Determinants of Bank Profitability in the South Eastern Europe Term Paper

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govern the profitability of banks in the South Easter part of Europe. The banking profitability in question is evaluated in terms of the rate of Return on Assets (ROA) and the rate of Return on Equity (ROE) .These two measures are expressed in terms of various other determinants. This paper therefore makes use of a series of raw data collected from South Eastern Europe credit institutions over a five-year period (2003-2007).The determinant used in this study are bank-specific and are also industry related. Macroeconomic determinant are also utilized in the examination of the banks' profitability. The study revealed that apart from liquidity alone, all the other remaining bank specific determinants greatly affects a bank's profitability in a predictable manner. The structure conduct performance hypothesis is proven true by the positive results of concentration that is obtained. However, it is worth noting that the efficient structure proposition's applicability can not be ruled out. This paper also seeks to examine the effect of banking reforms to the bank's profitability amid the various macroeconomic determinants. This paper presents the findings obtained while giving recommendations on the applicability of the necessary reforms that are intrinsic to the profitability realization for SEE banks.


The banking sector plays a very integral role in the South Eastern European (SEE) economies. The financial system in the SEE is heavily reliant on the banks and therefore important milestones in the banking system have a direct and palpable effect on the SEE economies. It is worth noting that the illiquidity ration of the Capital Market portion of the SEE financial dynamics is however very high. This is coupled with immaturity in the part of the other non-bank segment of the financial system. The banking sector reform that have been hugely accepted and implemented has been on of the major driving forces in the sustainability and profitability of the SEE banks. This is because of the necessary and closely regulated aspects of the baking industry that it has introduced. The reforms have made baking safer, more efficient and more successful due to the streamlining of the necessary institutional and legal frameworks that have been put in place to safe guide the interest of the SEE banking sector. The reforms have in fact motivated even foreign banks to venture into the SEE market. This is largely due to the friendly and safe guidelines that were considered in the drafting of the SEE banking reforms.

It is the objective of this research paper to critically highlight the effects of certain bank-specific variables on the profitability of the South-Eastern banking sector. The variables are also related to specific industries. The countries under our study include the following;( Albania, Serbia, Fyrom, Bulgaria, Romania, Turkey, Croatia and Moldova).The study focuses on the period of 5 years in the period of 2003-2007.This paper considers two main point of study. The initial proposition is based on the examination of the effects of both the internal and the external determinants that affect the banking profitability in the SEE countries. The second proposition however examines the direct and indirect influence of the banking sector reforms in the profitability gap of the SEE countries. This is based on the efficient structure proposition. The macroeconomic environment for profitability is also examined.

This paper is arranged into various sections. The first section discusses the reform process that has happened in the SEE banking sector in the last couple of years. The second section is concerned with the literature review regarding this subject area. The content under this section concern the elements of a bank profitability and its subsequent driving force (determinants).The third section gives a full description of the SEE banking data sources and the methodology involved in the collection and analysis. It focuses on the econometric determination the SEE banking sector profitability.

The final conclusions and the special policies that are drawn from the study

Conclusions and some policy are then. The final section gives a presentation and the critical analysis of the obtained empirical information.

The SEE countries Banking Reforms

The formation of sound and viable banking system in the financial circles of the Southeastern European (SEE) countries was one of the most important quantum leaps in their economies. This has necessitated the transition of their economy to a market oriented type of economy which in tern has offered more profitability due to a wider market and more streamlined regulatory, supervisory and operationaldynamics.However the process of achieving such a transition was never easy.

Several studies have proven than the onset of the financial system transition process was indeed very weak, shallow and mainly underdeveloped. This happened somewhere in the 1990s.The forces that impeded the growth and ease of operation of the financial systems was mainly due to either internal causes or several other external setbacks. The system has however over the last decade been transformed into a better one even though it still experiences some problems. Despite the challenges that affect the system, it is worth noting that there has been improved economic performance coupled with a more improved macroeconomic stability and a projected long-term growth all of which are a function of the level of improvement in the operation and regulation of the financial institution's operations and the market dynamics that all form part of the more improved financial infrastructure.

The reforms of the financial system were not as a result of an academic research findings but rather were due to real lessons that were experienced and a call of action was prompted in the process. Through the assistance of the major global financial institutions, the government of these countries embarked on a journey that would see their financial institutions being fine tuned to fit into appropriate level. This was as a result of adopting the necessary reforms that would revolutionize their financial processes and their capital markets' operations. Their collaboration was aimed at creating a coming up with a financial system that was better in more ways. The system would be institutionally stable, with better administrative functions and more sensitive to the demands of their emerging markets.

During the final years of the transition, there were various changes in the banking and financial market systems that were spearheaded by the combined action of the World Bank and the International Monetary Funds. These changes mainly centered on the legal, institutional, regulatory and supervisory framework of the financial system. Over the years however, these prescribed guideline have been continuously improved. The foundation of the contemporary banking system was therefore laid down by the World Bank using a model developed from the experience gathered from the various ways and means that the system had earlier operated.

The reforms in the banking sector have been actualized through the adoption of various programs. The main programs at the center of the change were economic adjustment programs and stability programs. Surveillance programs were also instituted in order to provide constant reports on the changes to the system. The process of restructuring was country-specific and industry related. The promotion and implementation of the policies that revolutionized the banking sector had been made possible through the adoption of appropriate monetary policy management programs. The processes of their implementation were also fuelled by the timely management programs that were offered by the various visiting missions and the domestic advisors of the specific countries.

The process of financial restructuring has been supported by various other international financial institutions. Such institutions include OECD, EBRD, EIB, ECB and BIS. The bilateral processes between the European Union and the SEE countries have also fuelled the rate of change in the reform process.

It is worth noting that due to the variation in the banking system from country to country; all the initiatives and efforts of the international financial organizations to streamline the financial systems still face serious challenges. Such challenges include elements of weaknesses in the system together with localized fragmentation and fragility. The problem of undercapitalization is always eminent. All these challenges have continued to emerge despite the various efforts that are put in place by the reports generated through the process of academic studies and assessments.

Several new reform measures have been instituted by the international financial institutions. These measures are concentrated around the major indicators of financial systems stability in the SEE countries. The measures mainly target the various indicators of market growth. These changes are aimed at recapitalizing the banking sector; this is achieved through the process of liquidation whereby insolvent institutions are reliquidated.Mergers and acquisitions are also done in order to consolidate the banking industry into strong and consolidated financial units. There is also an adoption of improved administrative efficiency techniques and improved capacity of the banking sector. There have been recent changes in the system that mainly targeted the deposit insurance scheme policies and loan collateral policy guidelines.

A quick review of the banking sector progress has shown that in many ways than one, the process of development of the guidelines that govern the institutions and the accompanying fundamental principles has overtaken the…[continue]

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