The determinants of profitability of Indian commercial banks: A panel data approach

TLDR

The Indian banking sector has undergone changes such as demonetization, sustainability issues, and frauds over a 10‑year period. The study examines the determinants of profitability of Indian commercial banks. The authors analyze balanced panel data from 2008‑2017 for 69 Indian banks, measuring ROA and ROE and evaluating bank‑specific factors and macroeconomic variables using stationary tests and pooled, fixed, random effect models with panel‑corrected standard errors. The results show that bank size, branch count, asset management ratio, operational efficiency, and leverage drive ROA, while bank size, asset management ratio, asset quality ratio, and liquidity ratio positively influence ROE, and macroeconomic variables—inflation, exchange rate, interest rate, and demonetization—significantly affect ROA, with all but demonetization impacting ROE.

Abstract

Abstract The current study examines the determinants of profitability of Indian commercial banks. The analysis is conducted over a period of 10 years in which the Indian banking sector has gone under different changes such as demonetization and issues related to banking sector sustainability and banking sector frauds. The analysis is based on balanced panel data over a period ranging from 2008 to 2017 for 69 commercial Indian banks. Profitability of Indian banks is measured by two proxies, namely, return on assets (ROA) and return on equity (ROE), whereas bank size, assets quality, capital adequacy, liquidity, operating efficiency, deposits, leverage, assets management, and the number of branches are used as bank‐specific factors. Further, a set of macroeconomic determinants such as gross domestic product, inflation rate, interest rate, exchange rate, financial crisis, and demonetization are used as independent variables. Stationary test along with pooled, fixed, random effect models and panel correction standard error are used in this study. The results revealed that bank size, the number of branches, assets management ratio, operational efficiency, and leverage ratio are the most important bank‐specific determinants that affect the profitability of Indian commercial banks as measured by ROA. Furthermore, among the bank‐specific determinants, the results revealed that bank size, assets management ratio, assets quality ratio, and liquidity ratio are found to have a significant positive impact on ROE. With regard to the macroeconomic determinants, the results revealed that the inflation rate, exchange rate, the interest rate, and demonization are found to have a significant impact on ROA. However, in the case of ROE, the results show that all macroeconomic determinants except demonization have a significant impact on the bank's profitability as measured by ROE.