The determinants of South African bank profitability

M.Com. (Finance)Abstract: The banking sector fulfils a fundamental role within the economy of a country. In South Africa, this sector contributes in excess of 20% toward GDP, and is responsible for more than 10% of overall employment in the country. Bearing the importance of this sector in mind, this study empirically investigates the most significant determinants of South African bank profitability by examining bank-specific internal and macroeconomic external factors under a panel regression framework. The four largest commercial banks in South Africa (Absa, FirstRand Bank, Nedbank and Standard Bank) as well as South Africa’s largest alternative banking institution (Capitec Bank), were examined between 2006 and 2015. Based on the results obtained, this study concludes that both bank-specific internal as well as macroeconomic external variables are statistically significant determinants of South African bank profitability. The variables of asset quality, capital strength, operational efficiency, economic activity (GDP), annual inflation and the real interest rate were found to be statistically significant on a 95% confidence level. Capital strength, economic activity (GDP), annual inflation and the real interest rate respectively displayed positive relationships to bank profitability, whereas asset quality and operational efficiency displayed inverse relationships to bank profitability. In light of these findings, this study asserts that bank management may increase profitability by closely monitoring asset quality and ensuring that expected loan losses are minimised. Banks should ensure that they are well capitalised at all times, and aim to minimise expenses incurred relative to income produced. From a macroeconomic perspective, this study informs strategic-level bank management that profitability may increase in times of positive economic growth, rising inflation levels and an increasing real interest rate. In order to ensure the profitability and longevity of South African banks, bank management needs to monitor and respond to changes in these identified variables as efficiently as possible to mitigate the risk of poor financial performance and potential bank failure in the future