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Determinants of Return On Assets of Public Sector Banks in India: An Empirical Study
Determinants of Return On Assets of Public Sector Banks in India: An Empirical Study
The time period after 2008 was very volatile for financial markets throughout the world. The global banking
system was adversely affected by the weakening of global growth, escalation of the sovereign debt crisis and
financial market crisis. However, the fundamentals of the banking sector in emerging economies were
comparatively better, which was reflected in higher economic growth and sound capital base in those economies.
As far as India is concerned, we observe that RoA and RoE of most of the banks in India have dipped during last
one or two years. This makes the study on the determinants of ROA of public sector banks very significant
particularly when the banking system in India is predominantly led by public sector banks. From the study, we
find that the most significant factors influencing RoA of public sector banks are spread, operating expenses,
provisions & contingencies and non interest income.
Key words: Return on Assets, Public Sector Banks.
2. Provisions and Contingencies (PC): (provision & H5: Operating expenses has a negative relationship with ROA.
contingencies/ total expenses) A portion of profits
H7: Net NPA as a % of net advances has negative relationship
which is kept aside for contingent situations and
with ROA.
expenditure is known as provision for contingencies,
and it has a direct bearing on the profitability. H8: Non interest income has a positive relationship with ROA
3. Non-Interest Income (NII): (Non interest income / Statistical Tools: Backward multiple regression analysis was
total assets) Non interest income refers to the Income used to analyze the impact of determinants on the ROA of
of a bank from its allied and non-banking activities. public sector banks.
Banks should aim to increase their non interest
Results and Discussions
income to enhance their return on assets.
We framed a regression equation to see the impact of various
4. Credit-Deposit (CD) Ratio (Total advances/Total
predictors on the RoA of the public sector banks as under.
deposits). Higher the CD ratio, higher is the
utilization of depositor's money which helps banks to
earn higher return on their assets.
5. Operating Expense (OE) Ratio (Operating Where,
Expenses/Total expenses): The ratio has a negative
relationship with profitability, and a high OE ratio Y = Return on Assets (RoA)
highlights operational inefficiency of a bank. X1 = Spread Ratio (SP)
6. I n v e s t m e n t - D e p o s i t ( I D ) R a t i o X2 = Credit-Deposit (CD)
(Investments/Deposits): The ratio indicates the
efficiency of a bank to invest its deposits and surplus X3 = Investment-Deposit Ratio (ID)
cash so as to generate profits. X4 = Capital Adequacy Ratio (CAR)
7. Capital Adequacy Ratio (CAR) (Capital/Risk- X5 = Operating Expense (OE)
weighted assets): In the adoption of risk management
strategies by a bank, the ratio determines the cushion X6 = Provisions and Contingencies (PC)
available to a bank against the credit risk, operational X7 = Non-Performing Asset Ratio (NPA)
risk and market risk.
X8 = Non-Interest Income (NII)
8. Non-Performing Asset (NPA) ratio (NPA/Total
assets): The ratio bears a negative relationship with First multivariate regression is run by including all the
profitability as it indicates the credit risk of a bank. independent variables mentioned above, the results of which
are shown below. From our first model (1) for the year 2009-
Time Period: We have taken data for three years covering time 10, we find that 88.3% of variation in the dependent variable
period from 2009-10 to 2011-12. was explained by all the eight variables taken together.
Similarly, the models explained 81.7% (model-2) and 87.5%
Source of data: Secondary data have been collected from the
(model-3) of variation in RoA in 2010-11 and 2011-12
annual reports and websites of respective banks, the website of
respectively. All the three initial models were found to be
Reserve Bank of India and Indian Banking Association and
significant at 1% level. However, we found many of the
their bulletins.
independent variables to be insignificant in the regression
Hypotheses of The Study models for the time periods-2009-2012.
The present study attempts to test a number of hypotheses
which as below:
H1: There is a positive relationship between spread as a %
assets and ROA.
H2: Provision for contingencies has a negative relationship
with ROA.
H2: There is a positive relationship between credit deposit
ratio and ROA.
H3: There is a positive relationship between Investment
deposit ratio and ROA
H4: CAR bears a positive relationship with ROA.
Pacific Business Review International 26
Then backward multiple regression was run to remove variations in RoA. The results of the backward regression
insignificant variables and get a fit model for explaining the analysis for the three periods are shown in Table 1below.
27 Volume 5 Issue 11 (May 2013)
Since neither of the predictor variables has a variance inflation cent by independent variables, but model is significant for
factor greater than ten during all three periods in the final explaining banks' profitability. During 2011-12, 83 per cent of
models (4 to 6) as shown in Table 3 (appendix), there are no variation in ROA is explained by SP, OE and NII. Coefficients
apparent multicollinearity problems; in other words, there is such as SP and OE during this period were found to be
no variable in the model that is measuring the same statistically highly significant. We found that NII has the most
relationship as is measured by another variable or group of positive impact on ROA of public sector banks. It is statistically
variables. significant at 1% level. Spread as a percentage of assets is
another variable with positive impact on ROA and found to be
Table 1 above shows that 83 per cent of variation in ROA is
statistically significant at 1% of significant for all the three
explained by the factors viz., SP, PC, NPA, and NII during
years. PC and NPA had the negative impact on the ROA.
2009-10 and 85 per cent of variation by all independent
Both PC and NPA were found to be statistically significant at
variables. The coefficients of SP, PC, NPA and NII were found
10% level in 2011-12. Durbin-Watson test is done to find if
to be statistically significant and theoretically sound. F-statistic
there is the problem of autocorrelation in the model/s. During
in the model (33.262) is significant at 1 % level indicating that
all three years, the Durbin-Watson statistic shows absence of
our model is fit. Though during 2010-11, adjusted R2 explains
autocorrelation.
72 per cent of the variation in ROA by SP and NPA and 77 per