Bank-Specific and Macroeconomic Factors Related to Bank

Profitability and Stock Return in Thailand

Junevio Antonio Silva Ximenes

A Thesis Submitted in Partial Fulfillment of the Requirements

For the Degree of Master of Business Administration

International College

University of the Thai Chamber of Commerce

2014

THESIS APROVAL

INTERNATIONAL COLLEGE

Master of Business Administration

Degree

ii

International Business

Major Field

Bank-Specific and Macroeconomic Factors Related to Bank Profitability and

Stock Return

JUNEVIO ANTONIO SILVA XIMENES 2015

Name graduation year

Accepted by International College,University of the Thai Chamber of Commerce in

Partial Fulfillment of the Requirements of the Master’s Degree

(……………………………...) Dean of International College

(Dr. Jakarin Srimoon, Ph.D.)

(……………………………...) Chairperson

(Dr. Nattapan Buavaraporn, Ph.D.)

(……………………………...) Advisor and Committee

(Assistant Professor Dr. Li Li, Ph.D.)

(……………………………...) Committee

(Assistant Professor Dr. Wanrapee Banchuenvijit, Ph.D.)

(……………………………...) Committee

(Dr. Boonlert Jitmaneeroj, Ph.D.)

(……………………………...) External Committee

(Dr. Kittiphun Kongsawatkiet, Ph.D.)

Thesis Title : Bank Specific and Macroeconomic Factors Related to

Bank Profitability and Stock Return in Thailand

Name : Junevio Antonio Silva Ximenes

Degree : Master of Business Administration

Major Field : International Business

Thesis Advisor : Asst. Prof. Dr. Li Li

iii

ABSTRACT

The study investigated the relationship of bank specific and macroeconomic factors

on the bank profitability and stock return of Thai Commercial banks. The study used

multiple regression of quarterly data covered from period of 2004-2013. Bank

profitability measured by return on assets (ROA), return on equity (ROE), net interest

margin (NIM). Stock return defined by the quarterly adjusted closing prices of stock.

Both profitability and stock return used as dependent variables. Bank-specific and

macroeconomic variables were used as independent variables. Bank-specific variable

include Asset size (LNA), Capital adequacy (CA), Liquidity (LQD), Main source of

banks funding (DA), operational efficiency (CIR), Credit risk (LLP_TL).

Macroeconomic variables used Real Gross Domestic Product growth rate (GDPR),

inflation rate (INF) and real interest rate (RI). The dummy variables of Financial

Sector Master Plan also included in the study.

The empirical results showed that asset size (LNA), capital adequacy (CA), liquidity

(LQD), main source of banks funding (DA) have positive relationship on bank

profitability. Dummy variable of FSMP has positive relationship on stock return (SR).

While, operational efficiency (CIR), credit risks (LLP_TL), inflation rate and real

interest rate have negative relationship on bank profitability and stock return. Asset

quality (LLR_GR) and real GDP growth rate are insignificant to both bank

profitability and stock return.

iv

ACKNOWLEDGEMENTS

I praise God the almighty for granting me life and opportunity in finishing this study.

This thesis could be done because of the valuable help and guidance of several people and

institution. Therefore, I would like to give my sincere gratitude to them.

First of all, my grateful thanks to my advisor Asst. Prof. Dr. Li Li, who are willing to

help and guide me with critical comments, excellent advises and correction of the thesis

during the writing process.

Secondly, my very special thanks to the Ministry of Education of Timor-Leste

through Human Capital Development Fund for giving me an opportunity to continue my

study. It is an honor to be part of more than 100 Timorese to get a scholarship award to study

in Thailand.

Third, I would like to thank the committee member for the constructive comments

and correction during the proposal and final defense. Their valuable insights and comments

are highly appreciated during the course of this proposal and final defense.

Fourth, I would like to thank IC Program Coordinator, Dr. Nattapan Buavaraporn and

all IC staffs for their technical help in facilitating my study activity in UTCC.

Lastly and most of all, I am very grateful for my beloved parents, wife and my lovely

sweet daughter for their support during my difficult time in thesis writing process. They are

the source of my strength during this difficult moment. I also appreciate the support of friends

for their ideas and suggestions in writing process.

“For you I study,

For you I work,

For you I live,

For you I am ready even to give my life.”

-St. John Bosco

Junévio Antonio Silva Ximenes

Bangkok, Thailand

v

TABLE OF CONTENTS

Contents page no.

Abstract…………………………………………………………………………........i

Acknowledgements…………………………………………………………………..ii

Table of Contents………………………………………………………………........iii

List of Tables…………………………………………………………………………v

List of Charts……………………………………………………………………….vi

Chapter 1: Introduction

1.1 Introduction and Problem Statement……………………………………….1

1.2 Objectives of the Study……………………………………………………..2

1.3 Significance of the study……………………………………………………3

1.4 Research Question…………………………………………………………..3

1.5 Scope of the Study………………………………………………………….4

1.6 Expected Benefits…………………………………………………………..9

1.7 Operational Definition……………………………………………………...9

Chapter 2: Background

2.1 Overview of Thailand Banking Sector ……………………………………12

vi

Chapter 3: Review of Literature

3.1 Previous Studies…………………………………………………………...19

3.2 Conceptual Framework……………………………………………………31

3.3 Research Hypothesis………………………………………………………41

Chapter 4: Methodology

4.1 Methodology………………………………………………………………..42

4.2 Data…………………………………………………………………………44

Chapter 5: Results

5

5.1 Descriptive Statistics………………………………………………………..46

5.2 Correlation Analysis………………………………………………………...49

5.3 Regression Results…………………………………………………………..56

Chapter 6: Conclusion and Discussion

6

6.1 Conclusion…………………………………………………………………66

6.2 Discussion………………………………………………………………….70

6.3 Research Recommendation…………………………………………………71

6.4 Limitations and Further Research…………………………………………..72

References………………………………………………………………………….73

vii

List of Tables

Table Page

Table 1.1 Financial Business under BOT Supervision and Examination………….4

Table 2.1 Financial Institutions under BOT’s Supervision………………………..13

Table 2.2 Year on Year Percentage Change of Total Assets of

Thai Commercial Banks…………………………………………………16

Table 3.1 Summary of the Variables and the Expected Results…………………...37

Table 4.1 Name, Size and Abbreviations of Thai Commercial Banks

Listed in Stock Exchange of Thailand…………………………………..45

Table 5.1a Descriptive Statistics for the Variables (All Banks)……………………..46

Table 5.1b Descriptive Statistics for the Variables (Large Banks)…………………..48

Table 5.1c Descriptive Statistics for the Variables (Medium and small banks)……..49

Table 5.2a Correlation Analysis (All banks)…………………………………………50

Table 5.2b Correlation Analysis (Large banks)……………………………………...53

Table 5.2c Correlation Analysis (Medium and small banks)………………………..55

Table 5.3a Regression Result (All banks)……………………………………………56

Table 5.3b Regression Result (Large banks and medium and small banks)…………61

Table 6.1 Comparison of Result between large and medium and small banks…..69

viii

List of Charts

Charts Page

Chart 2.1 Gross Domestic Product (1988 prices)……………………………14

Chart 2.2 Performance of the Banking System 2007………………………..15

Chart 2.3 Profitability of the Banking System 2012…………………………17

CHAPTER 1

INTRODUCTION

This chapter provides a brief introduction of the factors that might affect

profitability and stock return of Thailand banking sector. The chapter divided into

seven parts. First, we describe statements of the problems. Second, explain objectives

of the study and significance of the research in third section. Fourth and fifth section

related to research questions and scope of the study respectively. Sixth and seven

sections are about expected benefits and operational definition.

1.1 Introduction and Problem Statement

Banking industry is important for an economic activity of a country. Banks

contribute to the allocation of funds from people who deposit their money and those

who need funds for their business activity and thus support the economic growth of a

country. However, banking sector performance also might suffer both from the

mistake decision of bank management and financial crisis that happened in a country.

Therefore, the assessment on bank profitability and stock return is important because

of its importance to financial stability and economic growth.

The financial crisis of 1997 has greatly affected the performance of Thailand

banking industry. For Example, in March 1997, the Bank of Thailand and the

Ministry of Finance notified 10 financed companies because of their asset quality

problem and insufficient liquidity. These companies need to increase their capital

(Charoenseang & Manakit, 2002, p. 602). Later, there are more finance companies

that were suspended from their operations and need to restructure their management.

On top of that, the intention of the Government of Thailand during the crisis was to

steer Thai commercial banks back to profitability (ADB Report 2011).

In 2004, the Financial Sector Master Plan (FSMP) phase one was initiated to

“rationalize the structure and roles of the existing financial institutions” (BOT

2

supervision report 2004). The goal is to increase efficiency which results in few

players in banking sector. In general, the players in banking industry will consist of

Thailand financial institutions (commercial bank and retail bank) and foreign financial

institutions (foreign bank branch and subsidiary). Both finance and credit foncier

companies can apply for the commercial bank status. Furthermore, foreign-owned

financial institutions such as existing full branches can apply for subsidiary status or

also can merge with finance companies and then apply to become a subsidiary. In

short, the efforts to improve efficiency through rationalization process give an

opportunity for existed financial institutions to restructure their organizations and

adapt to the changing financial landscape (BOT 2004 p. 35).

The changes in Thailand banking sector which started from 1997 financial

crisis, especially the initiative to implement Financial Sector Master Plan in 2004

become the concern of this study to know the extent to which bank internal factors

and external factors affect Thailand commercial bank profitability and stock return.

This paper studied the relationship of bank specific and macroeconomic factors on the

bank profitability and stock return in Thailand. The study on determinants of bank

profitability and stock return were sought with special focus on bank internal factors

and external factors. This study focused on the post-crisis period in Thailand and

examined the bank profitability and stock return from the period of 2004-2013. The

period used because from 2004-2008, the Financial Sector Master Plan phase one was

started which continued by the stage two of the implementation of Financial Sector

Master Plan from 2010-2014.

1.2 Objectives of the Study

Banking sector have a critical role in the economy activity of a country.

Internal decision of management board and the influence of business environment

could affect its performance. The Thailand banking industry is chosen as a subject of

study because it has experience a lot of transformation after the financial crisis in

1997. This is a good reason in understanding to what extent internal and external

factors of banking sector affect its profitability and stock return.

3

The ultimate objective of bank is to get profit in business and maximize

shareholders wealth. This is one of the reasons for the study to check how bank

internal factors and external factors related to bank profitability and stock return. This

study was conducted with the following objectives:

To investigate the relationship of bank-specific and macroeconomic factors

on bank profitability from 2004-2013, and;

To investigate the relationship of bank-specific and macroeconomic factors on

stock return from 2004-2013.

1.3 Significance of the Study

The study contributes to the existing literature of bank performance in

Thailand through the following ways. First, many study have done study on bank

profitability before and after the crisis. However, there is still little attention on the

impact of the implementation of Financial Sector Master Plan on bank profitability

and stock return. This study tries to use the newly updated data which cover from

2004-2013 related to bank profitability and stock return. Second, this study has the

same concern with Heberholz et al (2010) about the post crisis period in Thailand.

However, this study only focus on listed commercial bank and at the same time try to

use dummy FSMP variable to know to what extent it affects bank performance during

the period of 2004-2013. Overall, the study also similar to previous study to see the

effect of macroeconomic factors on stock returns. However, the new contribution to

the study is also to consider the impact of bank-specific factors to bank stock returns

in Thailand.

1.4 Research Questions

The research aimed to answer the following questions:

To what extent, the bank-specific factors such as asset size, capital adequacy,

asset quality, liquidity, main source of banks funding, operational efficiency

and credit risk have significant relationship on ROA, ROE, NIM and stock

return?

4

To what extent, macroeconomic factors such as gross domestic product

growth rate, inflation, real interest rate and dummy FSMP have significant

relationship on the ROA, ROE, NIM and stock return?

1.5 Scope of the Study

According to the recent data from Bank of Thailand, there are various

financial business currently operate under the supervision and examination of the

Bank of Thailand (as shown in Table 1.1).

Table 1.1

Financial Business under the Bank of Thailand Supervision and Examination

Under Bank of Thailand Supervision Under Examination of Bank of

Thailand as appointed by the

Ministry of Finance

1. Financial Institutions

1.1. Commercial Banks

Commercial Banks

Retail Banks

Subsidiaries

Foreign Bank Branches

1.2. Finance Companies

1.3. Credit Froncier Companies

1. Specialized Financial

Institutions

2. Thai Asset Management

Corporation

3. National Credit Bureau

2. Foreign Financial Institution

Representative Offices

3. Asset Management Companies

4. Non-Banks

Credit Card Companies

Personal Loan Companies

Source: The Bank of Thailand (BOT) website

5

However, the scope of the study focused on banking sector, especially for Thai

commercial banks listed in Stock Exchange of Thailand and cover the from the period

of 2004-2013. The lists of Thai commercial banks studied are as follows:

No Institution Name Year of Established

1 Siam Commercial Bank Public Company LTD 1904

2 Bangkok Bank Public Company LTD 1944

3 Bank of Ayudhya Public Company LTD 27 January 1945

4 Kasikornbank Public Company LTD 8 June 1945

5 TMB Bank Public Company LTD 1957

6 Krung Thai Bank Public Company LTD 14 March 1966

7 Tisco Bank Public Company LTD 1969

8 Kiatnakin Bank Public Company LTD 1971

9 CIMB Thai Bank Public Company LTD 1998

10 Thanachart Bank Public Company LTD 22 April 2002

11 Land and Houses Bank Public Company LTD 19 December 2005

Source: The Bank of Thailand (BOT) Website

So, the scope of the study focus on Thailand commercial banks listed in the

Stock Exchange of Thailand and excludes retail bank, foreign commercial banks

subsidiary and foreign banks branches, finance companies and credit froncier

companies.

The brief profile of Thailand Commercial banks listed in the Stock Exchange

is as follows:

(1.5.1) Siam Commercial Bank Public Company LTD (SCB)

The Siam Commercial Bank PCL started in 1904 and previously known as

“The Book Club”. The Bank was the first Thailand indigenous commercial bank and

6

the second largest commercial bank by their total assets, as of December 31, 2012.

The bank offer a full range of financial services, including corporate and personal

lending, retail and wholesale banking, foreign currency operations, international trade

financing, cash management, custodial services, credit and charge card services and

investment banking services.

(1.5.2) Bangkok Bank Public Company LTD (BBL)

Bangkok Bank PCL established in 1944 and is the largest commercial bank in

Thailand by its total assets. Bangkok Bank PCL is the market leader in corporate and

small medium enterprise banking and has the country largest customer base. The

Bangkok Bank PCL first traded at Stock Exchange of Thailand in 1975.

The bank's overseas branch network exists in 13 countries such as China,

Hong Kong, the USA, the UK, Japan, Taiwan, Singapore, Malaysia, Vietnam, the

Philippines, Indonesia, Laos and Myanmar.

Bangkok Bank offers full commercial banking services and arranging

syndicated loans, debt securities underwriting, trade finance, project finance, custodial

services, SME and merchant services and specialist industry advice.

(1.5.3) Bank of Ayudhya Public Company LTD (BAY)

Bank of Ayudhya PCL (or Krungsri Group) was established on 1945. It is the

fifth largest bank in Thailand based on their assets size. Bank of Ayudhya PCL has

been listed in Stock of Exchange in Thailand on 1977. Bank of Ayudhya PCL

provides a full range of banking service to both commercial and individual customers.

(1.5.4) Kasikornbank Public Company LTD (KBANK)

The Kasikornbank PCL, previously known as Thai Farmers Bank, was

established in 1945. The company has been listed on the Stock Exchange of Thailand

(SET) since 1976. Kasikornbank operates in 965 branches and sub-offices across the

7

country and ten overseas offices. The Kasikornbank PCL provides full financial

services to corporate, small and medium enterprise, and retail customer. The bank

also has branches in all parts of Thailand and overseas.

(1.5.5) TMB Bank Public Company LTD (TMB)

Thai Military Bank PCL started its operation in 1957 and is one of the largest

retail banks in Thailand. The initial objective is to provide financial services to

military personnel and their families. However, in 1973 the TMB bank PCL become

full commercial bank and expanded to serve corporate, small and medium enterprises

and retail customers. The Thai Military Bank PCL started its first trade in Stock

Exchange of Thailand in 1983.

(1.5.6) Krung Thai Bank Public Company LTD (KTB)

Krungthai bank PCL is a state bank and started its operation in 1966 through

the merger of two state owned banks (Kaset Bank and Monton Bank). In 1988, Krung

Thai Bank was the first bank expanded its branches to cover every province of

Thailand. Krung Thai Bank PCL provides commercial banking services to

individuals, organizations, institutions, and government and state agencies. Krung

Thai bank PCL started its first trade on the Stock Exchange of Thailand in 1989.

(1.5.7) Tisco Bank Public Company LTD (TISCO)

TISCO Bank PCL as part of TISCO Group was a finance company established

in 1969. The name TISCO is an abbreviation of “Thai Investment and Securities

Company Limited”. In 2004, Ministry of Finance approved TISCO status to

commercial bank. TISCO started its banking operation in 2005. TISCO bank PCL

provided banking services in areas such as retail and SME lending, corporate lending,

retail deposit, private banking, cash management and custodian services.

8

(1.5.8) Kiatnakin Bank Public Company LTD (KKP)

Kiatnakin Bank PCL is part of Kiatnakin-Phatra Financial Group which

focuses on commercial banking business. Kiatnakin Bank PCL was established in

1971 under the name of Kiatnakin Finance and Securities Company Limited.

Kiatnakin Bank PCL fully operated as a commercial bank in 2005. It provides full

range of financial and investment services professionally such as financial

consultation by highly competent personnel.

(1.5.9) CIMB Thai Bank Public Company LTD (CIMBT)

CIMB Thai Bank PCL, previously known as Bank Thai PCL, was established

in 1998 with the Financial Institutions Development Fund (FIDF) as the major

shareholder. In 2008, CIMB Bank Berhard became the largest shareholder in Bank

Thai PCL and changed the name to CIMB Thai Bank Public Company Limited. The

CIMB Thai Bank PCL is a member of CIMB Group, a leading financial institutions

based in Malaysia. CIMB Thai Bank PCL provides corporate and personal lending,

retail and wholesale banking, international trade financing and investment banking

services.

(1.5.10) Thanachart Bank Public Company LTD (TBANK)

Thanachart Bank Public Company Limited (TBANK) is part of Thanachart

Capital Public Company Limited (TCAP) and started its operation on 2002. The

Thanachart Bank PCL granted full commercial banking license in 2004 by the

Ministry of Finance. The bank is the Thailand’s sixth-largest bank by total assets. The

TBANK provide wide range of financial services to over 4 million customers include

Retail, Hire Purchase Corporate and SME banking, Insurance, Life Assurance,

Securities Brokerage and Fund Management.

9

(1.5.11) Land and Houses Bank Public Company LTD (LHBANK)

Land & Houses Bank Public Company Limited was established based on the

initiative of Land & Houses PCL and Quality Houses PCL. The Land and House

Bank PCL started its operation in 2005 through the licensed of Ministry of Finance.

The Land and House Bank PCL provides deposit services like other commercial

banks but cannot conduct transactions related to foreign currencies and derivatives,

except money exchange as an authorized money lender. The Bank also provides

lending to retail customers and small and medium enterprises.

1.6 Expected Benefits

This study is expected to provide an understanding on the factors affected

profitability and stock return of Thailand Commercial Bank listed in Stock Exchange

of Thailand. Particularly, this study provides an insight on how the internal factors in

bank-specific which is related to the internal decision of management board can affect

the performance of bank. Moreover, external factor (macroeconomic factor) which is

beyond bank control is also need to consider by seeking its influence on the bank

profitability and stock return.

1.7 Operational Definition

In this section, we divided the operational definition based on the variables

used in this study to four parts namely bank-specific factors, macroeconomic factors

and profitability factors and stock return.

1.7.1. Bank Specific-Factors

Asset Size is measured by natural logarithm of total assets. Asset size is total assets of

the banks are used to represent bank size.

10

Capital Adequacy is measured by total equity to total assets and expressed in

percentage. Capital adequacy refers to the bank ability to absorb unanticipated losses

related to the risks in banking sector.

Asset Quality is measured by loan loss reserve to gross loan and expressed in

percentage. Asset quality indicates the extent to which assets are devoted to loan.

Liquidity is measured by total loans to total customer deposit and expressed in

percentage. Liquidity defined as the capability of the bank to fulfill its obligations,

especially of depositors.

Main Source of banks funding is measured by deposit to total assets and expressed

in percentage. Deposit is source of bank funding and cheap source for a bank.

Operational efficiency is measured by operating expenses over total operating

income, expressed in percentage, which is also called cost-income ratio. It refers to

the operating costs (such as administrative costs, salaries, property plan and

equipment costs, excluding looses from bad and non-performing loans) over total

operating income. Cost-income ratio is to measure the impact of operational

efficiency on the profitability of the banks.

Credit Risk is measured by loan loss provision to total loans, expressed in

percentage. Credit risk refers to the possibility that loan payment may not be made in

time or loan principal may not be fully recovered because of default.

1.7.2. Macroeconomic Factors

Economic Activity is measured by quarterly real gross domestic product growth rate,

expressed in percentage and adjusted for inflation. Quarterly real GDP growth rate is

a measure of the rate of change that a nation GDP experiences from one quarter to

another.

Inflation Rate is measured by Consumer Price Index for all goods and services.

Inflation is the rate at which the general level of prices for goods and services is

increasing, and, subsequently, purchasing power is decreasing.

11

Real interest rate (RI) is measured by the nominal interest rate adjusted for inflation.

Previous study shows that interest rate has significant impact on bank profitability

(Alper & Anbar, 2011, Riaz & Mehar, 2013). In addition, bank profits increase in line

with the rising interest rate. Therefore, it is important to use interest rate in the study

because it directly impacts bank interest income and expenses, and the net result that

further affect profitability (Obamuyi, 2013).

Financial Sector Master Plan is measured by dummy variable by using phase I (0)

and phase II (1). Dummy variable for FSMP is used to know the impact of financial

structure master plan which might affect bank profitability and stock return during the

implementation of phase I (2004-2008) and II (2010-2014).

1.7.3. Profitability Factors

Return on Assets (ROA) is measured by net income divided by total assets and is

expressed in percentage. ROA is an indicator of how profitable a company is relative

to its total assets. ROA refers to the ability of bank management to increase the

earnings from bank assets.

Return on Equity (ROE) is measured by net income divided by total equity and

expressed in percentage. ROE refers to the amount of profit that the bank earned

compared to total amount of money that shareholder have invested.

Net interest Margin (NIM) is measured by the net interest and dividend income to

total earning assets and expressed as a percentage. NIM examines how successful a

firm's investment decisions are compared to its debt situations.

1.7.4 Stock Return

Stock Return is measured by the natural logarithm of the adjusted closing prices of

stock for the current period divided by the adjusted closing prices of stock of the

previous period. Stock return is the profit earned as a result of increase in stock price.

12

CHAPTER 2

BACKGROUND

This chapter has an objective to give an overview of the banking sector in

Thailand especially during the implementation of Financial Sector Master Plan phase

one from 2004-2008 and phase two from 2010-2014.

2.1 Overview of Thailand Banking Sector

Bank of Thailand (previously known as Thai National Banking Bureau) begun

its operations in 1942 and play a function as a central bank of Thailand. Thailand

commercial banks, retail banks, subsidiaries and foreign bank branches are under the

supervision of Bank of Thailand, include other financial institutions such as finance

companies, credit foncier companies, specialized financial institutions, asset

management companies, non-banks and Credit Bureau Company.

(2.1.1) Financial Sector Master Plan Phase one (2004-2008)

The 1997 financial crisis has given many experiences to Thailand to improve

the performance of financial institutions. As a result, there was the initiative to

implement Financial Sector Master Plan (FSMP) as a medium-term development plan

for financial institution under the supervision of Bank of Thailand.

In 2004, the phase one of Financial Sector Master Plan for 2004-2008 was

implemented with the objective to make the existed financial institutions become

more efficient in their structure and roles. The implementation of the plan is an

important event in Thailand post-crisis banking regulatory reform (Nakornthab, July

2007, p. 22). Financial groups have to follow “one presence policy”, which means

they can only have one form of deposit-taking institution. Some finance companies

need to merge to their parent companies or other finance companies in order to

13

* December 31, 2003

Before FSMP*

Thai Commercial Banks 13

Foreign Bank Branches 18

Finance Companies 18

Credit Foncier Companies 5

IBF’s attached to commercial Banks 24

Stand-alone IBFs 5

After FSMP

Thai Commercial Banks 15

Retail Banks 4

Foreign Bank Branches 18

Subsidiary 1

Credit Foncier Companies 3

Finance Companies 3

Total 44

Total 83

become commercial banks or give their license back to the Bank of Thailand. The

implementation of the FSMP resulted on the reduction of the number of financial

institutions from 83 in 2003 to 44 after the implementation of FSMP (See Table 2.1).

Table 2.1

Financial institutions under BOT’s Supervision

Source: Supervision report 2004, Bank of Thailand.

Under the Financial Sector Master Plan phase one, Bank of Thailand also

allowed the existing banks to offer broad range of financial services in hire purchase

and leasing, factoring, electronic money services, certain credit derivatives and plain-

vanilla commodity derivatives.

(2.1.2) Financial Sector Master Plan (FSMP) Phase Two (2010-2014)

The second phase of Financial Sector Master Plan (FSMP) announced in 2009

and has been implemented over the period of 2010-2014. The second phase of FSMP

has an objective to improve the efficiency of the financial institution system in order

to be more efficient and competitive in their intermediation role. Moreover, the

financial institutions also could be able to serve several groups of households and

businesses, and stay strong in uncertain business environment.

There are three pillars of the second phase of FSMP. First, reduce operating

costs to improve management efficiency of financial institutions so that they can

provide services with lower costs and able to compete with foreign competitors.

14

Second, promote competition and financial access in order to encourage financial

institutions to become larger, expand the scope of business, allow foreign branches

and subsidiaries to open additional offices, also consider new entry and by supporting

the role of specialized financial institutions. Third, strengthen the institutional

infrastructure as a requirement to improve efficiency of the financial institution

system. (BoT, 4 November 2009; Herberholz, Sawangngoenyuang, & Subhanij,

2010).

(2.1.3) Performance in the Thailand Banking System

The Bank of Thailand supervision report of 2007 mentioned that the year 2007

was a challenged year for the banking system in Thailand. It is because during the

period, the Thai banking system faced internal and external challenges such as the

domestic and global economic slowdown, political uncertainty, and the increase in oil

price. The overall economic stability remained strong but the growth rate in 2007 is

4.8% lower than the year 2006 which is 5.1% (See Chart 2.1 below).

Chart 2.1

Gross Domestic Product (1988 prices)

Source: Bank of Thailand Supervision Report 2007

15

However, during the time of these challenges, the commercial banks still

making profits (BOT supervision report 2007, p. 16). Net interest margin increased to

3.1% because of the decrease in deposit interest rate. Total operating profit increased

slightly up by 0.4% from 2006. Return on Assets (ROA) decreased from 0.8% in

2006 to 0.3% in 2007 (See Chart 2.2 below).

Chart 2.2

Performance of the Banking System 2007

Source: Bank of Thailand, Supervision Report 2007.

In 2011, the Thailand economy suffered from both internal and external

factors such as the flood in Thailand and the European sovereign debt crisis. The

flood caused the slowing growth in almost all categories of consumer loans, include

manufacturing sector. European crisis had limited impact on the Thailand banking

system because Thailand mostly relied on domestic funding (Bank Supervision

Report 2011, p. 7).

The classification of large, small and medium size of banks by its total assets

over the period of 2010-2012 showed that Bangkok Bank PCL, Krung Thai Bank

PCL, the Siam Commercial Bank PCL, and KasikornBank PCL are maintain its place

as the important player in banking industry based on the year on year percentage

change of its total assets (See Table 2.2).

16

Table 2.2

Year on Year Percentage Change of Total Assets of Thailand Commercial Banks

Source: www.setsmart.com, http://tcap.listedcompany.com/fin_tbank.html based on author calculations

Yearly/2012 Yearly/2011 Yearly/2010

(31/12/2012) (31/12/2011) (31/12/2010)

Name of the Banks Symbol '000 Baht %Change '000 Baht %Chan

ge '000 Baht %Change

Bangkok Bank Public Company Limited BBL 2,338,098,705.00 14.95 2,034,001,632.00 6.16 1,915,985,798.97 10.1

Krung Thai Bank Public Company Limited KTB 2,248,267,725.00 14.76 1,959,121,233.00 11.56 1,756,093,947.14 14.05 The Siam Commercial Bank Public

Company Limited SCB 2,145,315,513.00 21.34 1,767,986,978.00 20.6 1,465,949,267.73 15.6

KasikornBank Public Company Limited KBANK 1,921,320,806.00 19.74 1,604,566,971.00 10.31 1,454,540,205.20 13.06

Bank fo Ayudhya Public Company Limited BAY 986,466,735.00 11.24 886,822,905.00 7.01 828,727,055.08 8.95

Thanachart Bank Public Company Limited TBANK 951,007,485.00 8.31 878,053,323.00 82.14 482,063,220.00 -

TMB Bank Public Company Limited TMB 711,968,281.00 -0.89 718,330,168.00 21.87 589,425,725.64 8.82

Kiatnakin Bank Public Company Limited KKP 223,931,479.00 16.63 192,009,372.00 33.39 143,949,068.39 11.57

CIMB Thai Public Company Limited CIMBT 200,268,931.82 20.24 166,551,270.52 19.64 139,210,184.24 0.22

TISCO Bank Public Company Limited TISCO 23,166,248.00 29.43 17,898,499.00 -6.95 19,235,781.80 2.26 Land and Houses Bank Public Company

Limited LHBANK 12,941,276.00 3.64 12,486,561.00 113.67 5,843,867.10 -

http://www.setsmart.com/http://tcap.listedcompany.com/fin_tbank.html

17

In 2012, Thai banking system still strong with continuous credit growth,

satisfactory loan quality, high provisioning, and good profitability . The Bank of

Thailand placed a great emphasis on three key areas such as financial stability,

financial sector development and financial customer protection in order to make sure

that Thailand’s banking system remained to be strong in order to support economy

and was strong to the future challenges that might be happened in the country (BOT

supervision report 2012).

The banking system registered an overall operating profit of 287.9 billion

baht, increasing by 32.7 billion baht from 2011 or 12.8% growth. This is because of

an increase in net interest income and high loan growth. Net interest margin to

average assets (NIM) remained stable due to the result of higher cost of fund. Finally,

return on assets (ROA) increased to 1.2%.

Chart 2.3

Profitability of the Banking System in 2012

Source: Bank of Thailand, Supervision Report 2012.

18

In sum, all the changes happened in Thailand banking sector during the

implementation of Financial Sector Master Plan greatly affect the performance of

Thailand commercial banks. Some changes are under the management control in

order to enhance bank performance, thus toward profitability. Other changes are

beyond management control, which is related to external factors such as

macroeconomic condition of the country. This has become the motivation to assess to

what extent the internal and external factors related to the profitability of Thailand

banking sector and also the bank stock return.

19

CHAPTER 3

REVIEW OF LITERATURE

This chapter is divided into three parts. First, we will review the previous

studies on bank specific factors, macroeconomic factors, bank profitability and stock

return. Second, we will build a conceptual framework based on the review of the

literature. Third, we will provide the research hypothesis to test in this study.

3.1. Previous Studies

Many previous literatures evaluate the determinants of bank profitability of

banks based on group of countries and single country level. The result also different

based on the data and methodology that they use in their studies.

(3.1.1) Group of Country Studies on the Determinants of Bank Profitability

The studies based on the group of countries included in this literature are

Molyneux & Thornton (1992), Bonin, Hasan & Wachtel (2005), Albertazzi &

Gambacorta (2009), Karim, Sami & Hichem (2010), Olson & Zoubi (2011), Li

(2013), Perera et al (2013), Yilmaz (2013) and Almazari (2014).

Previous studies showed that capital is important to explain bank profitability

(Karim, Sami & Hichem, 2010; Yilmaz, 2013). Early study such as Molyneux &

Thornton (1992) examined the determinants of bank performances across eighteen

European countries between 1986 and 1989. They found that capital ratio is positively

related to bank profitability. Li (2013) in the study of accounting based and market

based performance of banks in eight Asian emerging markets showed that ROA is

significantly positively associated to the bank capital adequacy. NIM is significantly

positively affected by capital adequacy; whereas the Q ratio is significantly positively

20

related to capital adequacy. In addition, the recent study of Almazari (2014) on

Jordanian and Saudi bank’s performance also confirmed that there is a significant

positive correlation between bank profitability with total equity to asset ratio.

Previous literature showed that bank size is also important determinants for

bank profitability (Yilmaz, 2013). Bonin, Hasan & Watchel (2005) studied on bank’s

performance in eleven transition countries from 1996-2000. Their study showed that

bank size has significant coefficient which indicates that ROA increases with bank

size. Moreover, bank size has a positive impact on bank profitability (Karim, Sami &

Hichem, 2010). Another study of ten Middle East and North Africa (MENA)

countries during the period of 2000-2008 by Olson & Zoubi (2011) also confirmed

that bank size has positive impact on the bank’s accounting measures of profitability.

In addition, the banks of MENA showed high profitability and did not show much

contradiction between the cost and profit efficiency although they were smaller in

size. Perera et al (2013) found that bank size is positively associated with profitability.

It means that the higher competition still allows banks to earn higher profits.

However, Almazari (2014) found that there is negative relationship between bank size

and profitability.

The study on determinants of bank profitability based on group of countries

also showed that asset quality, liquidity, operating efficiency (cost income ratio), and

credit risk are used as bank-specific factors. Credit risk is important determinants of

bank profitability as measured by ROA and NIM (Yilmaz, 2013). Moreover, Li

(2010) applied five groups of performance indicators such as cost control, quality of

assets, efficiency and market-based measures to find the relationship between

ownership and bank performance. Bonin et al. (2005) investigated the effect of

foreign ownership on the performance of the banks in eleven transition countries over

period 1996-2000. They found that there is no significant effect of ownership on

profitability. In addition, privatization is not enough to improve bank efficiency.

Previous studies on group of countries found the positive relationship between

asset quality and profitability. Li (2013) found out that profitability (as measured by

ROE and Q ratio) is significantly and positively related to asset quality. On the other

21

hand, Molyneux and Thornton (1992) found that there is a weak inverse relationship

between liquidity ratio and profitability. Li (2013) showed that net interest margin

negatively affected by liquidity. Almazari (2014) found that there is a significant

positive correlation between bank profitability and liquidity risk. In addition, their

study also showed that bank profitability has a negative and significant correlation

with cost-income ratio.

Finally, macroeconomic variables also are important determinants for bank

profitability. Molyneux and Thornton (1992) found that nominal interest rates are

positively related to bank profitability. Then, Yilmaz (2013) mentioned that inflation

is important determinants for both ROA and NIM. Moreover, Albertazzi &

Gambacorta (2009) studied on the link between bank profitability and the business

cycle by using data for ten industrialized countries over the period of 1981-2003. The

study found that GDP growth rate exerts a positive effect on ROE. In addition, the

coefficient for the inflation rate is positive, but not significant (Albertazzi &

Gambacorta, 2009, p. 403). Furthermore, Karim et al. (2010) examined the effect of

factors that contribute to profitability of Islamic banks in Africa from 1999-2009. The

study concluded that economic growth and inflation have positive and significant

effect on bank profitability (Karim et al., 2010, pp. 52, 54)

(3.1.2) Single Country Studies on the Determinants of Bank Profitability

The study on the determinants of bank profitability based on individual

country also can be divided into internal and external factors. Internal determinants of

bank profitability can be described as those factors that are influenced by the bank’s

management decision and policy objectives. Internal determinants include bank-

specific variables. While, external determinants of bank profitability are influenced by

events outside the influence of banks (Dietrich & Wanzenried, 2009; Staikouras &

Wood, 2011). In addition, some previous study results showed that factors under the

control of managers (which is bank-specific factors) are the most significant

determinants of the bank profitability (Acaravci & Çalim, 2013; Ongore & Kusa,

2013).

22

In most studies, factors such as bank-size, capital adequacy, asset quality,

liquidity, main source of banks funding, operational efficiency and credit risk are used

as bank-specific factors. Mamatzakis and Remoundos (2003) concluded that variables

related to management decisions (size, capital adequacy, ownership, cost structure,

business risk) are found to assert a major impact on the profitability of Greek

commercial banks. Kosmidou, Tanna & Pasiouras (2005) studied on the determinants

of the United Kingdom owned commercial bank’s profit found that efficiency in

expense management and bank size also significant determinants for banks

profitability. Javaid et al. (2011) showed that total assets, equity to total assets,

deposit to total assets and loans to total assets are the major determinants of

profitability of banks in Pakistan.

The previous study showed the different result of the relationship between

bank size and profitability. Bilal, Saeed, Gull & Akram (2013) found that bank size

have significant impact on the profitability. Some literatures showed the positive

relationship between size and bank profitability (Sufian, 2009; Davydenko, 2010;

Sufian, 2011; Alper & Anbar, 2011; Muda et al., 2013; Tabari, Ahmadi & Toyeh,

2013). Other literatures showed the negative relationship between size and bank

profitability (Naceur, 2003 Ben Naceur & Goaied, 2008; Sufian & Chong, 2008;

Syafri, 2012). Ali, Akhtar & Ahmed (2011) study showed that profitability (as

measured by ROA) seems to have been positively affected by size. On the other hand,

profitability as measured by ROE seems to have negatively affected by size. While,

Gul, Irshad & Zaman (2011) results of correlation analysis showed that size has a

positive relationship with ROA and ROE. However, size has negative relationship

with NIM.

Moreover, Athanasoglou et al (2008) found that effect of bank size on

profitability is not important. Bukhari & Qudous (2012) study was to find out the

relationship between internal and external factors that affect profitability of a bank in

11 banks in Pakistan over the period of 2005-2009. The study found that size of the

bank has no significance on the profitability of a bank. The study of Zeitun (2012) on

Islamic and conventional banks in Gulf Cooperation Council (GCC) countries found

23

that the estimated effect of size provides evidence of economies of scale in Islamic

banking using the ROE, while it is not significant for conventional banks.

Previous study also used capital adequacy as internal determinants of bank

profitability. Naceur (2003) in the study of Tunisian banking industry found that high

net interest margin and profitability tend to be associated with banks that hold a

relatively high amount of capital. Kosmidou, Tanna & Pasiouras (2013) study showed

that capital strength of UK commercial banks has a positive and dominant influence

on their profitability. Aburime (2008) concluded that capital size is significant to bank

profitability. Athanasoglou et al (2008) found that capital is positively and highly

significant, reflecting the sound of financial condition of Greek banks. Other studies

found that capitalization have a positive impact on bank profitability (Sufian &

Chong, 2008; Ben Naceur & Goaied, 2008; Ben Naceur and Omran, 2008; Sufian,

2009; Davydenko, 2010; Syafri, 2012; Tabari, Ahmadi & Toyeh, 2013).

Dietrich & Wanzenried (2009) analyzed the profitability of 453 commercial

banks in Switzerland from 1999-2006. The study found that better capitalized bank

seem to be more profitable and loan volume growth affects bank profitability

positively. Sufian (2010) tried to examine the determinants of bank profitability of the

Republic of Korea during 1994-2008. The result of the study found that the banks of

the Republic of Korea with high capitalization level tend to have higher profitability

levels. Ali, Akhtar & Ahmed (2011) found that ROA negatively affected by capital

while ROE positively affected by capital. Bilal, Saeed, Gull & Akram (2013) found

that capital ratio has significant association with ROE but insignificant with ROA.

The studies on the determinants of bank profitability also consider asset

quality as a bank-specific factor. Kosmidou, Tanna & Pasiouras (2005) found that the

impact of asset quality (measured by loan loss reserve to gross loans) is positive and

significant on NIM. Alper & Anbar (2011) found that the ratios of loans/assets and

loans under follow up/ loans are found negative and significant impacts on ROA. This

indicates that credit portfolio volume and weak asset quality impact negatively ROA.

However, the study of Sufian & Kamarudin (2012) concluded that all bank specific

24

determinants influenced the profitability of the Bangladeshi banking sector except

asset quality.

Liquidity also used as a bank-specific factor in the study of the determinants

of bank profitability (Guru et al, 2002; Abduh et al, 2012). Some literatures showed

that liquidity has negative impact to profitability (Sufian, 2009; Davydenko, 2010;

Hasan et al, 2013). Other literatures found that bank liquidity is positively related to

profitability (Sufian, 2011). However, the study of Alper & Anbar (2011) showed that

liquidity has no important effect on bank profitability. In addition, Sufian (2009)

found that the impact of liquidity on bank profitability is varied among the types of

bank studied.

Deposits are the main source for the financing of the banks. Some previous

literatures showed the positive and significant relationship between deposit and

profitability (Javaid et al, 2011; Gul, Irshad & Zaman, 2011). Other literatures found

the negative relationship between deposits as a main source of bank funding and

profitability (Davydenko, 2010). However, the study of Aburime (2008) showed that

deposits do not significantly determine the profitability of banks in Nigeria. Alper &

Anbar (2011) concluded that deposit to total assets has no important effect on bank

profitability. Bilal et al (2013) found that deposit to total assets has favorable but

insignificant impact on both profitability measures ROA and ROE. Riaz & Mehar

(2013) found that total deposits to total assets have significant impact on ROE.

Other bank-specific factor used to determine bank profitability is cost-income

ratio. It is used to measure the impact of efficiency on bank profitability. Guru et al

(2002); Kosmidou et al (2005) and Sastrosuwito & Suzuki (2011) showed that

efficient expenses management is one of the most significant factors explaining bank

profitability. Athanasoglou et al (2008) found that operating expenses has a negative

effect on profitability. Moreover, Sufian & Chong (2008) concluded that overhead

expenses are negatively related to bank profitability.

Furthermore, Ali, Akhtar & Ahmed (2011) evaluated the determinants that

affect the profitability of both public and private commercial banks from 2006-2009

25

in Pakistan. The results showed that ROA seems to have been positively affected by

operating efficiency. But, ROE negatively affected by operating efficiency. In

addition, Alkhatib & Harsheh (2012) empirically examined the financial performance

of five Palestinian commercial banks listed on Palestinian securities exchange (PEX)

from 2005-2010. The study concluded that operational efficiency and asset

management found to be significant and affect ROA. Zeitun (2012) found that the

cost-to-income had a negative and significant impact on Islamic and conventional

banks performance. Many previous literatures showed that cost-to-income ratio has

negative effect on bank profitability (Syafri, 2012; Tabari, Ahmadi & Toyeh, 2013;

Hasan et al, 2013).

Credit risk is used as a bank-specific factor to determine bank profitability.

Theory suggests that increased exposure to credit risk is normally associated with

decrease firm profitability. Chantapong (2005) studied the performance of domestic

and foreign banks in Thailand during the period 1995-2000. The study found that both

domestic and foreign banks reduced their credit exposure during the crisis years and

have gradually improved their profitability during the post-crisis years. The result also

showed that the average profitability of foreign banks is higher than the average of

profitability in domestic banks. However, the gap of profitability is narrow after the

crisis period which suggests that there is a positive result of financial restructuring.

Previous study showed different result related to the risk and bank

profitability. Aburime (2008) found that the relationship between bank risk and

profitability is inconclusive in Nigeria. Moreover, Alkhatib & Harsheh (2012)

concluded that credit risk has insignificant effect on ROA. Previous literatures

showed that credit risk is negatively related to bank profitability (Athanasoglou et al

2008; Sufian & Chong, 2008; Davydenko, 2010; Sufian, 2010; Sufian, 2011; Ali,

Akhtar & Ahmed, 2011; Bilal, Saeed, Gull & Akram, 2013). Other studies found the

positive relationship between credit risk and profitability (Ben Naceur and Omran,

2008; Sufian, 2009; Bukhari & Qudous, 2012; Syafri, 2012)

As macroeconomic environment changes, factors that affect profitability of

banking sector might change as well. Previous study showed macroeconomic factors

26

as the profitability determinants (Abduh, Omar & Mesic, 2012). Guru, Staunton &

Balashanmugam (2002) study of banks in Malaysia found that inflation has positive

effect on bank performance. Mamatzakis and Remoundos (2003) reported that the

deregulation of the market and the process of European integration with the

introduction of the Euro have enhanced the competitiveness of the Greek banking

sector. Athanasoglou et al (2008) found that business cycle significantly affects bank

profit. Expected inflation positively and significantly affects profitability. In general,

the study provided evidence that the profitability of Greek banks is shaped by bank-

specific and macroeconomic factors.

The study of Tunisian banking industry by Naceur (2003) found that the

macroeconomic indicators such inflation and growth rates have no impact on bank’s

profitability. Stock market development has a positive effect on bank profitability.

This reflects the complementarities between bank and stock market growth.

Moreover, Kosmidou, Tanna & Pasiouras (2005) found that macroeconomic factors

as measured by GDP growth and inflation, concentration in the banking industry and

stock market development have a positive impact on bank performance. However, the

overall external factors relatively have small impact on bank performance.

Ongore and Kusa (2013) found that the effect of macroeconomic factors is

inconclusive. In addition, Sufian & Chong (2008) showed that economic growth and

the level of stock market capitalization have not explained the variations in the

profitability of the Philippines banks. Moreover, Ben Naceur and Omran (2008) study

on Middle East and North Africa (MENA) countries indicated that macroeconomic

and financial development indicators have no significant impact on bank

performance. Also, the study conducted by Sastrosuwito & Suzuki (2011) on

Indonesian banking system profitability after the crisis showed that the impact of

macroeconomic environment cannot be confirmed due to insignificant result. In

addition, they found the evidence of the structure-conduct-performance hypothesis,

indicated by a positive and significant effect on industrial concentration on

profitability. Alper & Anbar (2011) found that macroeconomic factors (real GDP

growth rate and inflation rate) have no important effect on bank profitability. Sufian

& Kamaruddin (2012) found that the global financial crisis has no significant impact

27

on the profitability of banks in Bangladesh. Finally, Bukhari & Qudous (2012) also

found that import-exports and CPI have no significance on the profitability of a bank.

Davydenko (2010) tried to relate macroeconomic indicators to overall

profitability of Ukrainian banks. The result concluded that inflation as well as foreign

ownership dummy have negative effect on profitability. Davydenko (2010) also found

out the positive effect of concentration rate and exchange rate depreciation. Sufian

(2010) study showed that the industry concentration of the national banking system

has a positive and significant effect on the banks. Moreover, the impact of both the

Asian financial crisis and recent global financial crisis are negative, while the banks

have been relatively more profitable during both the calm periods.

Some study found the positive relationship between macroeconomic factors

and bank profitability. For example, Dietrich & Wanzenried (2009) study showed that

GDP growth rate, as the most important factor, has a positive impact on bank

profitability. Sufian (2011) study showed the impact of inflation is positively related

to the Korean bank’s profitability. Ali, Akhtar & Ahmed (2011) concluded that GDP

is found to have positive impact on profitability as measured by both ROA and ROE

in their study on the bank profitability in both public and private commercial banks in

Pakistan. Alper & Anbar (2011) found that real interest rate is found to having

positive effect on profitability, as measured by ROE in Turkey. Gul et al (2011)

showed that inflation and GDP have a positive relationship with ROA and ROE. In

addition, inflation and stock market capitalization has a positive relationship with

NIM which means that bigger banks have lower NIM. Zeitun (2012) found that GDP

is positively correlated to bank’s profitability.

Bilal, Saeed, Gull & Akram (2013) used external variables such as inflation,

real GDP and industry productive growth in their study. From macroeconomic

variables, Industry Production Growth Rate (IPGR) is observed to have a strong

positive and significant influence on both profitability indicators ROA and ROE.

Higher growth rate of GDP seems to have a strong positive and significant impact on

performance measure ROA and GDP has positive impact on ROE. Inflation which

have insignificant but positive impact on ROE while has strong negative association

28

with ROA. This means that in high inflation there is decline in the profitability of

banks.

Other study found the negative relationship between macroeconomic factors

and bank profitability. For example, Sufian & Chong (2008) concluded that the rate of

inflation is negatively related to Philippines bank’s profitability level. Gul et al (2011)

showed that stock market capitalization have a negative relationship with ROA and

ROE (Gul, Irshad, & Zaman, 2011, p. 76). Correlation with NIM shows that loan and

GDP have a negative relationship with NIM. In addition, Sufian & Kamarudin (2012)

found that macroeconomic indicators such as GDP and market concentration have

negative and significant impact on bank performance. Moreover, inflation shows a

negative relationship with the profitability of Bangladesh banking sector. Zeitun

(2012) found that inflation is negatively correlated to bank’s profitability. Syafri

(2012) found that inflation rate have negative effect on profitability. But, economic

growth has no effect on bank profitability. Hasan et al (2013) found that consumer

price index and financial crisis are inversely affecting the bank profitability.

The use of interest rate as a macroeconomic factor in the study of banks in

Pakistan showed that that interest rate has significant impact on ROE. Moreover, the

interest rate also has a significant influence on the ROA and ROE (Alper & Anbar,

2011; Riaz & Mehar, 2013). In addition, the study of Acaravci & Çalim (2013) used

real gross domestic products, inflation rate, real exchange rate, and real interest for the

macroeconomic determinants. Macroeconomic factors such as real GDP and real

exchange rate have been effective on the profitability. The 2001 economic crisis has a

negative effect on Turkish banking sector.

(3.1.3) Previous Studies on Bank-Specific, Macroeconomic Factors and Stock

Return

Stock return is the benefits enjoyed by the investor over an investment made.

Return is the motivating factors that cause investor to invest money in stocks. Return

29

means the profit earned as a result of increase in stock prices (Jeyanthi & William,

2010, p. 86).

Previous studies showed that bank-specific and macroeconomic factors are

determinants of stock return. For example, Drobetz et al. (2007) and Kasman &

Kasman (2011) tried to find the relationship between bank-specific variables and

stock return. Drobetz et al. (2007) evaluated the importance of bank-specific

fundamental variables in explaining the cross-section of expected bank stock return.

In addition, Kasman & Kasman (2011) used some bank specific variables and

efficiency to find the relationship for stock performance.

Drobetz et al. (2007) study on European banks showed that there is positive

impact of the ratio of loans to total assets, the ratio of non-interest income to total

income, and the ratio of off-balance sheet items to total assets on subsequent bank

stock returns. However, the ratio of loan-loss-provision to net interest revenue and the

ratio of book value of equity to total assets load negatively on bank stock returns.

While, Kasman & Kasman (2011) found that measures of bank performance such as

technical efficiency, scale efficiency and productivity have positive and significant

effect on stock returns. In addition, the control variables which included in the

regression analysis showed that changes in equity over total assets and natural

logarithm of total assets are negatively and significantly related to the stock returns,

showing that larger banks and banks that have higher capital adequacy ratios have

lower returns.

In the previous literature, macroeconomic factors are widely used among

studies on the factors that affect stock returns. The study of Tan & Floros (2012) for

bank in China showed that there is positive relationship between bank profitability,

stock market development and inflation in China. In addition, Tangjitprom (2012)

classified macroeconomic variables that affect stock return into four groups. First,

variables related to general economic conditions. Second, variables related to interest

rate and monetary policy. Third, variables related to price level include consumer

price index, oil prices and gold price. Fourth, variables related to international

activities such as exchange rate and foreign direct investment. On top of that,

30

Tangjitprom (2012) concluded that the overall evidence show that there are

significant relationships between macroeconomic variables and stock returns.

The overall study of macroeconomic factors and stock return showed that

there is significant relationship among them. Cole et al (2008) examined the dynamic

relationship between the stock prices of the banking industry and future GDP growth

of 38 markets and the result concluded that there is positive and significant

relationship between bank stock returns and future GDP growth. Moreover, Ibrahim

& Agbaje (2013) investigated the long run relationship and dynamic interactions

between stock return and inflation in Nigeria. They found that there is the existence of

relationship between stock returns and inflation. Furthermore, Saeed & Akhter (2012)

examined the impact of macroeconomic factors on banking index in Karachi Stock

Exchange by using Arbitrage Pricing Theory (APT) context. The study concluded that

money supply, exchange rate, industrial production and short term interest rate

negatively affects the banking index while oil prices has positive impact on banking

index.

However, other study showed insignificant relationship between

macroeconomic factors and stock return. For example, Tu & Li (2013) studied the

impact of macroeconomic factors on banking industry stock return in China. The

study concluded that macroeconomic variables such as inflation, exchange rate,

interest rate and money supply have relationship with banking industry stock return.

Particularly, inflation rate has a positive but insignificant impact with the banking

industry. Moreover, in the recent study, Luthra & Mahajan (2014) examined the

relationship between macroeconomic factors such as inflation, GDP, exchange rate

and gold prices on Bombay Stock Exchange (BSE) Bankex Index from 2002-2013.

The regression result of their study showed that exchange rate, inflation, GDP growth

rate affect banking index positively and Gold prices have negative impact on BSE

Bankex. However, none of the macroeconomic variables have significant impact on

Bankex.

31

3.2. Conceptual Framework

After done the related previous studies, this section identified variables that

used in this study and the expected relationship among variables that found in the

review of literature.

(3.2.1) Bank Profitability and Stock Return Measures (Dependent Variable)

The previous study in the literature review showed that financial ratios are the

most popular used to measure bank profitability. They are return on assets (ROA),

return on equity (ROE) and Net Interest Margin/NIM ( for example; Naceur 2003;

Bonin et al 2005; Gul et al 2011; Acaravci & Çalim 2013; Riaz & Mehar 2013; Li

2013). In addition, some previous study also combined financial ratios with market

based performance measurements such as Tobin’s Q ratio (Alkhatib & Harsheh 2012;

Li 2013). However, this study focused on financial ratios (namely ROA, ROE and

NIM) to evaluate the impact of internal factors and external factors that affect bank

profitability during 2004-2012. In addition, return of the stock also used as a

dependent variable in this study (Saeed & Akhter, 2012).

Return on Assets (ROA) measured by net income divided by total assets and

is expressed in percentage. ROA indicates the ability of bank management to increase

the earnings from bank assets. ROA is chosen to be bank profitability measurement of

Thai commercial banks to know how efficient the using of its assets in generating

income, which in turn affects its profitability. Previous study on Thai bank

performance during 1997-2001 showed that ROA is affected by financial crisis

(Intarachote, 2002).

Return on Equity (ROE) is defined as net income divided by total equity and

is expressed in percentage. ROE refers to the amount of profit that the bank earned

compared to total amount of shareholder equity invested or found in balance sheet. It

is important to use this measurement because we want to know the effectiveness of

the management in using shareholders funds which in turn give profit to the

shareholders (Ongore & Kusa, 2013).

32

Net interest Margin (NIM) is a measure of the net interest and dividend

income to average total earning assets and expressed as a percentage. This variable is

important to use in this study because it shows the cost of bank intermediation

services and the efficiency of the bank which can affect bank performance. In short,

banks get profit from NIM through interest activities (Naceur 2003).

Stock Return is measured by the natural logarithm of the adjusted closing

prices of stock for the current period divided by the adjusted closing prices of stock of

the previous period. Stock return is the profit earned as a result of increase in stock

price (Jeyanthi & William, 2010).

(3.2.2) Bank Specific Determinants (Independent Variable)

Previous studies on bank specific determinants (Aburime, 2008; Acaravci &

Çalim, 2013; Alexiou & Sofoklis, 2009; Ali, Akhtar, & Ahmed, 2011; Alper &

Anbar, 2011; Athanasoglou, Brissimis, & Delis, 2008; Bilal et al., 2013; Ongore &

Kusa, 2013) showed that basic goal of bank’s management decision is to achieve

profit and thus maximize shareholder wealth. The variables for bank specific

determinants are asset size, capital adequacy, asset quality, liquidity, main source of

banks funding, operational efficiency and credit risk.

Asset Size (LNA) is measured by natural logarithm of total assets. It used to

measure the asset size of banks (Alper & Anbar 2011; Riaz, 2013). Staikouras &

Wood (2011) mentioned that empirical industrial organization literature has shown

that the distribution of firm sizes in many industries and countries can be

approximated by various skewed distribution of which most widely used is the

lognormal. The log of assets is used instead of assets in order to reduce scale effect

(Staikouras & Wood, 2011). This variable control for cost differences related to bank

size and for the greater ability of larger banks to diversify. Size is important to

measure if large, medium or small size of commercial banks is efficient and thus

33

affect bank performance. Larger banks tend to have higher degree of product and loan

diversification than small banks (Acaravci & Çalim, 2013).

Previous studies showed different result of the relationship between bank size

and profitability. Some literature concluded that there is positive relationship between

size and profitability (Aburime, 2008; Alper & Anbar, 2011; Gul et al., 2011; Karim

et al., 2010; Olson & Zoubi, 2011; Perera, Skully, & Chaudrey, 2013; Yılmaz, 2013).

Other studies concluded that there is negative relationship between bank size and

profitability (Ben Naceur & Goaied, 2008; Sufian & Chong, 2008; Syafri, 2012). The

study on stock return showed that asset size as measured by natural logarithm of total

assets is negatively and significantly related to the stock return (Kasman & Kasman,

2011).

Total equity to total assets (CA) used as a proxy for capital adequacy.

Capital adequacy indicates bank ability to absorb unanticipated losses related to the

risks in banking sector. It is expected that the higher the ratio, the lower the need for

external funding and the higher the profitability of the bank (Alper & Anbar 2011).

For central bank capital adequacy is useful to absorb losses. Therefore, it is important

to include in measurement of bank performance because capital adequacy is overall

indicator for capital strength of banks.

Previous studies such as Mamatzakis and Remoundos (2003), Li (2013),

Syafri (2012), Tabari, Ahmadi & Toyeh (2013), and Almazari (2014) showed that

there is positive effect of equity to total asset on bank profitability. Furthermore, the

capital adequacy is negatively and significantly related to the stock return (Kasman &

Kasman, 2011).

Loan loss reserves to gross loan (LLR_GR) used as a proxy for asset

quality. Asset quality indicates the extent to which assets are devoted to loan. It is

because loan is the major assets of commercial banks from where they generate

income. The quality loan portfolio determine bank profitability (Ongore & Kusa,

2013). Loan loss reserve is stated on balance sheet account which related to the

money that banks set aside to pay off losses on outstanding loans and serve as an

34

insurance to absorb potential losses caused by risky assets. Basel Capital Accord

requires that banks need to have regulatory capital (through combinations of equity,

loan loss reserves, subordinated debt, and other accepted instruments) at least 8% of

the value of its risk-weighted assets (such as loans and securities) and asset-equivalent

off-balance-sheet exposures. Previous studies showed the positive relations between

loan loss reserve to gross loans (Asset Quality) and bank profitability (Kosmidou et

al., 2005; Li, 2013). In addition, asset quality is negatively related to bank stock

returns (Drobetz et al., 2007).

Total Loans to total customer deposit (LQD) used as a measurement for

liquidity. Liquidity is defined as the capability of the bank to fulfill its obligations,

especially of depositors. Insufficient liquidity is one of the major reasons of bank

failures (Davydenko, 2010). Previous studies did not find similar result on liquidity.

Some study showed negative relationship between liquidity and bank profitability

(Davydenko, 2010; Molyneux & Thornton, 1992; Sufian, 2009). Others found a

positive relationship between liquidity and bank profitability (Kosmidou et al., 2005;

Sufian, 2011). In addition, there is positive impact of bank liquidity on stock return

(Drobetz et al., 2007).

Deposit to total assets (DA) will use as proxy for main source of banks

funding. Higher interest margin and profit also depends on the more deposits are

transformed into loans. Therefore, it is important to use because as a main source of

banks funding this ratio also affects the profitability of the banks. Previous studies

showed that deposits have positive impact on bank profitability (Gul et al., 2011;

Javaid, Anwar, Zaman, & Gafoor, 2011). In addition, there is strong positive

correlation between deposit and share price (Rawling & Shanmugam, 2013).

Cost-income ratio (CIR) is measured by the percentage of total operating

expenses over total operating income. Cost-income ratio will use as a proxy for

operational efficiency (Dietrich, 2009; Syafri, 2012; Almazari, 2014). The costs

include administrative costs, staff salaries and property costs, while the ratio excludes

losses due to bad and nonperforming loans. The importance of this ratio is to measure

35

the impact of efficiency on the profitability of the banks. Higher cost income ratio has

negative impact on the bank profitability.

Previous studies showed that the cost-income ratio has negative impact on

bank profitability (Almazari, 2014; Athanasoglou et al., 2008; Syafri, 2012; Zeitun,

2012). In addition, the empirical findings showed the positive impact of the cost-

income ratio on bank stock return (Drobetz et al., 2007).

Loan loss provision to total loans (LLP/TL) used as a measurement for

credit risk. The increase in credit risk is associated with the decrease in profitability.

Athanasoglou et al (2008) argued that the increased exposure to credit risk is normally

associated with decrease firm profitability. Loan loss provision is an expense recorded

on bank income statements which is reserved for defaulted loans or credits. Since

2006, Bank of Thailand set the regulation related to International Accounting

Standard No. 39 (IAS 39), that requires banks to increase their provision to 100% for

all loans classified as substandard and doubtful (Bank of Thailand, 2007, p.32). Bank

will enhance profitability by improving screening and monitoring of credit risk. The

previous study such as Athanasoglou et al (2008) found that credit risk is negatively

and significantly related to bank profitability. Sufian (2011) also has similar result as

Athanasoglou et al (2008). In addition, loan loss provision to net interest revenue is

negatively related to bank stock returns (Drobetz et al, 2007).

(3.2.3) Macroeconomic Determinants (Independent Variable)

Banks profitability is expected to be sensitive to macroeconomic variables

(Alper & Anbar, 2011). Macroeconomic determinants are variables that reflect the

economic and legal environment that affects the operation and performance of banks

(Athanasoglou, 2008). External variables such as economic activity, inflation, interest

rate and dummy for FSMP were used as independent variables of macroeconomic

factors.

36

Real GDP growth rate (GDPGR) measures the growth in the economic

activities after adjustment of inflation. The importance of using real GDP growth rate

in macroeconomic factors based on the reason that the GDP growth rate reflects the

economic condition which is expected to have impacts on the demand for bank loans

and thus generate direct impacts on profitability of banks (Kosmidou et al., 2005).

The literature review showed that GDP growth rate has positive impact on

bank profitability (Dietrich & Wanzenried, 2009; Gul et al., 2011; Kosmidou et al.,

2005). Moreover, there is also a positive and significant relationship between GDP

growth and stock return (Cole et al., 2008).

Inflation rate (INF) measures the percentage increase in Consumer Price

Index (CPI) for all goods and services (Riaz, 2013; Alper & Anbar, 2011). Inflation

rate both anticipated and unanticipated can affect the bank performance related to

proper adjustment of bank interest rate to increase revenue than cost (Alper & Anbar

2011).

Previous studies showed that there is relationship between inflation and bank

profitability (Athanasoglou et al., 2008; Kosmidou et al., 2005). Other study found the

negative relationship on bank profitability (Sufian & Chong, 2008). In addition, the

inflation also has effect on banking industry stock return (Tu & Li, 2013; Ibrahim &

Agbaje, 2013).

Real interest rate (RI) measures the nominal interest rate adjusted for

inflation. Previous study showed that interest rate has significant impact on bank

profitability (Alper & Anbar, 2011, Riaz & Mehar, 2013). In addition, bank profits

increase in line with the rising interest rate. Therefore, it is important to use interest

rate in the study because it directly impacts bank interest income and expenses, and

the net result that further affect profitability (Obamuyi, 2013). In addition, the study

concluded that macroeconomic variables such as inflation, exchange rate, interest rate

and money supply have relationship with banking industry stock return (Tu & Li,

2013).

37

Dummy of FSMP measures the impact of financial structure master plan

which might affect bank profitability and stock return during the implementation of

phase I (2004-2008) and II (2010-2014). In this study, Financial Sector Master Plan is

used as a dummy to find the significance relationship with bank profitability and

stock return from phase I (0) and phase II (1).

Table 3.1 below summarizes the variables and the expected results of the

conceptual framework described above.

TABLE 3.1

Notation Measure Variable Expected

impact on

Profitability

and Stock

Return

DEPENDENT VARIABLE

Bank Profitability

ROA Net Income/Total

Assets

Return on

Assets

NA

ROE Net Income/Total

Equity

Return on

Equity

NA

NIM

Net Interest and

Dividend Income

/Total Earning

Assets

Net Interest

Margin NA

38

SR Ln(Pt/Pt-1) Stock Return NA

INDEPENDENT VARIABLE

Bank Specific Factors

Ln A Ln[Totalassets] Asset Size +/-

CA Total Equity/Total

Assets

Capital

Adequacy

+/-

LLR_GR Loan Loss

Reserve/Gross

Loans

Asset Quality

+/-

LQD Total Loans/Total

customer deposit

Liquidity +/-

DA Deposit/Total

Assets

Main Source of

Banks Funding

+

CIR Total operating

expenses/Total

operating Income

Operational

efficiency

+/-

LLP/TL Loan Loss

Provision/Total

Loans

Credit Risk -

Macroeconomic Factors

GDPGR Real GDP Growth Gross Domestic +

39

Rate Product

INF Inflation Rate Inflation +/-

RI Real Interest Rate Interest Rate +/-

D Phase I (0) and

phase II (1)

Dummy for

FSMP

+/-

The relationship of variables (bank-specific and macroeconomic variables as

independent variable), and profitability and stock return as dependent variables are

showed in the conceptual framework below:

40

Conceptual Framework

Independent Variable Dependent Variable

- PROFITABILITY:

ROA

e.g. Gul et al. (2011)

ROE

e.g. Gul et al. (2011)

NIM

e.g. Gul et al. (2011)

- STOCK RETURN

e.g. Tu & Li (2013)

CA

e.g. Li (2013)

Mamatzakis and

Remoundos (2003)

LLR_GR

e.g. Kosmidou et al

(2005);

Li (2013)

LQD

e.g. Sufian (2009)

Sufian (2011)

DA

e.g. Gul et al. (2011); Riaz

& Mehar (2013)

CIR e.g. Athanasoglou et al

(2008)

LLP/TL

e.g. Athanasoglou et al

(2008)

GDPGR

e.g. Kosmidou et al (2005)

INF

e.g. Athanasoglou et al

(2008)

Sufian & Chong (2008)

LNA

e.g. Alper & Anbar (2011)

Sufian & Chong (2008)

RI

e.g. Alper & Anbar (2011)

Riaz & Mehar (2013)

Dummy FSMP

Ban

k-S

pec

ific

Var

iable

s M

acro

econom

ic V

aria

ble

s

41

4.3. Research Hypothesis

After done the review of literature and described the conceptual framework,

the study proposed the following hypothesis:

Hypothesis 1:

Bank-specific factors (i.e. asset size, capital adequacy, asset quality, liquidity, main

source of banks funding, operational efficiency and credit risk) and macroeconomic

factors (GDP growth rate and inflation, interest rate and dummy for FSMP) have

significant relationship on ROA.

Hypothesis 2:

Bank-specific factors (i.e. asset size, capital adequacy, asset quality, liquidity, main

source of banks funding, operational efficiency and credit risk) and macroeconomic

factors (GDP growth rate and inflation, interest rate and dummy for FSMP) have

significant relationship on ROE.

Hypothesis 3:

Bank-specific factors (i.e. asset size, capital adequacy, asset quality, liquidity, main

source of banks funding, op