Profitability Determinants Of Banks In Emerging Economies: The Case Of Pakistan

For an economy to operate and grow,a functioning and resilient financial sector is a prerequisite.A sustained performance ensures stability of the financial sector and this in turns positively impacts economic growth.A strong banking system is at the core of a sound financial system,which does not only serve as a safeguard against shocks and crisis but is also central to accelerate recovery thereafter.The dynamic business environment of current era requires financial institutions to be profitable ventures to ensure growth,solvency and competitiveness.The determinants of bank profitability,for this reason,have always been of interest to management in particular and to stakeholders in general.The idiosyncratic and knowledgeintense nature of the financial institutions requires them to rely on a range of intangible and tangible resources.This has attracted researchers and academics to scrutinize and examine determinants of bank profitability.This study is a contribution to the knowledge in this spectrum.It investigates the determinants of bank profitability in emerging economies,using Pakistan as a case.This study analyses the impact of bank-specific,industry-specific and country-specific variables on the profitability of Pakistani banks.Additionally,the study also looks into the impact of corporate governance and political connections of bank directors on the profitability.Acknowledging that the knowledge-based intellect is a critical resource of modern era,this study also examines the impact of Intellectual Capital performance on the profitability and productivity.This study employs a two-step Generalized Method of Moments(GMM)system estimator,which produces robust and corrected inference and caters the problems of endogeneity,unobserved heterogeneity,and profitability persistence.However,both fixed effect and GMM regressions are also used for the additional analyses.The empirical results of this study show an inverted U-shaped relationship between assets and profitability,indicating that,up to a certain extent,an increase in the assets has a significant positive impact on the profitability,and beyond that extent,a further increase in the assets decreases profitability.Further,results show that the profitability of Pakistan banks is explained by factors like higher solvency,strong financial structure,higher labor productivity,lower operating cost,strong market power of banks,and economic growth of the country.On the other hand,the results also report that the profitability of Pakistani banks is significantly negatively affected by factors like lower credit quality,operational inefficiency,state of banking sector development,industry concentration,and inflation.This study reports new evidence related to the government transition and finds significantly lower profitability of banks in Pakistan during the period of government transition.Pertaining to corporate governance variables,the findings report an inverted U-shaped relationship between board size and banks profitability,suggesting that the board size beyond 8–9 members deteriorates the profitability.The study further reports a positive impact of board composition,board independence and directors' compensation while a negative impact of frequent board meetings,presence of foreign directors,and audit committee independence on banks profitability.Furthermore,the findings affirm that the bank profitability is negatively affected due to the presence of politically connected directors on the board.It finds significantly lower return on assets,return on equity,net interest margin and profit margin for banks who have politically connected directors on the board.This study also affirms the negative political influence in the sustainability of banking sector by reporting significantly lower return on assets,return on equity,net interest margin and profit margin during the government transition for the banks having politically connected directors sitting on their board.Concerning the Intellectual Capital determinants,the results report both linear and non-linear impact of value added intellectual coefficient(VAIC)and Modified VAIC on profitability and productivity,affirming an inverted U-shaped relationship.This suggests that an increase in Intellectual Capital performance increases the profitability and productivity up to a certain extent,and beyond that,a further increase in intellectual capital performance decreases profitability and productivity.Among the three components of value added intellectual coefficient,Capital Employed Efficiency and Human Capital Efficiency are found to have a significantly positive and Structural Capital Efficiency is found to have a significantly negative impact on banks profitability.The results further suggest that human capital is the most influential intellectual resource,which produces higher intellectual efficiencies and increases the profitability significantly.The results of this study are likely to be of interest to management,regulators,policy makers,researchers and academics.It is hoped that the study contributes by providing useful insights into the important conventional and non-conventional determinants that drive the bank profitability in emerging economies in particular,and in other economies in general.