Bank economic performance

The second part of the literature review relates to the economic performance of a bank, focusing on the important determinants and indicator of bank’s quality status.

There is a group of empirical studies focused on the performance of banking sector in particular countries, represented by Ghosh, Nachane, Narain and Sahoo, Mathuva, Berger, Bichsel and Blum, or Tripe. Ghosh et al. analyse Indian public sector banks on the multivariate panel regression model over the period 1997 through 1999. With changes of the capital ratio as the dependent variable and lagged capital ratio and set of dummies as proxy different regulatory forms authors tried find the evidence of appropriateness of the regulatory framework. The main contribution of the paper exposes that Indian regulatory supervisor should support Indian banks to keep higher capital level than officially required because of the differences in banks’ risk profile.

This fact relates to the second finding about Indian banking sector; that Indian public banks are not risk-averse (Ghosh et al., 2003).

The Kenyan banking sector’s profitability development on the eve of the crisis was studied by Mathuva. On the panel data created by all Kenyan banks from 1998 to 2007 the author studied, besides other things, the relationship between the op-erating effectiveness denoted by cost-income ratio and bank economic profitability represented by the return on asset and return on equity. The author found negative correlation of cost-income ratio to both economic indicators (Mathuva, 2009). Sim-ilar research was performed by Tripe, who uses cost-income ratio from the different point of view; he considers the usefulness of this ratio as a significant measure of bank performance for the Australian banking sector from the view of the banking structure differences additionally to the previous standard use as the explanation for the bank profitability. The author points at the transparency of the cost-income ratio showing that cost-income ratio figure as more comparable across boundaries than cost to asset ratios (Tripe, 1998). Contrary to this, Estrela, Park and Peristianiet con-cern the failure of the predictive power of different bank’s indicators. On the panel of the US banks’ data from 1988 to 1993 they found out that the simple ratios have better predictive power than the risk-employing indicators (Estrela et al., 1999).

Bichsel and Blum focused on the relationship between risk behaviour and the level of banks’ capital in Swiss banking sector using capital adequacy requirements. The relationship in the context of regulatory capital is based on the so-called buffer effect, in other words, the higher level of capital bank possesses, the lower is its probability of default. The problems arise from indirect incentives emerging from the minimum required level of regulatory capital. In accordance with (Blum, 2008), the authors consider the additional capital buffer to be very costly for the bank, and thus to com-pensate for this excessive implies higher risk premium investment. The overall effect is ambiguous, thus increase in regulatory capital can be followed by higher probabil-ity of default. The authors examined the panel of Swiss banks in period from 1990 to 2002 to conclude that even though there is a positive relationship between level of regulatory capital and the probability of default, the predictive power of the capital is not significant (Bichsel and Blum, 2004).

Many researches focus on the US banking market. Berger analyzed the relationship between the capital and profitability US banking sector. The panel of over 80,000 ob-servations created by US banks accounting parameters in period of seven years (1983 - 1989) denied theoretical hypothesis of negative relationship between capital ratio represented by the capital-asset ratio, and after-tax return on equity. The hypothesis following the one bank standard model in perfect competition and without informa-tion asymmetry expects trade-off between the level of capital ratio and risk on equity

and therefore expected return on equity. The author’s rejection of the hypotheses con-firmed the both economic and statistic significant and positive relationship between capital and profitability. Data prove the two-ways positive Granger causality; i.e. the increase in profitability arose as a consequence of unexpected capital increase and vice versa (Berger, 1995).

Hutchinson and Cox analyzed the relationship between structure of capital and profitability with respect to changes in regulatory burden for US banks. The au-thors separated the observed period between two sub-periods; first over 1983 to 1989 represents the period of weak regulation, and second period over 1996 to 2002 cor-responding to the period of stricter bank regulation. Despite earlier empirical evi-dence a positive relationship between financial leverage and profitability represented by return on equity was found for the both sub-samples (Hutchinson and Cox, 2006).

Using similar dataset, Christian, Moffitt and Suberly discussed the significant predic-tor of the future bank earnings by performing the fundamental analysis of financial statements variables. They defined 23 variables, which afterward divided into five classes: Size and growth, Loan exposure, Capital adequacy, Asset quality and Earn-ings. The analysis was performed on the dataset of all national commercial banks US banks over the period 1993 to 1998. The fundamental analysis showed that almost all of the variables (19 out of 23) have a more or less significant impact on the future earnings or returns, but these two groups of variables do not cover. From all 19 vari-ables, no one was significant at 1% level as an explanatory variable for both future earnings and returns. Among the most significant variables in current returns belong variables relating to quality of asset portfolio and capital adequacy. On the other hand, the most significant predictor of future earnings creates current year earnings (Christian et al., 2008).

The comparison of European universal bank and conglomerate cost and profit efciency is provided by the study of Vennet. On the sample of over 2,000 European fi-nancial institutions in years 1995 and 1996 the author found out that de-specialization of the institution can lead to the higher efficiency in the banking system. In other words, average levels of operating efficiency are higher for universal banks than for the specialized ones. In accordance with (Christian et al., 2008), the author identified cost-income ratio as a proxy of operational efficiency as the most important indicator of the bank profitability represented by return on asset, return on equity and ratio of net interest margin to total assets (Vennet, 2002).