Determinants of Bank Profitability in Macau

Introduction

As financial intermediaries, banks play an important role in the operation of an economy. This is particularly true in the case of Macau where no debt market exists. Here, banks are the sole providers of funds, and their stability is of paramount importance to the financial system. As such, an understanding of determinants of their profitability is essential and crucial to the stability of the economy. In banking literature, the determinants of profitability are empirically well explored although the definition of profitability varies among studies. Disregarding the profitability measures, most of the banking studies have noticed that the capital ratio, loan-loss provisions and expense control are important factors in achieving high profitability. In Macao, a relatively few studies have been performed on the determinants of bank profitability. The study of Wong and Cheung (1997) is by far the principal one which concludes that the banking industry in Macao is rather concentrated, with one single group of banks generating the highest level of profits. However, the factors which explain such a good performance are not empirically explored in the study. The objective of this paper is to examine the contribution of bank-specific as well as macroeconomic and financial structure factors to the variation in profitability across banks and over time in Macao. Utilising bank level data for the period 1993-2007, we adopt the panel data regression to determine the important factors in achieving high profitability. To this end, a comprehensive set of internal characteristics is examined. Meanwhile, when studying the relationship between profitability and bank-specific characteristics, macroeconomic as well as financial structure indicators are also included to control for the effect of external factors. The remainder of the paper is organised as follows. A review of the relevant literature regarding the determinants of banking profitability is given in Section 2. Section 3 presents the data and methodology to be applied while Section 4 contains the empirical results. Lastly, the conclusion will be given in Section 5.

Literature Review

There is an extensive body of literature that seeks to identify the determinants of bank performance. While some studies1 focus on the understanding of bank profitability in a particular country, others2 concentrate their analysis on a panel of countries. No matter whether it is a single country or a panel of countries study, the determinants of bank profitability can be divided into two main categories, namely internal factors and external factors download