The Profitability of the

Philippine Banking System

and Economic Growth
Buerano, Pamela Clarisse M. & Deraco, Rona Eilsel E.
Introduction
2
 Statement of the Problem

Given this background and considering that bank profits have been
increasing through the years, it is timely to determine if this increase
in return contributes to the sustainability and growth of the
economy. Also due to the scarcity of empirical studies in the
Philippines confirming the determinants of bank profits and the
relationship between bank profitability and economic growth, there is
a need to confirm if related theories hold in the country.

3
 Research Questions

1. Does bank profitability positively affect economic growth in the Philippines?

2. What is the causal relationship between bank profitability and economic
growth?
3. How does the causal relationship between the profitability of the banking
system and economic growth in the Philippines differ in the short-run and long-
run?
4. What factors contribute to the profitability of the Philippine banking system?

4
Significance of the Study

To
To policy-
existing
makers
literature

5
Theoretical
Framework 6
 The Impact of Bank Profitability
on Economic Growth

𝒈 = f (A, φ, s)

where:
g represents economic growth
A represents the marginal productivity of capital
Φ represents the proportion of national savings allocated to
productive investment projects
s represents the savings rate
7
 Endogenous Growth Model of Pagano (1993)

▰ Bank profitability can affect economic growth through the improvement in

capital efficiency (A).
▰ Profitable banks can also contribute to the growth in the economy by
increasing the proportion of saving that can be transformed into investment
(φ).
▰ Bank profitability can also affect economic growth by affecting the amount of
savings, and in turn, the savings rate (S).

8
The Impact of Bank Profitability on Economic Growth

Profitable Financial Financial Economic

Banks Intermediation Development Growth

9
 The Determinants of Bank Profitability

▰ Economies of Scales
▰ Risk
▰ Cost Minimization Principle
▰ Fisher Effect

10
Research
methodology 11
 The Impact of Bank Profitability
on Economic Growth
GDPt = 𝛼o + 𝛼1𝐺𝐷𝑃 + 𝛽1πt + 𝛽3 UNEMP+ 𝛽4 INT

where
▰ 𝑡 refers to quarterly time period;
▰ GDP is the real Gross Domestic Product;
▰ π is the measure of profitability of banks
▰ UNEMP is a control variable that refers to % change in
the number of unemployed persons
▰ INT is a control variable that refers to interest rate 12
 THE DETERMINANTS
OF BANK PROFITABILITY
π = 𝛽0 + 𝛽1TOTASS + 𝛽2QUAL + 𝛽3LIQ + 𝛽4CAP + 𝛽5EFF + 𝛽6ECON +
𝛽7INF + 𝛽8INT

where • QUAL is asset quality proxied by loan loss

provisions to total loan portfolio
• π refers to the measure of profitability
• EFF is operating efficiency proxied by cost-
proxied by net profit after taxes
to-income ratio
• TOTASS is the asset size proxied by growth
• INF is the inflation rate proxied by
rate of total assets
percentage change in the CPI
• CAP is capitalization proxied by capital
• ECON is economic growth proxied by the
adequacy ratio
real gross domestic product
• LIQ is liquidity proxied by liquid assets to
• INT is the interest rate
deposits
13
 THE DETERMINANTS
OF BANK PROFITABILITY

For these determinants, the growth rate of total assets, the capital
adequacy ratio, the ratio of liquid assets to deposits, the real gross
domestic product, and the interest rate are expected to positively
affect bank profitability. Whereas, the ratio of loan loss provisions
to total loan portfolio, the ratio of costs to income, and the inflation
rate are hypothesized to have a negative relationship with bank
profitability.

14
Variables and Sources of Data

Type of Data: Secondary Data

Sources:
▰ Bangko Sentral ng Pilipinas (BSP)
▰ Philippine Statistics Authority (PSA)
▰ International Monetary Fund (IMF)

15
Variables and Sources of Data

First Part: Quarterly Time-series Dataset (1999-2018)

Aggregate data of the Philippine Banking System as a whole

Second Part: Quarterly Data (2008-2018)

Aggregate data of the 5 banking groups of the Philippine Banking System

16
Statistical Methods and Procedures

THE IMPACT OF BANK PROFITABILITY ON ECONOMIC GROWTH

1.) Unit Root Test
2.) Optimal Lag Length
3.) Johansen Cointegration Test
4.) Vector Autoregression
5.) Causality Tests
6.) Structural Analysis
7.) Diagnostic Tests
17
Statistical Methods and Procedures

THE DETERMINANTS OF BANK PROFITABILITY

1.) Panel Regression
2.) Diagnostic Tests

18
PRESENTATION AND
ANALYSIS OF RESULTS
19
The Impact of Bank Profitability on Economic Growth

Unit Root Test

NPAT, RGDP, BRMONEY, & UNEMP – I(0)

Johansen Co-integration Test

There is a long-run co-integrating relationship

Lag Length Test

Lag length of six

20
 The Impact of Bank Profitability on Economic Growth

VAR Long-Run Coefficients

21
The Impact of Bank Profitability on Economic Growth

Pairwise Test

22
The Impact of Bank Profitability on Economic Growth

Block Exogeneity Wald Test

23
 The Impact of Bank Profitability on Economic Growth

Impulse Response Functions

24
The Impact of Bank Profitability on Economic Growth

Variance Decomposition Functions

25
The Impact of Bank Profitability on Economic Growth

Variance Decomposition Functions

26
 The Impact of Bank Profitability on Economic Growth

Summary of the Diagnostic Tests Results

Diagnostic Test
AR Inverse Root Graph
Correlogram of Residuals
Breusch-Godfrey LM Test for
Serial Correlation
White’s test for Heteroskedasticity
Cholesky’s test for Normality
Condition Result
Should show that all inverse root points lie inside the Satisfied
circle All inverse roots lie inside the circle
Should show that the residual points lie within the Satisfied
bandwidth. All residual points lie within the bandwidth
Majority of the probability values should fail in Satisfied
rejecting the null hypothesis that there is no serial 12/12 probability values failed to reject the
correlation. null hypothesis
The joint probability value should fail in rejecting the Satisfied
null hypothesis that the variance of the error terms is Joint probability value is equal to 0.4636
homoscedastic or stable. which failed to reject the null hypothesis at
1% level
The joint probability value should reject the null Satisfied
hypothesis that the residuals are not normal. Joint probability value is 0.0548 which
rejects the null hypothesis at 10% level
27
The Determinants of Bank Profitability

Results for Hausman Test

Probability
Hausman Test 0.543

28
Random Effects GLS Regression results
GRNPAT
COEFFICIENT
CONSTANT 148.295**
(60.771)
Internal Determinants
TOTASS .142***
(.007)
CAP .744
(2.574)
LIQ -1.052
(.639)
QUAL 1.164
(1.884)
EFF -1.913***
(.305)
External Determinants
ECON 1.746***
(.305)
INF -5.023*
(2.898)
INT 11.253
(11.584)

R2 within 0.176
R2 between 0.671
R2 overall 0.194 29
The Determinants of Bank Profitability

Diagnostic Tests Results

Prob>F

Test for serial correlation 0.0109

Test for heteroskedasticity 1.0000

30
CONCLUSION AND
RECOMMENDATIONS
31
 Conclusion

THE IMPACT OF BANK PROFITABILITY ON ECONOMIC GROWTH

1.) There is a co-integrating relationship between bank profitability and economic
growth
2.) The coefficient for bank profitability is positive and significant which indicates
that profitability of banks operating in the country influences economic growth.
3.) In the short run, there is a unidirectional causality running from bank
profitability to economic growth
4.) In the long run, there is a unidirectional causality running from economic
growth to bank profitability
32
 Conclusion

THE DETERMINANTS OF BANK PROFITABILITY

1.) For the internal variables, operating efficiency and asset size positively and
significantly affect bank profitability.
2.) For the macroeconomic variables, economic growth has a positive impact on
bank profitability while inflation rate is shown to negatively influence profits.
3.) Capital adequacy, asset quality, liquidity, and interest rate were shown to be
insignificant in explaining the variations in the profitability of banks operating in
the country during the period under study.
33
 Recommendations (Policies)

1. Continue promoting the stability of banks and further strengthen their

profitability by enacting policies that aim to prevent bank panics and
antagonized consumer confidence
2. Enact rules that obliges banks to practice expense control measures that are
more efficient
3. Enact policies that should encourage banks to devise strategies that will
allow them to optimally utilize their size and exploit their cost advantages
due to economies of scale
4. Sustain or improve their monitoring of macroeconomic factors
34
 Recommendations (Research)

1. Include more internal, industrial, and macroeconomic variables that were not
covered by this study
2. Come up with a larger data set to perform an analysis on the long-run and
short-run key determinants of profitability
3. Conduct a dynamic panel analysis using a suitable dataset to possibly come
up with more robust and stable findings
4. Extend the analysis on the neighboring developing countries of the
Philippines in Southeast Asia

35
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