Impact of Internal and External Factors on the Short Run and the Long Run Profitability of Commercial Banks in Lebanon

Abstract

The study of the determinants of bank profitability has a long history. A vast literature on these determinants has developed since the early 1980s. It is common in the literature to divide these determinants into internal and external factors. Internal factors are those factors under the control of the bank, while banks do not have control over external factors. This paper adds to the literature the effect of these same factors on the book value of bank equity, and not only on the Net Interest Margin. This is seldom tested elsewhere. Showing how the short run and the long run profitability of commercial banks is affected by these factors is important in order to identify which factors are relevant, the extent to which they are relevant, and to help banks react optimally to changes in these factors. Although theoretically the signs of the impacts of the factors are uncertain the results show that most of the factors selected have a statistically significant impact on the two measures of profitability, the Net Interest Margin, and the Net Worth. Moreover the results show that there is a statistically significant differential impact of some of these factors on large banks relative to small banks. The paper thus unveils quantitatively how banks respond to changes in economic indicators. This can help banks predict, react, and compare their performance to the market, to the industry, and to its own past evolution.

Keywords: Profitability, commercial banks, Lebanon, internal and external factors, robust least squares