Impact of financial development on bank profitability

Abstract

PurposeThis paper investigates the effect of financial development on bank profitability. The authors examine whether financial development is an important determinant of bank profitability.Design/methodology/approachThe ordinary least square and the generalized method of moments regression methods were used to analyze the impact of financial development on the profitability of the Nigerian banking sector.FindingsThe authors find a significant negative relationship between the financial system deposits to GDP ratio and the non-interest income of Nigerian banks. This indicates that higher financial system deposits to GDP depresses the non-interest income of Nigerian banks. The result implies that the larger the size of the Nigerian financial system, the lower the profitability of banks in Nigeria. Also, the authors observe that bank concentration, nonperforming loans, cost efficiency and the level of inflation are significant determinants of the profitability of Nigerian banks.Practical implicationsIt is recommended that regulators should establish market-enabling policies that encourage new banks to emerge in the banking industry. The entry of new banks can lead to increase in financial system deposits and credit supply for economic growth. Regulators also need to understand the role of Nigerian banks in promoting financial development and find ways to collaborate with banks towards financial sector development. Another implication of the findings for asset managers is that asset managers will need to take into account the prevailing level of financial development, particularly the size of the financial system, in their asset pricing and investment decisions. This will ensure that investors get value for their investments in Nigeria. The financial implication of the study is that the level of financial development in Nigeria can improve the finance-growth linkages in Nigeria through the efficient allocation of credit and capital to crucial sectors of the Nigerian economy to spur growth in those sectors.Originality/valueEvidence dealing with how financial development affects the profitability of the banking sector in African countries is scarce in the literature, and is completely absent for Nigeria. This paper addresses this research gap.