DETERMINANTS OF BANK PROFITABILITY IN THE SOUTH EASTERN EUROPEAN REGION

Introduction

The financial system of the South Eastern European (SEE) countries is characterised by the dominant role of the banking sector, with the capital market segment for long-term finance being illiquid and, in some cases, underdeveloped, while non-bank financial intermediaries, such as life insurance companies and private pension funds, are still at an embryonic stage of development (European Commission [EC], 2004). Yet, the recent reforms, aiming to liberalize and consolidate the existing banks, as well as to attract foreign ones in the SEE banking sector, were, to a large extent, quite successful. As a result, the legal, institutional, regulatory, and supervisory framework of financial institutions has been consistently improved and strengthened. These remarks explain why banking activities and performance have attracted the attention of practitioners, policy makers, and researchers alike, making the investigation of bank profitability in the SEE countries a more relevant issue today than in earlier times. This paper seeks to examine the effect of bank-specific, industry-related and macroeconomic variables on the profitability of the SEE banking industry (namely Albania, Bosnia-Herzegovina, Bulgaria, Croatia, FYROM, Romania and Serbia- Montenegro) over the period 1998-2002. It focuses on two main directions: Firstly, while a number of studies have examined the effects of internal and external factors on bank profitability in several countries and geographic regions, as far as we are aware of, hardly any systematic research has been carried out for the rapidly evolving SEE region; and secondly, while distinguishing between the structure-conduct-performance (SCP) and the efficient-structure (EFS) hypotheses, we also account for the effect of the reform process, that took place during this period, and the macroeconomic environment on profitability. The rest of the paper is organized as follows. Section 2 reviews and evaluates the reform process observed in the SEE banking sector over the last decade. Section 3 provides a background of the existing literature, relating bank profitability to its determinants. Section 4 describes the data and the econometric methodology, while Section 5 presents and analyses the empirical results. Conclusions and some policy suggestions are offered in the final section.download