Internal Determinants of Banks’ Profitability: A Case Study on Commercial Bank of Ethiopia (CBE)

Abstract

The profitability of banking sector is the most important instrument of financial system for the future of the economy. The objective of this study is to determine by Vector Error correction model (VECM) approach of the bank specific factors that affect the profitability of commercial bank of Ethiopia. The study was conducted to find out the impact internal factors on the profitability of CBE based on Vector Auto Regressive (VAR) model. The study has been conducted on secondary data for a period of thirty six (37) years from 1981-2017. Co-integration and vector error correction model tests are applied to assess the relationship among dependent and independent variables. ROA is used as the performance measure.The internal factors used in this study are Operating Efficiency Ratio, liquidity Risk Ratio, Size of the Bank and asset quality, which are independent variables. A stationary test was carried out using Graphical approach and Augmented Dickey Fuller (ADF) test. Variables have no unit root at first difference at 5% level of significance. The Johnson co-integration test showed that, there was long run co-integrating relationship between the variables. Based on the result operating efficiency ratio and bank size affects Return on Asset of the Bank significantly and negatively, Loan to Asset Ratio has positively and significantly determined commercial bank of Ethiopia profitability. However Liquidity Ratio Risk has not significant in the long run. The study suggests that focusing and reengineering the banks alongside the key internal drivers could enhance the profitability as well as the performance of the commercial bank Ethiopia (CBE). The regression result of VECM reveals that the one lag value of bank size has positive and significant relationship with ROA. The one lag value and the two lag value of operating efficiency have a positive and significant relationship with real ROA.

Keywords: Co-integration, Internal Factors, Return on asset, Unit root, VAR

DOI: 10.7176/RJFA/10-3-08