Determinants of Bank Profitability in Pakistan: Internal Factor Analysis

Abstract

Financial sector plays a pivotal role in the economic development. It is generally agreed that a strong and healthy banking system is a prerequisite for sustainable economic growth. Banks in Pakistan have been undergoing major challenges in the dynamic environment over the past few years.

In order to resist negative shocks and maintain financial stability, it is important to identify the determinants that mostly influence the overall performance of banks in Pakistan.

This study aims to give the analysis of the determinants of top 10 banks’ profitability in Pakistan over the period 2004-2008. The focus is on the internal factors only. This paper uses the pooled Ordinary Least Square (POLS) method to investigate the impact of assets, loans, equity, and deposits on one of the major profitability indicator return on asset (ROA). The empirical results have found strong evidence that these variables have a strong influence on the profitability. However, the results show that higher total assets may not necessarily lead to higher profits due to diseconomies of scales. Also, higher loans contribute towards profitability but their impact is not significant. Equity and Deposits have significant impact on profitability.

Key words: Financial Institutions, Banks, Profitability, Return on Assets, Correlation, Pooled OLS, Pakistan.