Major Determinants Of Bank Profitability In Zambia

Published Date: 02 Nov 2017

AREA OF STUDY

Profitability in the bank

Major determinants of Bank profitability in Zambia

ABSTRACT

Having assumed a bank management role at age of 26, I have learnt to appreciate that it hold be very difficult to maintain a role as manager if your unit is not generating any profit. Furthermore, it should be appreciated that in a profit making organization, the primary objective is to maximise shareholder’s wealth. This means maximizing shareholder’s value flow of dividends over time (Glen Arnold,2008)

A shareholder is the a corporate or individual who owns one or more shares if stock in a company. This means that the owns enjoy the profit if the company does well or directly suffer the loss if the company fails t make profit. They directly affect the organization by investing in it thus can affect or is affected by the achievement of an organization purpose (Freeman, 1984,p53). The above having been said, it is imperative that bank management understands the major determinants of profitability as the performance of banks affects other organizations as most companies depend on banks for finance.

BACKGROUND LITERATURE

Theory of Maximising shareholder’s wealth

One of the most supreme goals of an organization is to maximise shareholder’s wealth through increased profitability. This is supported by Watson and Head 2007 who also mentioned that the primary objective of shareholders of a firm is maximise wealth and at some time the existence of other stakeholders such as creditors, employee, customers and community are also affected when adapting to a corporate goal. It is important to consider the other objectives in the short and long-term as failure to do some may affect the achievement of the primary objective of maximizing shareholder’s wealth. For example, director’s of an organization cannot do anything they went just because it maximizes weath even if it is not ethical. In a nutshell, profits should be raised through in a legal and clean manner (Friedman ,1962). Legal business may be close in the shorter.

Practical limitations in profitability

Shortemism

Some organization have ended up short term profitability at the expense of longterm maximization of profit . However, the stockmarket is not has short-sighted as people thick as stock brokers such as Amazon ,London Stock exchange and Lusaka stock exchange reward organizations for taking long term views. (Taking the long view, The Economist November, 24th 2012)

Affected by accounting methods

Organizations with low value assets will not be as highly affected by depreciation cost compared to organizations with high value assets . This is true as the International Accounting Standard (IAS) 16 guides as below;

The cost of an item of property, plant and equipment shall be recognized as an asset if, and only:

It is probable that future economic benefits associated with the item will flow to the entity;

The cost of the item can be measured reliably.

It therefore entitles that organizations whose "assets" does not met the above definition do not qualify to be called assets and thus may not have any depreciation costs as only assets are depreciated.

The external factors affecting profitability

Below are the external factors affecting profitability as outlined by Scholasticus K (last update 1st January,2013);

Demand and Supply; Demand is the willingness and ability of consumers to purchase a commodity while supply is the ability of the business to provide to customers. The higher the demand the more likely that the selling price will be increased thereby positively affecting the profitability of the organization

Inflation; Inflation occurs when there is too much supply of money in the economy thereby making the cash weak in value. This affects profitability as the value of the profit is weaken as less goods and services can by purchased from the profit.

Exchange Rate; The strength of the local currency against foreign currencies also affects profitability as profit magins are affected by exchange rates. A bank with a long position in a foreign currency may face losses foreign currency depreciates against the home currency.

Government Regulation; Bank of Zambia has introduced a maximum lending rate this may affect profitability as Zambia bank’s may maximizing profit bank charging high interest rates on Banks

Industry Factors affecting profitability

Michael Porter’s famous Five Forces of Competition Position model under Glaister, Keith W and J Richard Falshaw 1999 provides a simple perspective for assessing and analysing the competitive strength and position of Banks. This has an impact on profitability. Below is a summary;

Existing competitive rivalry between suppliers ; The more the supplier in the industry the higher the competition. This affects profitability as all suppliers are competing for the same customer base. The competition environment is Zambia is very high as the number of banks at present are 19. This has made competition very stiff.

Threats of new markets entrants; Following the increase in the number of banks in Zambia , the central bank (Bank of Zambia) increased the capital requirement for bank to K104million rebased for local banks and K520million rebased for foreign banks. This is in line with Central Bank Circular No:02/2012 dated January 30, 2012

Bargaining power of suppliers ; The less the suppliers, the more bargaining power they are likely to have. This is unlikely for Zambia banks are the industry has too many banks.

Power of buyers; The more options the buyers have the more bargaining power they have as they are free to change from one bank to another.

Threat of substitute products; Micro financing organizations are offering substitute products in Zambia as they are giving out loans at a quicker rate then Banks despite these loans been expensive .

Internal factors affecting profitability

To analyse internal factors affecting profitability, the SWOT Analysis may be used . SWOT is an acronym used the particular strengths, Weakness, Opportunities and Threats . Reference is made to Casebeer , A (1993). The Opportunities and Threats have been discussed partly in part c of this sub heading as these are external factors. I will thus concentrate on the weakness and strength as these consititue internal factors . The internal analysis is based on the capability of the organization. These may be group into tangible and intangible assets . Tangible resources are easily indentified as these can be indentified from the organisation’s financial statements such as;

The firm’s borrowing capacity through the debt to equity ratio and credit rating

Internal cash generation through Ratio of net cash to capital expenses

Value of Assets in the balance sheet.

On the other hand , intangible assets are largely invisible but may be more impoartnt then tangible assets. Intangible assets include brands, image and technological assets such as the proprietary technology and know –how.

An Explanation of the need to do the research

With the increase in the number of banks in the Zambia industry, it is important for management of these banks to appreciate the major determinents of profit if they are to continue surviving . This research thus contributes highly to the strategic position of banks in the Zambia industry.

Aims, objectives and hypotheses

Aim

To explain the major determinants of bank profit in Zambia

Objectives

To measure profitability of Zambian banks over a period of time

To compare and establish the major causes of profitability in the top four(4) most profitable banks against the list four profitable banks in Zambia

To interview directors in the banks and statistically analyse response data

In order to achieve the aim, the individual objectives first have to be achieved. The research hypotheses should relate the aims and objectives. Below is an explanation of the dependent and independent variable to be used in the hypothesis;

Return on Assets (ROA); Return on assets of the bank. This is calculated as net profit after tax divided by total assets

Capital Ratio; shareholder’s funds divided by total assets of the bank

Liquidity; Total loans of the bank divided by total assets

Inflation; Raise or fall in inflation

Gross Domestic Products (GDP); Expressed in Zambia national currency

Market share of the bank as per Lusaka stock exchange

Money Supply; Zambia money supply

Operational expense; operational expenses of the bank to total assets

Asset quality; loan loss provision to total assets of the bank

Bank size; Is equal to total assets of the bank.

Investment in technology : techonology cost to total assets

The hypothesis is thus given below;

Shareholder’s funds vs ROA

It is argued that a company with 100% shareholder’s funds maybe operating with a high cost of capital as tax benefit of borrowing is not enjoyed considering that dividend and capital appreciation are not tax deductable . On the contrary interest on debt is tax deductable. Therefore, too high ratio of shareholder’s funds to total assets may affect profitability as debt if not taken in excess as compared to industrial averages maybe considered to be cheaper (Edinburgh Business School –Finance text book 9.4.4). Therefore, the below hypothesis maybe deduced

Ho: There is no significant relationship between capital and ROA

H1:There is a significant relationship between capital and ROA

Liquidity Vs ROA

If there is limited participation in the financial market, banks lower the cost of giving investors rapid access to their capital Anyon, Jean. Ghetto Schooling Journal of political economy ,1997. This will affect the ROA as profit may be lowered as the rate of lending is reduced. If the liquidity is high therefore, it may mean that they are less market paticipants and thus ROA may be reduced. The opposite is also true.

Ho: There is no significant relationship between liquidity and ROA

H1:There is a significant relationship between liquidity and ROA

Inflation Vs ROA

Higher inflations may mean that higher costs and higher selling prices. However, it is very difficult to increase prices just becouse the inflation has increased as the demand and supply rule together with increased competition might not allow . This is supported by BBP ACCA paper F9 Financial Manament for 2011 exams page 162. A relationship is thus formed for inflation and ROA as below;

Ho: There is no significant relationship between Inflaction and ROA

H1:There is a significant relationship between Inflation and ROA

GDP Vs ROA

The GDP being the an indicator of the level of income in the country was seen to have an effect on the bank performance reference is made to Molyneux, Philip and John Thornton 1992. The higher the GDP the higher the bank profit as explained in the journal. I thus need to review the below relationships.

Ho: There is no significant relationship between GDP and ROA

H1:There is a significant relationship between GDP and ROA

Market Share Vs ROA

It was discovered in The Antitrust Bullentin/Spring 1982 that market shareincreases profitability through the benefits of scale economies. I thus strongly few that there is a relationship between market share and ROA thus the below hypothesis.

Ho: There is no significant relationship between Market Share and ROA

H1:There is a significant relationship between Market Share and ROA

Bank Size Vs ROA

Profitability was found to be a linear function of the Bank size in the research entiled Determinants of Greek Commercial Banks Profitability, 1989 -2000 by E.C Mamatzakis , P.C Remoundos. It is thus important to analysis the relationship between Bank size and ROA

Ho: There is no significant relationship between Bank Size and ROA

H1:There is a significant relationship between Bank Size and ROA

Technology investment Vs ROA

Ho: There is no significant relationship between Investment on Technologyand ROA

H1:There is a significant relationship between Investment on Technology

and ROA

Methodology

The use of questionairs will be one of the prmary methods to raise data for the research. The likert scale model questionairs may be used for this purpose. This will be done for all then 19 banks in the industry as the some of the banks may not be able or willing to respond to the questionairs. However, to ensure that most banks respond, the below will be done;

Discussions will all banks to ensure they appreciate the benefits of the research to them as a business.

Assuring them that the information will be keep confidetial and no mention of the actual bank will be done in the research

Thanking them respondents for allowing me to discuss the importance of the research to me and them .

Sending of reminders to all respondents to ensure maximum response rate.

For financial performance analysis, income statements from the registra of companies will be obtained and an analysis of all the 19 banks in the industry will be done where the below ratios will be compared in detail for a period of the previous 3 years;

Ratio of liquidity vs ROA

Ratio of GDP vs ROA

Techonology investment vs ROA

Bank size vs ROA

Asset quality vs ROA

Operational expense vs ROA

Money supply vs ROA

Market share vs ROA

Inflation vs ROA

Shareholder’s funds vs ROA

Furthermore, it may be important to observe the quality of customers service in the banks as see if there is a relationship between the quality of customer service and the level of profit. In the research design, it is important to establish the research aims and objectives. There after, it reaserch design is divided into two parts. One been the positivity approach which besically is objective as it analysis actual data received mainly numerically. The other approach is the phemenological approach which is mainly subjective as it is used to predict complex outcomes such as the numerous human reactions to a given event. For customer service for instance, different quality of services will be given to customers by different bank staff owing to the complexity of human beings. It is important to use the two different approaches as they both have advantages and disadvantages . If mixed therefore, the quality of the research may be improved. Below is a summary of some of the differences;

Positivity is mainly quatitative while phenomenological views are normally subjective

The positivity answers the question of how much or how ofen but phemenolocial will answer the question of how and why

Positivity is separate from the research and remote while phenomenological approach is embeded part of the sample.

The above information will be triagulated to establish the relationship . From this information the aim of explaining the major determinants of bank profit in Zambia will be discovered thus contributing to knowledge base in this area.