The factors affecting the profitability of banks: The case of Latvia

Abstract

Bank profitability is a topical issue for a wide range of stakeholders including bank managers and investors, financial supervisors and economic policymakers as well as economists, analysts and journalists. While the general factors affecting the bank, profitability have been thoroughly investigated in the academic literature, differences in the significance of those factors among diverse bank business models and various degrees of banks systemic importance have been analysed less comprehensively. The paper sets out to determine the main factors and their level of impact on profitability of banks in Latvia. The analysis is enhanced by considering three different perspectives of the subdivision of the banking sector in terms of (i) bank business models or (ii) their systemic significance according to the assessment made by both the national supervisory authority and the Single Supervisory Mechanism. The research is based on the analysis of macroeconomic and bank's financial statement data; the conclusions are drawn based on the analysis of a fixed effects cross-section weights panel model. The research has shown that in Latvia bank profitability is affected mostly by factors such as economic environment, inflation, interest rates (spread), competition in the banking sector as well as individual bank overall effectiveness. The findings outline the differences between different bank business models and describe the unique banking market in Latvia from the perspective of bank business decisions, at the same time providing valuable insight on profitability aspects that could prove useful, among other parties, to the national supervisory authority and the European Central Bank in bank profitability analysis and assessment of systemically significant institutions.