Banks’ Profitability and Financial Soundness Indicators: A Macro-level Investigation in Emerging Countries

AbstractThe banking sector profitability has shrunk considerably after the setup of the global financial crisis, both in developed and emerging countries. The non-sustainable credit policies practiced by banks before the crisis have largely contributed to this distress. In particular in emerging markets, an easy access to credits has generated, after the financial turbulences, a considerable amount of non-performing loans which have subsequently affected the banks’ profitability. In addition, the need for an increased capitalization is also susceptible of negatively influencing the profitability in the short-run. Against this background, we test the influence of financial soundness indicators on the banks’ profitability, at the macro-level, in a set of emerging countries. Different from previous studies which assess the impact of the banking sector characteristics and of the macroeconomic context on the profitability, we focus on the internal conditions of banks. Using the IMF monthly data for the period 2005-2013 and a panel data approach, we discover that non-performing loans have a negative impact on banks’ profitability under the fixed effect model. While the level of liquidity has a mixed influence, the capitalization and the interest rate margins positively affect the banks’ profitability. As expected, the non-interest expenses negatively impact the profitability. The results prove robust either if we use the return on assets or the return on equity indicator to measure the level of profitability