Research On South Asian Banking Sector Profitability And Efficiency

Banking sector is backbone of the financial system of South Asian countries.In absence of sophisticated capital,bond and derivative markets,banking sector is the only alternate source of funds for the other sectors and sustainable economic growth of these developing countries.South Asia is chosen as the sample,because,it is a unique set of developing countries.Including Afghanistan,Bangladesh,Bhutan,India,Maldives,Nepal,Pakistan,and Sri Lanka,these countries share similar historical,cultural,economic,financial,and banking conditions.Banking sectors in these countries have been deregulated and privatized almost in the same period at the end of the 20^th century.In this scenereo,it becomes necessary to study the performance of South Asian banks,to take essential measures on part of banks'management and regulators to increase performance of banking sector in this region.Generally,to measure the performance of banking sector,its profitability and efficiency is measured.An efficient and profitable banking sector is more likely to withstand financial and economic distress like recent global financial crisis of 2008-2009.After extensive literature review it is found that abundant studies are available on profitability and efficiency of banking sectors around the world.But no adequate literature is available on South Asian banking sectors profitability and efficiency in recent years.The purpose of this study is to supplement the existing body of banking profitability and efficiency literature in South Asia.This study has used annual financial data from bankscope database for a period of 15 years from 2000 to 2014.This study has identified and emperically analysed how various factors affact profitability and efficiency of South Asian banking sector,to help South Asian banks to improve their profitability and efficiency.Keeping in view the literature gap this study has focused on the following four aspects of profitability and efficiency of South Asian banking sector.Firstly,under the concept of Traditional Theory of the Firm Profit Maximization,this study has tried to identify the latest internal and external factors affecting the profitability of commercial banks from all South Asian countries.Two step system GMM estimator is applied on data from 200 commercial banks for an extensive set of variables.The empirical results show that profitability of South Asian banking sector is negatively affected by funding cost,non-performing loans,and administrative expensive,and positively affected by capital adequacy,liquidity,non-fund based services,deposits,and loans.The effect of bank size,economic growth and inflation is found to be insignificant.These determinants of profitability have identified the control variables to study the effect of investments and global financial crisis on profitability of banks and remaining chapters.Secondly,Portfolio Management Theory describes,how risk-averse investors can build portfolios to boost anticipated returns,based on a certain level of market risk.As a result of increased credit risk during global financial crisis 2008-2009 Pakistani banks started diversifying their portfolio from loans to risk free fixed income securities and other investments.This study has empirically investigated the impact of this unique phenomenon on the profitability of Pakistani banking sector.The current study has proved theoretically and empirically that fixed effects model is appropriate for this analysis.Fixed Effects regression results grants empirical support to this fact that profitability of the Pakistani banking sector was reduced during 2008-2009 due to the global financial crisis?GFC?2008-2009 and resulting increased proportion of investments in total assets.Second stage analysis confirmed the above results and showed that the profitability of Pakistani banking sector was higher in pre and post crisis years,than in financial crisis period.Further,the study found that private and foreign banks were more affected by GFC than public sector,specialized and Islamic banks.The results are robust to alternate measures of profitability.In context of developing countries this study will help bank managers and the regulators to stay better prepared to face any financial crisis in future.Economic Theory suggests that if an industry is following the Economies of Scale,larger organizations would be more efficient and might provide services at a lesser cost,and vice versa.This study empirically proves that bank size augmented the profitability of South Asian banks during global financial crisis.Thirdly,Theory of Economies of Scope advocates that the overall cost of production declines when many goods and services are produced together by same firm.Banks take advantage of the Economies of Scope when they diversify their sources of income.This study provides some latest empirical evidence about how Economies of Scope through revenue diversification has affected profitability and stability of South Asian banks.The study used extensive panel data of 200 commercial banks from all South Asian countries during 2000-2014,to investigate the impact of revenue diversification on profitability and stability of commercial banks.Applying two-step system GMM methodology the study provides new evidence and explanations on the existing puzzle,how revenue diversification affects profitability and stability?Breaking down non-interest income,revealed that“fee and commission income”brings down,but“other non-interest income”augments profitability and stability of South Asian commercial banks.These results are robust to the use of different measures of diversification,profitability and stability.This study provides meaningful insights for bank managers in the region seeking profit maximization through revenue diversification under Theory of Economies of Scope.The Efficient-Structure?ES?theory,states that relatively more efficient corporations increase their size and market share because they are able to generate more profits.Finally,the study has used a two-stage estimation methodology to measure the technical efficiency of 200 commercial banks from all South Asian countries from 2000 to 2014.Firstly,Data Envelopment Analysis?DEA?is applied to measure the overall technical efficiency?OTE?,pure technical efficiency?PTE?,and scale efficiency?SE?scores of sample banks and specified whether these banks are operating at an increasing?IRS?,decreasing?DRS?or constant return to scale?CRS?.The study found that OTE and PTE are the major source of inefficiency in South Asian commercial banks,while SE is relatively higher throughout the sample period.Further,the study found that only a few commercial banks are operating at CRS.In second stage analysis by applying panel Tobit Model regression it is found that income diversification has improved all three types of efficiencies;OTE,PTE,and SE.The study also found that higher cost of funding and higher administrative expenses are the main cause of lower efficiency while loans,investments,bank size and profitability have a positive effect on technical efficiency of South Asian commercial banks.The empirical findings of the study have significant economic value for the managemnt of South Asian banks and the regulators to improve the profitability,stability and efficiency of South Aisan banks.