rate Spread (IRS): The difference between commercial banks' interest rate on deposit and lending is call interest rate spread. These rates may vary due to bank specific factors, industry/market specific factors as well as macroeconomic factors etc. Generally banks have different lending rates and deposit rates to its different products and the average of overall lending rate and borrowing rate is treated as interest spread (Mustafa & Sayera, 2009)

. It is measured as (interest received divided by all interest bearing assets) minus (interest paid divided by interest earning liabilities).
Net interest margin (NIM): NIM is the ratio of net interest income to total earning assets. Aboagye et al. (2008) stated that it is the best measure to represent bank interest rate spread which is supported by Amidu and Wolfe (2013), Ongore and Kusa (2013); and San and Heng (2013). It is measured as banks' interest income minus banks' interest expenses and the result is divided by total assets. Capital Adequacy (CAR): It is the ratio of total assets financed by equity. If the ratio is higher, then bank has lower external borrowings which positively contribute to the profitability.
Credit Risk (CR): It is the ratio of non-performing loans to total loan (earning assets). This variable measures the quality of lending because competition may force to lend high volume without maintaining quality of the client which ultimately reduces the profitability of the bank.
Deposit Growth (DG): Deposit is the prime source of banks' fund at lowest cost. If a bank's deposit is growing year to year, then lowest cost funding is increasing and that may contribute to the profitability of the bank. It is measured as deposit at year 1 minus deposit in previous year and the result is divided by deposit in previous year.
Loan to Deposit Ratio (LD): It is one of the determinants of liquidity as the amount of lending against the amount of deposit. Scheduled Commercial banks convert deposits into lending so that it can increase profit. A high ratio has positive relation with profitability where as increasing liquidity risk alternatively, a low ratio confides liquidity but reduces profitability.
Cost to Income Ratio (CTI): It is a measure of operating expenses as a percentage of operating income. It is a popular and critical measure of banks' efficiency. A lower ratio generally indicates higher efficiency and vice versa.
Bank Size (Size): It is the bank total asset size. This study takes logarithm of total assets as a proxy of size (Samad, 2015). This assets size influence the clients' confidence as well as profitability of the bank though operating efficiency. It may have positive relation with profitability (San and Heng, 2013;Zeitun, 2012).

Data
Data collection is a systematic process of gathering data for a particular purpose from various sources. In this study, data have been collected from published annual reports of 23 commercial banks covering a period from 2014 to 2018 resulting 230 sample observations. The data is reliable as it drawn from the audited financial statements included in the annual reports. The data is generated in the defined state using measurement techniques stated in table 2.

Data Analysis
The study adopts the quantitative approach to analyze data applying regression because the study seeks to establish the relationship between dependent variables and independent variables. The analyses are performed using SPSS 23.0.

Hypothesis of the Study
The hypothesis of this study is formed according to the effects of independent variables on dependent variables. In this study, it is expected that IRS, NIM, CAR, DG, LD and SIZE have positive effects on profitability where as CR and CTI may have negative effects on profitability. Therefore the declared hypotheses of this study are as follows: H 1 : IRS has significant positive effect on profitability.

Descriptive Statistics
The overall and segmented descriptive statistics are presented in Table 2. It is found that the overall ROA is 0.78% which typically represents the private commercial banks (PCBs) (0.83%) where as state owned banks (SCBs) earned around half (0.34%) of the overall figures and ICBs earned 30.77% more than the overall earnings (Islam and Rana, 2017). Similar trend found in ROE, NIM, LD and CTI where as IRS, CA, and Size are comparatively stable among the segments. The SD follows the same pattern (Rahaman and Akhter, 2015). In addition, SCBs have double and ICBs have half CR compared to the overall CR where as ICBs have three times of the industry DG and SCBs have just opposite position direction. Among the segments, PCBs are ideally representing the industry.

Regression
In Table 3, it is found that only CAR and CR have significant effects on ROA where as ROE is significantly influenced by CR and CTI . The adjusted R 2 for ROA and ROE are 48.1% and 39.6% respectively which indicates that these independent variables can explain ROA better than ROE (Hossain and Khalid, 2018). The models are well fit because the probability of the test statistic is significant for dependent variables. The detailed results are presented in table 3.   It is found that independent variables explain half of the dependent variables and only CAR, CR have significant influence on ROA (Noman et al., 2015) and ROE of PCBs respectively (Table 4). In table 5, independent variables explain aggregately 87.4% variation in ROA and it is significantly influenced by IRS, CAR and CTI of ICBs. Further, the model is well fit because the probability of test statistic is significant where as none of the independent variables has significant influence on ROE as only 12.5% of ROE can be explained aggregately by the selected independent variables . In all cases, these independent variables can superiorly clarify ROA than ROE. Only ROA of PCBs and ICBs is significantly influenced positively by CAR (Khatun and Siddiqui, 2016) where as ROE of only PCBs is influenced negatively by CR. The industry is represented and dominated by PCBs because the PCBs captured majority of the industry. On the other hand, the independent variables of SCBs cannot significantly influence its profitability (ROA and ROE) of SCBs, but can explain only 12.4% and 1.9% variation of ROA and ROE respectively and the models are not well fit because the probability of test statistic is not significant (appendix c). It indicates that SCBs profitability may be significantly influenced by other factors such as ownership structure, agency services to the government, etc. For example, these banks are owned by government and collect fees, charges, tax, etc, of government and also provide general banking services to its clients.

Summary of Findings
It is found that all the hypotheses are rejected for SCBs which means that none of these factors significantly influences the profitability of SCBs because this group provides client-services mostly related to government. So profitability of SCBs may be significantly influenced by fees, charges, commission, etc it received as non-operating revenue. H 1 is rejected except ROA of ICBs which indicates that ROA of ICBs will increase if its IRS increases. NIM cannot influence the profitability of commercial banks in Bangladesh (H 2 is rejected). Profitability (ROA) of PCBs and ICBs is influenced by CAR (partially accepted H 3 ) where as it is also (ROE of PCBs and ROA of ICBs) influenced by CR (H 4 partially accepted). DG has influence on profitability (ROE) of PCBs and ROA of ICBs is influenced by CTI (partially accepted H 5 and H 7 ). Finally, LD and SIZE have no significant influence on profitability of scheduled commercial banks of Bangladesh. The profitability of different segment of banks is influenced by different variables but CAR significantly influences the profitability of the industry.

Conclusion
The banking sector of Bangladesh is dominated by the PCBs because it captures the industry. The SCBs provide most of government activities related services where as motto of the ICBs is serving to client on Islamic shariahbased. The study importantly assesses how the internal factors influence profitability varying different segment of banks. It is found that CAR and CR have significant relationship with ROA and only CR has with ROE. None of these variables has significant influence on profitability of SCBs where as the profitability of the industry is influenced by CAR. So the study suggests policy makers to concentrates influential internal factors and efficient management of these factors will further contribute to the profitability of the entity effectively.