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With our study we intend to find out whether there is a strong relation between regulation and banks profitability. One might be expecting that if the level of regulation is very high, that is too demanding, then bank returns would decrease, not only because costs would go up but also because restrictions normally mean less business. On the other hand, more regulation may mean more efficient banks that work in a healthy environment and therefore could generate more profit.
We tried to find out whether there is a relationship between commercial banking Profitability (proxied by ROA) and explanatory variables that directly or indirectly are influenced by Regulation. We built an unbalanced panel data set for 16 years and with information for more than 12.500 different commercial banks in the world.
Using slightly different models relating ROA with explanatory variables that directly or indirectly may be considered as proxies for regulation, we conclude that normally bank size and Equity to Total Assets have a positive relationship with ROA. That is, in general, larger and more capitalized banks have better profitability. On the other hand, Tier 1 Ratio and belonging to the Crisis Group is negatively linked to bank profitability.
As expected, banks belonging to countries in the Crisis Group during the latter financial crisis suffered more than others in terms of decreasing their results. This variable in all models studied had a negative relationship with profitability.
The negative relationship between Tier 1 Ratio and ROA means that larger Tier 1 ratios have not been associated with larger bank returns. Of course we must always take into account that there is an important risk return trade-off associated with this ratio. That is less risk meaning higher Tier 1 means smaller funding costs and less return.
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Financial crisis Regulation Bank profitability Determinants of bank performance Supervision Banks