IMPACT OF PROFITABILITY IN COMMERCIAL BANKS IN THE

CONTEXT OF NEPAL

A Proposal submitted to the

Office of the Dean, Faculty of Management,

in partial fulfillment of the requirements for the Degree of

Masters of Business Studies

by

Hari Maya Pakhrin Tamang

Symbol No.: 37311/21

T.U. Registration No.: 7-2-260-6-2013

Saraswati Multiple Campus

Kathmandu

September, 2023
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1.1 Background of the study

According to (Rose, 2002) bank profitability is the net income or net earnings of a
bank often divided by a measure of bank size. The profitability of a bank may be
determined in a variety of ways. The most popular strategies are discovered to be
financial ratios. (Mamatzakis and Remoundos, 2003) substantiate this. This research
looked at the factors affecting the performance of Greek commercial banks and found
that financial ratios are very good at describing bank profitability.

In order to have a deeper knowledge of a bank's financial status and to assess the
bank's performance, financial ratios enable us to study and comprehend the financial
data and accounting information of the bank.

Financial ratios also enable us to compare banks of various sizes and act as a
benchmark for the sector, allowing us to compare each bank's ratio to the sector
average (Vasiliou & Frankfurt, 2000) (Guru, Staunton, and Balashanmugam, 2002)

Numerous financial ratios may be used to evaluate the profitability of a bank.

Financial ratios including returns on assets (ROA), returns on equity (ROE), and net
interest margins (NIM) were identified as typical indicators in earlier research. The
profitability of banks was measured by ROA and ROE in studies by (Naceur, 2003)

The author is motivated to address the issue by performing a study named

Improvement a Bank Size, Deposit ratio, and Sales Growth on ROA (Return on
Assets) Related to Company in light of the aforementioned description.

1.2 Problem statement

A research answer will be answerable in inquiry into specific concern or issues. It will
be an initial step in a research project after we will have an idea of what we want the
study. It will be everything in a research process will be built on. It will be useful in
the formulation of the hypothesis of the research. There will be negative relation
between ROA and ROE with loan ratio, deposit ratio and capital ratio, while positive
relation with bank size and inflation. NIM has a positive relation with bank size, loan
ratio, deposit ratio and inflation while negative relationship with capital ratio (Mishra,
Kandel and Aithal, 2021) but according to the researcher (Gaber, 2018) .Size has
positive impact on ROE. Capital is positively related to ROA. Deposits are negatively
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related to both ROA and ROE. This study found that neither internal nor external
factors have significant impact on NIM. The research will be directed towards
answering the following questions:

1. How is the trend of profitability of the sample bank?

2. How do the deposit ratio and bank size relate to return on assets?
3. What is the impact of deposit ratio and bank size on return on assets?
1.3 Objectives of the study
The major objective of the study will be to determine the relationship between deposit
ratio and bank size on return on assets.
1. To examine the trend of profitability of the sample banks.
2. To analyze the relationship between deposit ratio and bank size on ROA (return
on assets)
3. To examine the impact of deposit ration and bank size on ROA (return on assets).

1.4 Hypotheses of the study

The study was carried out based on certain hypothesis. With the help of hypothesis,
the study will be able to analyze the relationship between bank size, deposit ratio on
return on assets. Following will be the hypotheses made in order to study impact of
bank size and deposit ratio on return on assets.

Ho1: There is no significant relationship between deposit ratio and ROA.

Ho2: There is no significant relationship between bank size and ROA.

Ho3: There is no significant impact between deposit ratio on ROA.

Ho4: There is no significant impact between bank size on ROA.

1.5 Rationale of the study

The study attempts to examine the factors affecting on return on assets. The findings
of this study will be useful for banking institutions. This study will also help to
increase the profitability of the banks. The rationale of the study will be as follows:

1. The study will help organization, company and banking institution to managed
their deposit ratio and bank size for better result in ROA.
2. This study will also help to analyze and to maximize the ROA of the organization.
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3. This study will be useful for future researcher.

1.6 Limitation of the study

Every study has a limit and these limits are brought on by constraints in methodology
or research design. The following will be the limitations:

1. carried out with in limited time period.

2. Only two independent variables such that deposit ratio and bank size have been
considered in the entire study.
3. The data collected will be based on secondary data only.
4. The validity of the study depends on the accuracy of the data collected.

1.7 Chapter plan

The introduction, literature review, research methods, analysis and discussion, and
summary and conclusion are the five chapters that make up this study. The study's
introduction is covered in the first chapter. The study's background, problem
description, objectives, hypotheses, justification, limitations, and chapter design are
all included in this document. Both a theoretical and an empirical review are included
in the second chapter. The third chapter covers the study framework, the variables'
definitions, the population and sample sizes, the sampling designs, the types and
sources of data, the instruments used to gather the data, and the techniques of analysis.
The data analysis and discussion are presented in the fourth chapter in the form of
numerous tables and figures, and the summary and conclusion are covered in the fifth
chapter. At the conclusion of the investigation, a comprehensive list of references and
an annexure are supplied.

2.1 Theoretical review

The theories that are reviewed in this study are: Agency theory, Signaling theory and
resource-based theory.

2.1.1 Agency theory

Agency theory states that, it is the relationship between shareholders and managers
and there are three elements that can be used to analyze the behavior of managers
which are the element of the working of the managerial labor market, capital market
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and market work (Baral & Patnaik, 2021) , (Chang, Kang, & Li, 2016) and (Fu,
Kwok,and Wong, 2020)

2.1.2 Signaling theory

Signaling theory states that it is an action of company to give the investor clues about
how the company and manager view. The information collected by the company are
important which helps the investor to decide for decision making and forming
partnership (Kilon and Jamróz, 2015; Luscombe & Walby, 2017; Orlando et al., 2021)

(Astrawati, Fitriyani, Susilo,2023) researched the financial performance of using

ROA (return on assets) using this theory.

So, in this research this theory is also used to find ROA.

2.1.3 Resource- based theory

resource-based theory, which holds that commercial banks only have one goal in
mind: maximizing wealth and, by extension, profits. Frequently, banks expand into
related commercial operations that employ comparable resources in order to offer and
gain competitive advantage by using owned, controlled, and available resources.
According to (Barney & Peteraf, 2003) the idea places more focus on how well the
bank uses its resources to produce superior financial success. The resource-based
approach connects merger and acquisition as a strategy of utilizing bank's jobless
resources including money, skills, technology, new goods and services, and services
in lucrative but related operations that utilize comparable resources.

2.2 Empirical review

The researcher has done their research related to banks on profitability bank size,
deposit ratio, inflation, etc. Similarly, this study will be based on bank size and
deposit ratio while having ROA as dependent variable. The researcher Identified the
relationship between ROA, ROE and NIM with loan ration, deposit ratio and capital
ratio (Mishra, Kandel, & Aithal, 2021). the determinants of bank profitability is useful
for bank management in the process of making the policy, regulators and government
to regulate policy making and future research. the effect of macroeconomic variables
on profitability performance of Malaysian commercial bank. (San & Heng, 2013) .
According to the (Das, 2020), there positive and significant impact of advance deposit
ratio on return on assets of the banks and identified the excessive advance deposit
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ratio may create more credit risk that will be effect on financial health on the firm and
lower advance deposit ratio may also create ideal fund that enhance the opportunity
costs of the firm. There is statistically significant relationship between the size of
bank and return on assets in the short-run. Found bank size in the short-run does not
improve the profitability of commercial banks in Kenya instantly. Found the
demonstrate that bank size influences significantly the return of commercial banks in
kanya (Josephat, Mwangi, & Elly, 2019) . The researcher had found internal factors
(size, capital, loan and deposit) are significant determinants of profitability measured
by both ROA and ROE. Size has positive impact on ROE but capital gas positive
relation with ROA. Deposits are negatively related to both ROA and ROE (Gaber,
2018).

Table 1

Review of empirical studies

Study Major findings

Mishra, Kandel and Aithal (2021)
San and Heng (2013)
Das (2020)
Josephat, Mwangi and Elly (2019)
 Identified the negative relationship between ROA, ROE
and NIM with loan ratio, deposit ratio and capital ratio,
 Identified the higher loan ratio, deposit ratio,
profitability ratio, capital ratio and stable inflation can
increase profitability on banking sector.
 Identified the determinants of bank profitability is useful
for bank management in the process of making the
policy, regulators and government to regulate policy
making and future research.
 Identified the effect of macroeconomic variables on
profitability performance of Malaysian commercial
bank.
 Identified positive and significant impact of advance
deposit ratio on return on assets of the banks.
 Identified the excessive advance deposit ratio may create
more credit risk that will be effect on financial health on
the firm and lower advance deposit ratio may also create
ideal fund that enhance the opportunity costs of the firm
 Identified the statistically significant relationship
between the size of bank and return on assets in the
short-run.
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 Found bank size in the short-run does not improve the

profitability of commercial banks in Kenya instantly
 Found the demonstrate that bank size influences
significantly the return of commercial banks in kenya.
 Identified the bank size has positive relation on ROE and
Gaber (2018) capital has positive relation on ROA.
 ROA and ROE have negative relation with deposits

2.3 Research gap

In the above reviewed articles, there were 3 to 6 independent variable such as deposit
ratio, bank size, loan ratio, capital ratio and inflation whereas, dependent variables
were return on assets (ROA), return on equity (ROE) and Net interest margin (NIM)
while in this research there will be two independent variables which are deposit ratio
and bank size and dependent variable: return on assets (ROA).

The researcher in the above articles had taken data from 5 to 8 years while in this
research the data will be collected up to 10 years. The researchers had taken more
than twenty banks as their sample while in my study I would be taking only four
commercial banks as a sample for the study.

3.1 Research framework and definition of the variables.

Independent variable Dependent variable

Deposit ratio

Return on assets

ROA

Bank size

Figure1. Research framework of the study

The research framework developed in this study is based on the objectives of the
research which is to examine the impact of profitability in commercial banks. In the
study deposit ratio and bank size will be taken as independent variables whereas
profitability will be taken as dependent variable which is measured by return on assets.
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Table 2

Sources of variables

Variables Sources
Borhan and Towpek (2006), Mishra, Kandel, and Aithal (2021)
Deposit ratio
Gaber (2018) Das (2020)
Babalola and Abiola (2013), Josephat, Mwangi, and Elly(2019),
Bank size Mishra, Kandel and Aithal (2021) Gaber (2018), San and Heng,
(2013)
Appa (1996) (Josephat, Mwangi and Elly (2019) Mishra, Kandel
Return on assets
and Aithal (2021) Gaber (2018) San and Hen,(2013) Das (2020)

3.1.1 Deposit ratio

The -deposit ratio is a quick way to assess a bank's liquidity, and it also has an impact
on how well the bank is performing financially. The interest paid against loans and
advances is the primary source of income for banks, which implies that profits are
created by the favorable differential between interest on loans and advances and
interest on deposits. Profit, according to (Borhan & Towpek, 2006) is defined as
revenue profits or earnings from an activity, such as a company, business, or other
activity, over and above capital and any other associated costs. In general, if the
advance-deposit ratio is too low, banks could not be getting the best return.

3.1.2 Bank size

Bank size, on the other hand, plays an important role in the prediction of profitability
when economies of scale are considered. For instance, a forward-looking commercial
bank attempts to increase its size through consolidation —mergers and acquisitions—
in order to gain a competitive edge over the competition. A bank may leverage on
average cost reduction per unit while enhancing efficiency, capital base and market
share. (Babalola & Abiola, 2013)

3.1.3 Return on assets

The return on assets (ROA) ratio compares a bank's total net assets to its profitability.
The ratio is regarded as a measure of how well a bank uses its assets to produce cash
before having to meet contractual obligations. ROA is computed using the formula
EBIT/Total Assets. The banking industry's capital strength may be determined by
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looking at return on assets (Appa, 1996) An indication of a company's profitability in

relation to its total assets is called return on assets (ROA).

A manager, investor, or analyst can determine a company's ROA by looking at how

well the management uses its assets to produce profits.

3.2 Research Design.

The research design will apply in this research is quantitative. The study will
undertake to examine and analyze factors affecting ROA by deposit ratio and bank
size

Considering the objective, descriptive, relational, and causal research designs were
adopted to deal with various issues raised in this study.

3.3 Population and sample, and sampling design.

The population selected for the study will be the commercial banks. Out of 20
commercial banks as 31st August 2023,4 commercial banks would be chosen by
applying simple random sampling method. Among these four sample banks two
would be government owned and two would be from commercial banks for the period
of ten years from fiscal year 2012/13 tom2021/2022.

3.4 Nature and sources of data, and the instrument of data collection

The study will use only secondary sources of data. These secondary data would be
collected from annual report and websites of the respective banks, as well as from the
website of NEPSE for the period of the ten years fiscal year 2012/13 to fiscal year
2021/22. The data would be collected on the basis of the variables: dependent
variables would be return on assets whereas independent variables include bank size
and deposit ratio.

3.5 Methods of analysis

Various Statistical tools will be employed in the study. The following subsections
discuss the statistical methods that is to be utilized in this study to examine the data
findings.
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3.5.1 Descriptive statistics

A statistical measure known as descriptive statistics uses specific numbers, such as

mean, median and mode, to characterize data in order to make it simpler to interpret
and analyze. The data that is accessible (sample) is what descriptive statistics describe,
and they are not dependent on any theory of profitability because they don’t include
any generalization or inference beyond what is immediately available.

3.5.2 Correlation

Correlation is a statistical tool used to measure how strong a relation is between two
variables. Correlation is useful because they can indicate a predictive relationship that
can be exploited in practice. Thus, it is helpful. It is calculated as follows

�∑�� − ∑�∑�
�=
�∑� − ∑� 2 �∑� − ∑� 2

where,

n=Number of observations

x=Value of independent variables

y=Value of dependent variable

3.5.3 Regression analysis

Regression is a statistical measure that attempts to determine the strength of the

relationship between one dependent variable and one or more independent variables.
In this study, regression analysis will be applied to show the impact of independent
variable on dependent variable, It is calculated by applying following formula.

� = � + �1 �1 + �2 �2 + �

Where,

Y= Return on assets

a =Intercept

�1= Coefficient of bank size

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�2 =Coefficient of deposit ratio

�1= Bank size

�2 =Deposit ratio

e = error term
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