The Relationship Between The Economic Cycle And Bank Profitability: Evidence From Vietnam And The Asean-5 Countries.

Abstract

Amid an economic downturn, the performance of financial institutions tends to deteriorate due to its procyclicality, worsening the already unfavorable economic conditions in return. Hence, a deep understanding of the relationship between bank profitability and the business cycle is essential to develop effective macroprudential policies for better financial stability. To achieve those, this study aims to identify and evaluate factors that have a significant impact on the Diversification ratio (Diversification) and Profitability (Return on Equity – ROE) of financial institutions in Vietnam and the ASEAN-5 countries (Thailand, Malaysia, Singapore, Philippines, and Indonesia). It adopts a sample of 46 commercial banks in the countries mentioned before between 2007 and 2015 to determine whether there is a significant connection between either of the dependent variables adopted and the following independent variables: Real GDP (RGDP), Real GDP growth (RGDPG), Inflation (INF), Money market rate (MMR), Stock market to GDP ratio (MKC), Stock market volatility index (MKV), Industrial production index (IPI), Interest rate spread (SINT) (macroeconomic variables), and Bank Operating expenses (OE) and Total assets (TA) (bank-specific variables). A Regression model with Two-step Generalized Method of Moments (GMM) Estimator is applied to Diversification due to the existence of lags in the impacts of its explanatory variables, while a “static”, Generalized Least Squares model is adopted for ROE. This study finds that Diversification is positively related to RGDP, MMR, MKC, MKV, IPI, OE and TA, while negatively affected by INF, most of which demonstrate lagged effects. Concerning ROE, this variable is found to move in the same direction as TA but opposite one with INF and IPI, while other factors including RGDPG, MMR, MKC, MKV, SINT, and OE show no statistically significant impacts on ROE. Using this paper, bank financial managers could be aware of how important it is to set diversifying strategies at appropriate levels to benefit under various economic circumstances and be flexible in utilizing both available and predictive economic data to decide on the optimal business policies and regulations for operational efficiency maximization.