A Study on Determinants of Profitablity of Commercial Banks in Nepal

Abstract

Profitability is simply the difference between total revenue and total cost. Thus, the factors which affect commercial bank profitability would be those which affect banks’ revenue and costs. Hence, the impact of the internal and external determinants of commercial bank profitability is analyzed with a view to show their impact on bank revenue and costs. This theoretical study focuses on the dependent variable namely bank profitability. This is followed by the internal determinants of commercial bank profitability.

This study investigates the determinants of profitability of commercial banks in Nepal with respect to firm specific variables. The specific objectives of this study were to analyze the relationship and impact of capital adequacy ratio, bank size, liquidity, quality of asset and operating cost efficiency on return on asset and return on equity.

The research was based on primary and secondary data. The methods used for secondary data analysis included financial analysis, and analysis by forming portfolio, correlation analysis and regression analysis. The methods used for primary data analysis included percentage frequency distribution, mean scores of responses to 5 point Likert scale items.

The results of from the financial analysis concluded that profitability of SCBL, Nabil Bank and EBL is higher than other sampled banks. Additionally, HBL, NIBL, NSBI, BOK, NIC Bank, NCC Bank’s profitability is average and lastly, Laxmi, SBL, KBL, and LBL does not have satisfactory level of profitability of commercial bank in Nepal. Furthermore, from correlation analysis, portfolio analysis and regression analysis of secondary data shows that credit to deposit ratio, non performing loan and cost efficiency ratio has shown consistently significant explanatory power in negative manner in a ROA model indicating that return on asset decreases with increase in credit to deposit ratio, nonperforming loan ratio and cost efficiency ratio. In contrast, the study documents that capital adequacy ratio and firm size as insignificant in explaining the variations in return on asset of commercial banks in Nepal. Furthermore, cost efficiency ratio has shown consistently significant explanatory power in ROE model indicating that return on equity decreases with increase in cost efficiency ratio. Whereas, the study documents that capital adequacy ratio, firm size, credit to deposit ratio and non performing loan ratio as insignificant in explaining the variations in return on equity of commercial banks in Nepal. Furthermore, the study also concluded that the effect of a growing size on profitability has been proved to be positive to a certain extent. However, for banks that become extremely large, the effect of size could be negative due to bureaucratic and other reasons. Similarly the study also concluded that current profitability of commercial banks of Nepal is not sufficient in order to survive for the long run.