Banking has a long history in Mauritius, with the first commercial bank being formed in 1838. Ever since, the banking sector of Mauritius has grown vigorously and today, the sector constitutes extending international banks, strong domestic banks and regional banks like State Bank of India, Bank Of Baroda, Standard Bank from South Africa, all serving both the domestic and global markets. The banking sector has added more than six percent on an average to GDP over the last few years. The fast elaborating Mauritian economy and the coming forth regional potential present a lot of opportunities for investment in banking in and through Mauritius in areas like global business banking, private banking, investment banking. Constituting an international finance center Mauritius endorse banking assets from many African and Asian countries. In increase, international investors use Mauritius for investments into India, china and Africa. Even South African large corporates use Mauritius to admittance pan Africa markets.
Financial comprehension is one of the key themes for both the government and banks in Mauritius. The recent sub-prime crisis emanating from the USA has raised doubts about the performance of commercial banks all around the world. A study of the determinants of banking profitability would be considered pertinent at this stage as banks play a very important role in transmission mechanism in Mauritius and to investigate whether the banks are resilient to external shocks. Banking in Mauritius the Global Business perceptive Mauritius as a long passing down of elements of a culture from generation to generation of commercial banking dating back to 1812 and its importance assume showing attitude to development of banks. Until 2004 banking was split into two classify banking authorities in offshore and onshore with only about ten offshore banking units declare to be true in Mauritius.
The covering process was strict and requires applicants to submit audited financial statements for the previous five years. Since 2004, however the effectual underlying structure has been recognized and the banking act improved such that all banks now governed by one single license. The banking act provides for arising principle with respect of banks concentration of risk weighted capital sufficient to satisfy a requirement ratio, income acceptance as true and category of loans and advances for fitting out process, maintenance of accounting and other records and internal control system. The bank of Mauritius, the principles and supervisory body, has given support the Basle capital agreement and assumed the Basle committees core principles for effective principles of banks. The bank of Mauritius also set up a calendar for all banks to be complaint to the stipulated conditions of Basel underlying structure by December 2008.
As I have banking experience of 32 months I would like to study in depth of banking as well financial sectors. I am very much interested in finance because when I was doing job in bank by seeing managers and head of the departments I was very inspired and that motivates me a lot to go in depth of finding banks how it works and its advantages. Definitely in doing good research we will get more knowledge and interest to work further and also it is good practices. The data which I need to collect is regarding the determinants of banking profitability in Mauritius.
3. Preliminary Literature Review:
The global business sector was demonstrated in 1992 to appeal foreign investments to a wide range of banking and non-banking activities. Mauritius is an effective offshore legal power building on its 36 DTA's some of which have been in existence since 1980. With its expert global business legislation, Mauritius changes corporate and commercial clients to take advantage of its DTA's investment aims. Mauritius is a market driven economy which has enjoyed bearing political constancy. This part starts by furnishing an overview of several concepts in the bank profitability literature which shall include inter alia, basic profitability concepts and ratios and then continue with the theoretical determinants of bank particular, industry particular and microeconomic indicator of bank profitability. The second part of this part limits itself to the several earlier empirical analyses carries out with respect to the later which shall be segregated advance in formulating, formulated as well as in a panel of countries.
3.1 Theoretical Framework:
David Cole (1972) founds a method for evaluating the performance of banks through ratio analysis. A variant of the method is the return on equity model, utilized to analyze bank profitability and identifies particular assesses the rick.
3.1.1 Profitability Ratio: Return on Equity and Return on Assets
One of the most significant profitability metrics is return on equity (ROE). Return on equity brings out how much profit a bank earned in equivalence to the total amount of shareholders equity found on the balance sheet.
Formula for Return on Equity:
Return on Equity =
Net Profit
Avg. Shareholder's Equity
Shareholder equity is equal to total assets minus total liabilities. It's what the shareholder 'own'. Shareholder equity is creation of accounting that constitutes the assets created by the retained earnings of the bank and the paid-in capital of the owners. A higher ROE is seen as pertinent as it amends accumulated earnings for the bank so that the bank can more cash dividends when higher profits are made.
Return on Assets (ROA) evaluates how profitable a bank is relative to its total assets. In turn, it evaluates how efficiently a company uses its assets. A higher ROA is better, as it means that a bank is more efficient about using its assets. The connecting between ROA and ROE is by equity multiplier, which is the ratio of total assets to total equity.
Equivalence of a bank's assets with its equity is made by the bank's equity multiplier and generally a higher value indicates high bank debt, equity ratio or simple high financial leverage and therefore a profit as well as a risk assess.
3.2 Determinants of Profitability: Size
In the literature, Civelek and AI-AIami, 1991, Evanoff and Fortier, 1988 contend that a bank's total deposits, assets or an average assess based on total assets are usually used to catch bank size. Sizes commonly conceive disparities in economics of scale enjoyed by banks. Generally larger banks are improve able to enjoy more economies of scale diversify as opposed to smaller banks. Yet Evanoff and Fortier 1988 and Smirlock 1985 contend that economies of scale can have a convinced influence on profits but can be partly offset by bigger capacity for diversification of assets, which contributes to lower risk and expected return. Thus, the hit of bank size, a theoretical, is in determinant. Smirlock 1985 contend that there exists a convinced and significant link between size and profitability. Granting to Demirguc-Kunt and Maksimovic 1998 the degree to which profitability of bank is involved by financial, legal and other components, for example corruption is very much associated with form size. Furthermore, short 1979 contend the size is powerfully connected to the capital adequacy of a bank as a bigger bank have a tendency to have measure to cheaper capital and, therefore, be more profitable.
3.2.2 Risk Levels:
The requirement for risk management is intrinsic in banks. Substandard asset quality and liquidity problems are the two key sources of banks failure. In periods of climbing uncertainty, banks may choose for diversification of their portfolios or maintain more liquid assets in order to minimize their risk. Against this setting, risk may be sorted into credit and liquidity risk. Molyneux and Thornton 1992 assert that there is negative and important connection between the levels of profitability and liquidity, such that the high level of liquidity contributes to lower profitability the other way around.
3.2.3 Asset Quality:
Miller and Noulas 1997 assert that the effect of credit risk on profitability is doubtless negative. This is because as banks concede higher rick loans, non-executing loans increase as well and therefore cut down the profitability of the banks. The loan-asset ratio and the non-executing loan ratio are generally employed to evaluate credit risk. Portfolio theory specifies that investment in risky assets concede with higher returns than with primary assets. Granting to Civelek and AI-AIami 1991 Evanoff and Fortier 1988 the loan asset ratio is commonly extremely concerned with bank profitability while the non-executing loan ratio is negatively concerned. This evaluate of bank risk has created severe consequences, carrying that there is risk reduction behavior among bank managers.
3.2.4 Bank Efficiency:
Bank efficiency is another bank-particular component. An efficient bank is capable to increase profitability by making efficient use of its lending resources. Granting to Demiruc-Kunt and Huizinga 1999 a dimension of banks overhead costs are exceeded on to depositors and lenders while the rest cut down profitability. A rough assess of bank efficiency is bank overhead cost, though X-efficiency, a more advanced assess, has recently become popular. The latter shows how a specific set of prices and quantities of input and outputs change, in accordance with the banks preferred strategy, and how it involves bank profitability. Berger 1995 finds that X-efficiency is systematically associated with higher profits for a large sample of banks.
3.3 Empirical Framework:
Manly analysis have been done during the past few years on single country analysis such as Greece, Switzerland, UK, USA, China, Columbia, Brazil among others, from the several analysis during the few decades, capital, credit risk, productivity, expenses management and size, these firm particular components have importantly influence bank profitability. The firm particular components are generally classified into single country analysis and panel country analysis.
3.3.1 Single Country Analysis:
Berger 1995 Neeley and Wheelock 1997 furnish some evidences concerning the determinants of banks profitability in USA. Berger 1995 evaluates the connection between the profitability and the capital asset ratio for banks in the US for the period 1983-1992 applying the Granger relation and illustrates a convinced relationship between capital asset ratio of the commercial banks and their profitability. Neeley and Wheelock 1997 look into the profitability of banks in the US for the period 1980-1995. Applying GMM techniques, they find evidence of persistence and a convinced association between bank profitability and yearly percentage change in per capita income. Applying similar methodology, Angbazo 1997 researches the determinants of banks profitability for some US banks during 1989-2003 and find evidence of profit persistence. They also find convinced associations between bank profitability nonpayment risks, the opportunity cost of non-interest accepting reserves, leverage and management efficiency.
Applying pooled fixed consequences framework, Barajas et al 1999 studies the determinants of banks profitability for the period 1991 to 1998 and the finds the consequences of financial liberalization to be important on bank profitability for Columbia. Contempt profitability does not come down after the reform; the significant of the various components influencing profitability were involved by such assess. Applying pooled fixed consequences framework, Naceur and goaied 2001 research the determinants of banks profitability in Tunisia form the period 1980 to 1995 and show that banks which protest to labor and capital productivity progress in development strengthen their capital base and having higher deposits to asset ratios are most profitable. Applying similar framework, Naceur 2003 evaluates the determinants of banks profitability in the Tunisian banking sector for the period 1980 to 2000. He finds that within country inequalities in bank interest margins and net profitability is generally explained by bank particular characteristics. Highly profitable banks are those banks with high level of capital and large expenses. He also finds that banks come along to experience scale inefficiencies given that size has got a negative important consequence on net interest margin.
Also, no affect is found for macroeconomic indicators such as inflation and increase rates on banks profitability. Last, but not least, he finds that stock market growth as got an important impact on bank profitability, proposing complementarities between bank and stock market. Empirical evidence from emerging economies emanate from Columbia Barajas et aI 1999, Brazil Afanasieff et aI 2008, Malaysia Guru et aI 2002, Tunisia Ben Naceur 2002, 2003, Macao Vong and Chan 2009, Turkey Savilgan and Yildirim 2009.
3.3.2 Country Analyses:
Most of the panel country analyses were accomplished by Molyneux and Thornton 1992, Saunders and Schumacher 2000, Abreu and Mendes 2002, Goddard et al 2004, Athanaso et al 2006, Beckan 2007, in Middle East countries by Bashir 2000, formulated and growing countries by Demerguc-Kunt and Huizingha 1999, 2001. Flamini et al 2009 study the determinants of 389 banks in 41 Sub-Saharan African countries for a ten years period ending 2006 and finds that highly profitable banks are those with large size, activity diversification and private ownership, albeit those with high credit risk incline to be less profitability. It is also found that macroeconomics policies that promote price constancy and stable economic development increase credit development and profits. Applying GMM technique, it is also found that there is control persistence in profitability. Promote, Granger relation from profitability to capital occurs with important lag proposing that profits are not retained for recapitalizing the banks and entailing that higher capital necessities are required to improve financial stability.
4. Research Questions and Objectives:
Various commercial banks around the globe have had their financial performance affected during the recent decade on account of the recent sub-prime crisis. Also, some banks have had to shrink their assets and some have even failed and went out of business. Moreover, many studies regarding determinants of banking profitability have been conducted in Asian countries, European and American countries. However, very few studies have been carried out for Mauritius. Even if there are few studies, the sample size is too small or there is a wrong functional form for models utilized. The present study shall close a significant gap in the literature by trying to achieve the following objectives:
To investigate the determinants of Return on Equity (as a measure of profitability) in a sample of 15 banks over the period 2005 to 2011 in Mauritius.
To investigate the determinants of Return on Assets (as a measure of profitability) in a sample of 15 banks over the period 2005 to 2011 in Mauritius.
To investigate the determinants of Net Interest Margin (as a measure of profitability) in a sample of 15 banks over the period 2005 to 2011 in Mauritius.
The above objectives will provide an insight as to whether the banking sector in Mauritius is resilient to external shocks or not.
5. Data and Methodology:
The part starts by bringing in the data source and aimed methodology referring to the study of the determinants of banks profitability. We then continue by giving the baseline model adjusted from Flamini et al 2009. Thereafter a review of the applicable theories considering econometric study viz, the classic fixed effects, the random effects and the Hausman stipulation test are furnished. The reserve diagnostic tests of the like of Ramsey-RESET test, which test for stipulation test furnished. This furnishes the points about the methodology followed in assist in achieving research objectives. It include the approach followed to study the effect of main determinants on banks profitability, the type of data used and the techniques employed to collect the data, the sampling mechanism admitting sample size, the methods applied to manage and examine the data, and the process of constructing empirical model with recognition and the measurement of its factors.
The analyses are based on a panel of 15 commercial banks. Data is found from the annual reports of the banks. The sample data starts in 2005 to 2011 for the simple cause of data inaccessibility for some banks. Rather doing a cross section analysis, this study looks at a panel data stipulation. Baltagi 1995 highlights the advantages of applying the latter. First, panel data accounts for the conception those banks and the countries are heterogeneous in conditions of accounting policies and standards within certain dynamic period, a situation that cannot be found in either time series or cross section analysis. Second, in panel data we admit all the banks data without having an appeal to aggregation or averaging, which of course eliminates all biases linked with the latter.
6. The Research Approach:
In terms of ascertain facts study there are two common ideas to business and social research
Deductive approach formulates theories and hypotheses complied by a research strategy to test the hypotheses.
Inductive approach finds data and formulates theories as a result of the data analysis.
The deductive approach brings in a high level of objectiveness in research through external notice insofar as the choice of questions and subsequent phrasing are not subjective. In contrast, the inductive approach furnishes a high level of subjectiveness and a number of theoretical future prospects based on the context of the individual research position. This study will analyze the previous findings in the literature, and apply the consequences in current practical settings. Therefore, deductive approach was followed by constructing an empirical model and hypothesizing its collinear relationship between target determinants and its dependent variable profitability of banks.
7. Data Analysis:
Due to time constraint and data accessibility, the study is based on secondary quantitative data. Which obtain from public database. Researcher said that the advantage of using secondary data admits the higher quality data equated with the primary data collected by the researcher themselves. The feasibility to carry on longitudinal studies, which is the case in this study and the permanency of data, which mean secondary data generally furnish a source of data that is both permanent and available in a form that may be assured relatively easily by others, i.e. more open in public examination. Therefore, increase the reliability of the data.
