Bank-Specific and Macroeconomic Determinants of Profitability: A Revisit of Pakistani Banking Sector under Dynamic Panel Data Approach

Abstract

This study aims to examine the effect of the bank-specific and macroeconomic determinants of profitability for the banking sector of Pakistan. To incorporate the issues of endogeneity, unobserved heterogeneity, and profit persistence, we apply a generalised method of moments (GMM) technique under the Arellano–Bond framework to a panel of Pakistani banks that covers the period 2003–2017. The results of a dynamic panel data approach reveal that capital adequacy accelerates the profitability of the banking sector in Pakistan. Capital adequacy helps the financial system to absorb any negative shock by reducing the number of bank failures and losses. Conversely, our empirical investigation reveals that the liquidity ratio, business mix indicators, interest rates, and industrial production deteriorates the bank profitability. Liquidity risks enhance the probability of default risks and transmit into the unpaid loans and hence the lower return. Our empirical evidence further reveals that Pakistani banks are not getting any benefit of the economies of scale in terms of financial performance.