Determinants of bank profitability in vietnam does foreign presence matter

UNIVERSITY OF ECONOMICS

INSTITUTE OF SOCIAL STUDIES

HO CHI MINH CITY

THE HAGUE

VIETNAM

THE NETHERLANDS

VIETNAM – THE NETHERLANDS PROGRAMME FOR M.A IN
DEVELOPMENT ECONOMICS

DETERMINANTS OF BANK PROFITABILITY IN
VIETNAM: DOES FOREIGN PRESENCE MATTER?

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

By
TRUONG UY PHAP

Academic Supervisor
Dr. DUONG NHU HUNG

HCM city, December 2014


CERTIFICATION
“I hereby claim that the substance of this thesis has not ever been submitted for any

degree and has not been currently submitted for any other degree.
I certify that to the best attempt of my knowledge and support received during the
preparation phrase of this thesis and all resources have been acknowledged in this
thesis”.

TRUONG UY PHAP
Date: … December 2014

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ACKNOWLEDGEMENT
I would not be able to write and finish my thesis without the help and support
of people surrounding me.
Above all, I would like to express my greatest appreciation to my supervisor,
Dr. Duong Nhu Hung, for his precious comments, advices and guidance,
encouragement during the writing period. Without his guidance, my thesis would
not be completed.
I would also like to offer my special thanks to Dr. Truong Dang Thuy for the
econometric guidance and valuable suggestions that help to develop this thesis.
Besides my mentors, special thanks also to all the lecturers at the Vietnam –
Netherlands Program for their expert knowledge and sharing during the coursework
phrase.
In addition, I really appreciate my friends and people who are always beside
me and provide supports for my thesis.
Last, but not least, I am very deeply grateful to my family. Without their
warm encouragement and patience, I would not be possible to complete well this
thesis.

TRUONG UY PHAP

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ABSTRACT

The present paper seeks to examine the determinants of bank profitability in
Vietnam during the period 2004–2013. The empirical findings suggest that credit
risk, non-interest income, operating expense and liquidity variables have a
statistically significantly impact on bank profitability. The empirical findings
suggest that credit risk and expense preference behaviour are negatively related to
banks' profitability, while non-interest income and liquidity have a positive impact.
During the period under study, the results suggest that inflation has a negative
impact on bank profitability, while the impacts of economic growth and money
supply have not significantly explained the variations in the profitability of the
Vietnamese banks. Besides, foreign presence from the macroeconomic view and
enterprise view do not show the significant relationship with bank profitability. In
other words, the opening up policy to allow more foreign entry entering into
domestic banking market and relaxing of foreign ownership restriction in local
banks are considered unclear for policy implications.

Key words: bank profitability, foreign presence, ownership, Vietnam, determinants

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ABBREVIATION

SBV

State Bank of Vietnam

SOBs

State-Owned Banks

JSBs

Joint Stock commercial banks

JVBs

Joint Venture banks

FOBs

100% foreign-owned banks

GMM

Generalized method of moments

FEM

Fixed Effect Model

REM

Random Effect Model

OLS

Ordinary Least Square

LSDV

Least Square Dummy Variable

GDP

Gross Domestic Product

WTO

World Trade Organization

FS

Foreign Shareholding

FSP

Foreign Strategic partner

FP

Foreign presence

ROA

Return on Assets

NIM

Net interest margin

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TABLE OF CONTENTS

CHAPTER 1: INTRODUCTION ............................................................................. 1
1.1.

Problem statement ............................................................................................ 1

1.2.

Research objective ............................................................................................ 3

1.3.

Research questions ........................................................................................... 3

1.4.

The scope of the study ...................................................................................... 3

1.5.

Structure of the study........................................................................................ 4

CHAPTER 2: LITERATURE REVIEWS .............................................................. 5
2.1.

Theory of Bank profitability’s determinant ...................................................... 5

2.2.

Foreign presence/ ownership and its impact on bank profitability ................ 10

CHAPTER 3: RESEARCH METHODOLOGY AND DATA ............................ 16
3.1.

Research methodology ................................................................................... 16

3.1.1. Estimation panel regression model:................................................................ 16
3.1.2. Test for an appropriate panel data regression choice ..................................... 18
3.2.

Model specification ........................................................................................ 20

3.3.

Variable measurement and test hypothesis..................................................... 25

3.3.1. Bank profitability definition ........................................................................... 25
3.3.2. Internal determinants ...................................................................................... 26
3.3.3. External determinants ..................................................................................... 29
3.3.4. Foreign presence and foreign shareholding .................................................... 30

3.4.

Estimation strategy & Data collection ............................................................ 32

CHAPTER 4: RESEARCH RESULTS & DISCUSSION ................................... 35
4.1.

Vietnam banking background ......................................................................... 35

4.2.

Descriptive statistic of the sample .................................................................. 39

4.3.

Empirical results & findings discussion ......................................................... 45

4.3.1. Result of Test for panel regression model ...................................................... 45
4.3.2. Empirical results ............................................................................................. 46
4.4.

Discussion of findings .................................................................................... 48

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4.4.1. Overall model ................................................................................................. 48
4.4.2. Internal determinants ...................................................................................... 49
4.4.3. External determinants ..................................................................................... 52
4.4.4. Foreign presence ............................................................................................. 53

CHAPTER 5: CONCLUSION................................................................................ 55
5.1.

Conclusion ...................................................................................................... 55

5.2.

Recommendations .......................................................................................... 57

5.3.

Limitations & suggestion for future studies ................................................... 58

APPENDIX A: INFORMATION OF BANK OBSERVATION SAMPLE.......... 62
APPENDIX B: SUMMARY OF SOME MAIN EMPIRICAL LITERATURE
REVIEWS

........................................................................................................... 71

APPENDIX C: DESCRIPTIVE SUMMARY ANALYSIS .................................... 77
APPENDIX D: PANEL REGRESSION MODEL .................................................. 79
APPENDIX E: RESULTS OF BREUSCH – PAGAN LM TEST ......................... 87
APPENDIX F: RESULTS OF HAUSMAN TEST.................................................. 89
APPENDIX G: RESULT OF ROBUST STANDARD ERROR (FIX
HETEROSKEDASTICITY) ..................................................................................... 91

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LIST OF FIGURES

Figure 2.1: Analytical framework of determinants of bank profitability..................15
Figure 4.1: Trend of foreign presence in Vietnam ....................................................38
Figure 4.2: Average bank’ equity by different levels of foreign presence ...............42
Figure 4.3: Average bank’ total assets by different levels of foreign presence ........42
Figure 4.4: Average bank’ return on asset by different levels of foreign presence ..43
Figure 4.5: Average bank’ net interest margin by different levels of foreign presence
...................................................................................................................................43

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LIST OF TABLES

Table 3.1: Tests for choosing the appropriate panel regression model .....................20
Table 3.2: Definition, notation and expected signs of relevant variables .................22
Table 3.3: Data collection sources ............................................................................34
Table 4.1: Numbers of banking institutions in Vietnam (2004-2013) ......................37
Table 4.2: Performance of banking industry and its contribution to Vietnam
economy ....................................................................................................................39
Table 4.3: Summary statistics for all variables in this research ................................40
Table 4.4: Correlation analysis among independent variables .................................44
Table 4.5: Results of F test and Breusch – Pagan Test .............................................45
Table 4.6: Results of Hausman Test .........................................................................45
Table 4.7: Result of Test for heteroskedasticity .......................................................46
Table 4.8: Results of the final models .......................................................................47

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CHAPTER 1: INTRODUCTION
1.1.

Problem statement
In the world of financial liberalization during the last few decades, in terms of

facilitating the critical roles of international trade, the rise of international banks has
become important significantly. Banks have expanded multinationally by not only
establishing foreign susidiaries and branches as local incoporation formation but also by
taking over estabished foreign banks. As other corporations, banks have always operated
with the aims of profit maximization. The foreign banks operates in developing
countries will be considered as the same strategy afterward. However, to what extent
will the foreign bank operating in particular country yield a better return than those
domestic competitors, or vise-versa? This is the question leading to many reseaches
conducted recently.
There have been some researches regarding the impact of the internal factors such
as bank specific characteristics (size, risk level, liquidity status and so on) and external
factors such as inflation, GDP from the country-specific factors on banking profitability
(Pasiouras and Kosmidou, 2007). These determinants have been anlayzed not only in a
series of pooled countries but also in a single country. However, to integrate the effect of
foreign ownership structure into this link is critically necessary especially for developing
countries where they are concentrating on the progress of financial liberalization and
seeking for foreign entry to enhance the domestic market. As part of the privatization
and financial liberalization strategy, more and more developing countries allow foreignowed banks or greenfield bank (Bonin et al, 2005) to operate in their domestic market.
As stated in their study, privatization of banking sector, particularly in developing
countries is usally accompany with complex procedures and phrases. These may
dramatically change the whole banking sector operation in which they would affect to
the value of banking, growth rate, risk exposures and defintely performance of banks.
Some markets such as China followed a more prudent approach where they open a
certain limit of foreign investor in their domestic commercial bank so-called strategic

partner program (Shen et. al., 2009). Since foreign banks represent one of bank
ownership type besides domestic state-owned or private-owned banks, will foreign
ownership, either at greenfield bank or at domestic bank, with the role of strategic

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foreign investor or at board management, affect the banking profitability besides bank
specific charateristics and macroeconomies factors in a typical developing market?
The answer of Bonin et. al. (2005) and Claessens et.al (2001) was considered as
“YES”. Generally, they found that foreign-owned banks are more cost-efficient than
other banks and deem better performance in terms of profitability, in particular if they
have a strategic foreign owner. Indeed, if foreign-owned banks use modern technology,
better expense management, and rely on the human capital of their parent banks, they
should perform better than government-owned or domestic private banks in transition
countries. In the scope of a developing country like China, the findings of Shen et. al.
(2009) have concluded the insignificant impact of the foreign presence at individual
bank’s stake on banking profitability. The reason for this could derived from the impact
on both revenue and expense that somehow mututally reduced the final influence on
profitability. That led to the conclusion of further research to investigate more on the
actual influence on each component or activity rather than release more stake to foreign
investors. Neverthelese, they have observed a increasing trend in attracting more foreign
penetration in Chinese banking industry was significant, especially when Chinese
government considered a opening-up policy to enhance its own financial market. That is
happened in China banking industry, Should foreign penetration or foreign ownership at
individual bank have the same impact and the same findings on an emerging market
where it witness the fast changing environment recently ?
To the limited knowledge of author, there have been many reseaches examining
how different bank profitability could be affected critically by the bank internal factors
and external factors, especially in a particular country. In Vietnam, a typical less

developed country, the similar study unlikely yield the similar answers, or maybe
“YES”. Moreover, a more interesting topic flagged up besides the traditional
determinants mentioned above is the relationship between foreign presence and bank
profitability. As noticed Vietnam recent banking industry is applying the strategy from
some countries such as China, Hungary when introducing foreign strategic partners and
100% foreign-owned bank type in our commercial banking market. These could be
somehow have impacts on domestic bank profitability, as our opinion. That is the reason
why these trends could be brought up for our study interests. In this study, these impacts
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would be identified to provide a clear understanding of this relationship of both the
internal and external determinants of banking profitability in Vietnam banking industry
during period of 2004 to 2011. This period invloves a significant improvement of
economic conditions with really high boom after joining WTO in 2006-2007. In addition
to this research aim, the question of how to improve the financial market or banking
market in developing countries like Vietnam could be deemed as crucial to investigate.
Should Vietnam allow more and more foreign penetration entering into banking sector
to improve the profitability and its impact, if any, and the policy implication that
Vietnamese government should be considered when follow the similar opening-up
policy to liberalize our own domestic banking market? Or any other factors, as a hint, for
policy maker to understand and react could be considered significant to enhance the
banking industry?
1.2.

Research objective
The objectives of the thesis are to:

a. To examine the impact of internal factors (i.e. bank sepcific characteristics) and
external factors (i.e. macroeconomies & industry variables) on Vietnamese

bank’s profitability in Vietnam.
b. To investigate the impact of foreign presence on bank profitability controlling
others factors in different bank ownership types in Vietnam;
1.3.
-

Research questions
What are the impacts of internal factors and external factors on Vietnamese bank
profitability?

-

Does the impacts of foreign presence affect bank profitability? Shall we allow
more and more released stake for foreign penetration entering into our market?

1.4.

The scope of the study
This thesis used yearly data of most of commercial banks in Vietnam during the

10-year period from 2004–2013. It focuses on two aims to answer the research questions
above. First, this paper will examine the determinants for bank profitability, both
internal and external factors. Second, it will try to apply a variable to test the impact of
foreign ownership or foreign presence on individual bank profitability. The dataset is

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collected from Bankscope, which is one of the most reliable financial resources for
banking industry meanwhile some external macroeconomics variable may be found on

Worldbank, ADB and other sources. The data sources for foreign shareholding will be
collected through banks’ annual reports and be verified against information from
Bankscope, other reliable media.
1.5.

Structure of the study
The structure of this study is displayed as a five-chapter format template. Beyond

the first chapter - Introduction chapter - flagged up to steer the attentions, the second
chapter introduced the concepts and theoretical study of banking profitability and its
relevant determinants with the coverage of foreign ownership discussion. Besides, some
empirical researches has also been employed as the foundation of our study followed by
the next couple chapters. Next chapter - chapter three - the research methodology and
data collection, variables explanation and model specification would be introduced
gradually. Chapter four will then drive us through the snapshot of Vietnamese banking
industry background meanwhile the important part of this research – empirical findings
& discussion will be brought up as the main section among others. Final chapter, the
study will summarize all of the policy implication, limitations, and further approach for
research.

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CHAPTER 2: LITERATURE REVIEWS
This chapter generally covers two main sections and the derived framework. The
first section provides definitions and theory of bank profitability and reviews theoretical
backgrounds about the critical factors that could impacts on banking profitability. The
second section summarizes previous empirical researches that studied on foreign
presence or foreign ownership and its impact on profitability. Based on relevant
contents, the final drawn part will recommend in this chapter the construction of

conceptual framework for this study.
2.1.

Theory of Bank profitability’s determinant
Knowledge of factors influencing the bank profitability will be challenged for all

the economists. In Vietnam, this is vital for all banks management level to have a better
view of the effect of those determinants to their bank profit. A lot of researches related
in this study area examine the determinants of bank profitability within the scope of
single country (Ábel & Siklos, 2004; Sufian,2009) or the pooled countries
(Athanasoglou et al, 2008; Molyneux & Thornton, 1992; Kosmidou & Pasiouras, 2007;
Demirgüç-Kunt & Huizinga, 1999). However, to what extent of the knowledge of the
research author, there was only a limited number of research focusing on this field for
Vietnam market rather than a variety of countries or individual developing country such
as Phillipine or Malaysia.
The theory of bank profitability’s determinants came from the study of a more
comprehensive set of variables that would be discussed in this study conducted by
Demirgüç-Kunt & Huizinga in 1999. In this research, they have employed most of the
important factors to examine their impact on bank profitability. They had used banklevel data for 80 countries since 1988 and found that differences in interest margins and
bank profitability derived from different types of factors such as bank characteristics,
macroeconomic conditions, explicit and implicit bank taxation, deposit insurance
regulation, overall financial structure, and underlying legal and institutional indicators.
Using the linear regression and controlling for fixed effect, in which Net interest margin
(NIM) and return on asset (ROA) were the key dependent variables representing the
interest margin and bank profitability, some conclusions results in the lower margin and
profit derived from maintaining a larger assets to GDP and a lower market concentration
5


ratio. Besides, Demirgüç-Kunt & Huizinga in 1999 also found that difference in bank

activities, leverage, and the macroeconomic environment could account for the change
of margin and profit. The method they used was fixed effect regressionl with weighted
least squares, with the weight being the inverse of the number of banks for the country in
a given year to control the different number of banks in each country.
The model was based on the accounting identity representing that the bank
variables themselves had impacts on profitability. This is the original theory that we
based on to conduct a clear hyportheisis of internal factors on bank profitability. Income
statement in accounting principle relect how well the bank operating and yield profit or
loss. Most of the determined factors accounted for bank profitability are shown in this
statement. Basically, profit comes from the result of main revenue deducted by other
sources of expense. In this scope of study, accounting identity of profit before (PBT)
over total asset (TA) named ‘return on assets’, and the definite term or value to measure
the bank profitability, was shown as the equation below:
PBT/TA = PAT/TA + Tax/TA

(2.1)

PBT is profit before tax and it has the detailed expanded accounting identity as
the main resources for most of the determinants retrieved:
PBT/TA = NIM + NII/TA – OV/TA – LLP/TA

(2.2)

Where NIM is net interest margin – a fraction of , NII is non-interest income, OV
is overhead, and LLP is loan loss provisioning. NII/TA represents the how diversifying
the bank have exposure on other nonlending activities, such as investment banking and
and exchange rate arbitrary or fee-based services, OV/TA illustrates how the bank
manages its own non operating expense to serve its assets and operation, and LLP/TA
measures the proportion of the bad debt in total asset. In this circumstance, we are
ignoring the effect of tax due to the biased effect from different taxation rate or any

advatage from tax shield. This accounting was considered such a generic idea for most
of the determinants of profitability had been taken into account in most recent studies,
for example, Claessens et.al (2001). The researchers have found that most of the key
bank-specific or internal determinants are significantly with bank profitability. These
variables can be grouped by profit and loss statement’s factor and balance sheet factor.
Firstly, Profit and loss statement or so-called income statement illustrate how well the
6


bank operates and earn profit or suffer loss. That is obviously tight with profitability
where the accounting equation (2.1) and (2.2) have shown above. These variables that
they have employed here net interest income, overhead, non interest income, loan loss
provision. They do not take into account the effect of NIM on profitability since the
bank’s operation traditionally deals with the activities of earning the spread of lending
rate and deposit rate. That could result from the logic that bank is the financial
intermediaries who circulate the money across the country’s business performance from
macroeconomic perspective. The second bank-specific determinants here are balance
sheet related items where capital, liquidity, and bank size play significant role towards
bank profitability. These variables were usually used by many authors to test the
relevant impact on bank profitability from Demirgüç-Kunt & Huizinga, 1999; Kosmidou
& Pasiouras, 2007; Shen et al 2009 etc. Normally, these factors are indirectly affect the
bank profitability. For example, the larger bank seems to attract better customer thanks
to it reputation and branch network and may not compete with other smaller banks
especially in price. Hence it would yield a better performance through lower cost of fund
and higher profitability. These have been proved by Bonin et al in 2005 while testing the
impact of size on the Return on asset and other authors.
The regression analysis of Demirgüç-Kunt & Huizinga (1999) started by the
following equation:
Yijt = α0 + αiBijt + βjXjt + γtTt + δjCj + εijt

(2.3)

Where Yijt is the dependent variable (either ROE or ROA or sometimes ROAA)
for bank i in country j at time t, Bijt are characteristics of bank i in country j at time t, Xjt
are characteristics of country j at time t while Tt and Cj are time and country dummy
variables, and εijt is a white-noise error term.
Shortly, more researchers have applied the basic concept of internal and external
determinants and employ some other variables such as cyclical output, privatization
ownership (Athanasoglou et al, 2008), credit risk ((Pasiouras & Kosmidou, 2007;
Sufian, 2009) and the scope of studies varied from European regions to a particular
developing countries such as Malaysia, or Philiipine. Actually, there has not been a
detail study that could employed the complete sets of data induced by Demirgüç-Kunt &
Huizinga (1999), the latter authors have used some critical variables and combined with
7


their specific research aims at a particular country scope. Some authors have tried to
combine with other variables to test the distinguished impacts on profitability between
foreign and local banks (Shen et al, 2009; Claessens et.al 2001). The relationship
between foreign entry or foreign ownership would then be discussed in more detail
within the next sections.
Besides the bank-specific factors like Non-interest income, capital etc,
macroeconomic factors such as GDP growth, money supply growth and inflation rate are
also important variables for researchers to evaluate the impacts on bank profitability.
Indirectly reflecting on profitability, the external or macroeconomic factors mentioned
above played a significant role that have influence on the enviroment host where
commercial banks are considered as players. For example, GDP growth slows down
during recessions may unfavor indirectly reducing bank returns by deteriorating credit
quality & increasing default (Sufian & Chong 208). Many authors such as DemirgüçKunt & Huizinga (1999), Pasiouras & Kosmidou (2007); Sufian (2009) and so on have
mentioned different macroeconomic controlling variables such as GDP, inflation,

industry concentration, money supply etc and their impacts on bank performance. Other
authors have employed cyclical output, or interest rate Some impacts may be reflected
significantly while others may not. No matter how the outcomes of these studies
concluded, banking industry could be seen as the main activity among other country’s
activities recognizing a logical impact from macroeconomic factors. These factors and
their impacts will be discussed more detail later.
Bonin et al (2005) chose a different approach that indirectly evaluated the impact
of internal factors on profitability. They used translog functional form with the model of
Stochastic Frontier approach to estimate the profit efficiency and cost efficiency across
11 transition countries from 1996 to 2000 with the sample size around 856 bank-year
observation. They also found that bank size is porsitive and no relationship between
different ownership strucutre significantly impact on profit. Rather than that, they have
suggested the better cost efficiency of foreign bank than other types of bank. It has also
employed the normal linear regression with ROA as the dependent variables to compare
with profit efficiency from different ownership types.

8


Suffian & Hibibullah (2009) employed the fixed effect regression for 220 bankyear observation from 2000-2005 in China banking market to illustrate the effect to bank
profitability. They have found that liquidity, credit risk, and capitalization played a
significant role to improve bank profitability while cost has negative impact on it. The
impact on joint-stock banks seems to be manified than state-owned ones. Moreover, they
also examined that economic growth have positive impact on profitability while money
supply growth is found to have reversed effect. The shorfall of this study is that the
author only can observed the quite short period when the economic conditions are
considered to pace with “change” quickly.
Similarly approach, Athanasoglou et. al. (2008) applied General Method of
moment (GMM) technique on a dynamic panel data to investigate the changing impact
on profitability from different group of independent variables including bank specific

characters, industry and macroeconomic variables. They have employed Return on asset
as a dependent variable in Greek banking market from 1985 to 2001 and found that most
of the internal determinants except for size have anticipating signs on bank profitability.
Besides, the ownership status of the banks is insignificant in explaining profitability
even the provate banks yield higher profit. As similar result, other macroeconomic and
industry concentration status were insinificantly affect to the final profitability except for
positive impact by business cycle.
In the scope of study regarding the Vietnam banking market, Vu and Nahm in
2013 investigate the effects of some both internal and external factors to profit efficiency
of 56 Vietnam banks for the period of 2000- 2006. They used a techniques called Tobit
or two step instrumental variables to examine the efficicency score. There were four
types of variables employed in that study. They consist of, firstly bank-specific
characteristics such as size, credit risks and so on; secondly the ownership feature (Stateowned Banks or Foreign-owned banks...); thirdly transitional indicators; and finally
environmental factors such as GDP, inflation. The instrumental variable that they used
are the fraction of capital over total asset. They have found the size and better
management ability remaining positive impacts on profit efficiency, while lower asset
quality and high capitalization would somehow drive a bad influencing power. Besides

9


the positive impact of high growth in per-capita GDP, it was better for banks to improve
their profitability by the success of government in maintain a low-inflation rate.
Another study conducted by Dinh (2013) to examine the impact of determinants
on foreign bank profitability specifically. She has used least square method of fixed
effect on the foreign bank dataset, domestic bank dataset, combined dataset and
compared each others for robustness check. The size of data they applied here is over 51
commercial banks operating in Vietnam from 2000 to 2012. They have extended the
study by adding multinational factors such as parent bank’s profitability to better
measure the impact on foreign bank profitability in Vietnam market. It was found that

most of bank specific factor, macroeconomic factors significantly affect bank profit. In
detail, total asset and other income redemmed positive impacts while foreign banks
parent profit negatively affect on foreign bank profit. Foreign bank thanks to it
ownership advantage seem to perform better than doemstic banks since the competition
arised since opening up policy to allow 100% foreign incorporation.GDP growth
showed a signifcant impact on profitability of all banks.
Similar approach except for multinational factors has been employed by Sufian to
test the impact on profitability of Malaysian banks during 2000 – 2004. However, the
findings have some differences where economic growth negatively affected the
profitability and inflation rate had positive impact to improve it. Besides, negative
effects of credit risk loan concentration on profit also had been found meanwhile the
positive ones are suggested within the apperance of capitalization, non interest income
and expense.
In conclusion, bank specific characters such as the items in Balance sheet and
income statement and macroeconomic conditions have been studied and suggested to
have significant relationship with bank profitability. These effects can be different
between foreign and domestic banks and within the different circumstances, they may
show different signs with profitability.
2.2.

Foreign presence/ ownership and its impact on bank profitability
Some authors have studied on detail ownership types to understand whether any

relationship between different ownership structure and profitability. According to Ábel
and Siklos in 2004, they assessed the privatization of the banking sector in Hungary that
10


took place during the 1990s. The Hungary government steadily chose a path named
“strategic foreign partner” to allow foreign participation in domestic banking industry

instead of foreign owned banks or so-called Greenfield banks (Bonin et al, 2005) to
enter into this transition market at the early stage of financial reformation. They also
have tested that this strategy was considered successful when the variable to measure
profitability significantly has responded positively. This was very similar to the strategy
that Vietnam used to develop its banking and financial market at transition stage. They
concluded that strategic foreign partnership is supportive in terms of reforming the
emerging industries.
Bonin et. al. (2005) also studied the ownership structure’s impact on bank
performance but applied another techniques called Stochastic Frontier analysis (SFA) to
measure the efficiency on bank performance in 11 transition countries. Regarding the
differences in bank performance measurements, they have found that foreign banks with
a strategic owner earn an average ROA that is much more than other ownership
categories. This result was driven by better cost efficiency controlled by foreign banks
rather than domestic competitors.
Historically, the research of Demirgüç-Kunt & Huizinga (1999) have found that
foreign entry’s impact on profitability are significantly positvely in developing country
rather than developed countries by employing a dummy variable named “foreign” with a
threshold of 50% ownership stake. In a country level study, Vu & Nahm 2013 have
found that “The effect of being a foreign bank in Vietnam is also positive and
significant, even though its magnitude is less than half of the effect of being a stateowned bank. This is in line with the general finding in the literature that Foreign banks
are more efficient than domestic banks on average in transitional banking sectors”
(p.11).
Besides, to the limited handful of knowledge, the most comprehensive of testing
the impact of foreign presence on bank’s performance is through the research conducted
by Claessens et al. (2001). They investigated how foreign presence impacts on domestic
bank performance where it was measured by set of set of bank financial variable such as
net interest margins, profitability, non-interest income, overhead expenses, and loan loss
provisions with a size of individual bank data in 80 developed and developing countries
11

over the 1988–1995 period. The result has shown the reduction in profitability, noninterest income, and overall operating expenses of domestic-owned banks are associated
with the foreign bank penetration. They applied the extension measurement based on the
model of Demirgüç-Kunt & Huizinga, 1999. The basis estimated equation is as descibed
below
yi = α+ βfi +γXi + ui

(2.4)

Where yi is the performance indicator for country i, fi is the share of bank assets
held by foreign banks, Xi is a matrix of control variables, ui is the error term, and α, β,
and γ are parameters to be estimated. To extent the study and fix the problem of joint
endogeneity, the “change” of performance impacted by foreign presence in subsequent
year has employed by Claessens et al 2001:
ΔIijt = α+ βΔFSjt +δiΔBit+ γjXjt + εijt

(2.5)

Where Ijt is the performance indicator of bank i in country j at year t, FSjt is the
foreign bank presence in country j at time t, Bit is the bank specific variable of bank i at
year t. Xit is a character of country j at year t, and εijt is the error term.
They investigated the change of performance by different factors in which foreign
presence is proxied by marcroeconomic view. The foreign presence proxy here is the
number of foreign bank at 50% threshold ownership stake over total banks. They have
found that the large share of foreign presence, the more rduction in profitability that
domestic bank may encounter through enforce domestic bank to a higher level of
competition in short term and invest in operation, technonoly to improve efficiency.
These results encouraged policy implication as evidence that foreign bank entry
improves the efficiency of the overall market and it would show a positive view on
continuing opening up signal in policy point of view.

The study of Shen et al in 2009 focused more on the foreign penetration both in
the policy-making point of view and in the internal individual bank’s view. They have
evaluated the way that foreign bank or foreign penetrations may have impact on local
China bank performance. The method that they used to analyze those impacts from
different edge was least square dummy variable method (LSDV) with the similar
approach as equation (2.4). To proxy the foreign bank penetration or bank presence, they
employed two variables called macro foreign penetration and micro foreign penetration.
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While the macro foreign penetration was measured by the fraction of number of banks
with foreign strategic partners occupying at 5%-25% threshold over total number of
banks, the micro one focus more on the proportion of foreign’s shareholding in each
individual banks. This first one is very similar to variable used by Claessen et. al. (2001)
where the second one focus at the detail proportion shareholding to demonstrate the
impact of foreign strategic investor to each bank. They have found the positive
relationship when relaxing the limitation for foreign factor could lead to the
improvement of profitability nor reduction of cost. That has been seen as a proven trend
where more local banks have followed recently to allow more foreign partners to be
onboarded in their businesses. This positive influence can be attributed to technology
transfers from foreign investors or the creation of improved competitive environments.
However, while employing foreign pesence in microeconomic view, which was found
neither profitability nor cost. Some reaons for this have been mentioned where costs and
revenues increase after foreign partner were participating in the local banks. Some might
said that the cost increased by investing in human capital, training and even the
technology enhancement to provide the advanced level of competition with the short
term expense increase. Another thoughts were derived from the difference in culture and
strategic objectives of their own local main shareholders. Besides, lack of employees
who are fluent in English and who are familiar with international affairs might also be a
barrier for local banks to communicate and cooperate successfully with foreign partner’s

representative working in their banks. Those have led to the repressed impact from
introducing foreign strategic partner in a bank’s operation. That’s why, Chinese
government considered if the cap of foreign investment proportion at 20–25 percentage
was appropriate.
Unite & Sullivan (2003) also follow this study approach to examine the effect of
foreign entry in Philippine banking market when it has gradually reform its domestic
market by liberalizing restrictions on foreign investment.. By employing the random
effect model, they have found that in general the results are somehow similar to what
Claessens et al. (2001) have found. Interest rate spreads and operating expense declined
once more foreign penetrate into domestic market due the hypothesis of increasing
competition and efficiency. However, it was only found true for those domestic banks

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that are affiliated to a family business group. Foreign entry corresponds more generally
with improvements in operating efficiencies, but a deterioration of loan portfolios. The
increase in the percentage ownership by foreign investors in domestic banks is shown to
result in an increase in operating expenses and a decrease in noninterest income – a
proxy of accounting profit where Philippine banking industry encourage banks to pursuit
this approach rather than traditional activities. They believed liberalization of foreign
presence will have positive effects on economic growth and will enhance the ability of
the economy to overcome negative external shocks.
To conclude, there are different approaches to test the impact of foreign presence
to bank profitability. It could be found that foreign presence represented by the number
of banks with foreign ownership’s influence over total number of banks might be
considered to have some relationship with bank profitability. However, the influence
may be different if we employed another variable to represent foreign presence such as
foreign proportion shareholding or dummy variable with specific threshold. These
approaches have yielded different results so that it is still a critical concern for research.

Table B.1 (Appendix B) below summarizes all relevant empirical studies
discussed in this study. They greatly provide the audiences a better and concrete view on
the theories that have been demonstrated and introduced above.
Based on the literature reviews, the impacts of internal and external determinants
together with foreign presence factors on bank profitability are graphed by figure 2.1

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Figure 2.1: Analytical framework of determinants of bank profitability

Bank-specific factors
Capital

(+)

Expense

(–)

Credit risk

(+)

Liquidity

(–)

Diversification

(+)

Size

(+/–)

Macroeconomic factors
GDP growth

(+)

Inflation rate

(+/–)

Money supply growth

Bank profitability
Return on asset

(+)

Foreign presence factors
Foreign presence

(+)

Foreign ownership

(+/–)

The diagram shows generally the link among estimated variables in this study.
Dependent variable is Return on asset. The internal key set of indicators of bank
profitability is used as independent variables consist of size, capital, credit risk, nontraditional income, expense, liquidity. Besides, the model also involves a series of
macroeconomic explanatory variables such as Inflation, GDP growth, and money supply
growth.

The

important

variables,

“foreign

presence”

and

“foreign

ownership/shareholding” are employed here to test the significant relationship with bank
profitability.

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CHAPTER 3: RESEARCH METHODOLOGY AND DATA
This chapter includes four main parts. The first part steer our attention to the
introduction of suggested research methodologies considered to apply in this research.

Secondly, the model specification will be drawn out to answer for the research
questions. Third section provides the audience with the comprehensive introduction of
variable measurement to answer the research question. Finally, the estimation strategy
and data collection should be discussed for this study.
3.1.

Research methodology
As mentioned above, the research will make use of panel dataset of bank-year

observation in Vietnam. In econometric view, a panel data set has multiple entities, each
of which has repeated measurements at different period. Panel data may have individual
(group) effect, time effect, or both, which are analyzed by fixed effect and/or random
effect models (Park, 2011). These effects will be discussed in detail respectively. As the
strategic estimation for this study, since the Panel data used for this regression analysis
might drive the biased estimation when the omitted variables are constant over time. The
omitted variable could be the customer behavior, for example, the customers prefer the
big banks that have good reputation to deposit than small banks or sometimes they
decide to bank with local SOE banks because of the historical creditability of public
sector. Especially, during the high inflation period, Vietnamese tend to buy gold instead
deposit their money. Those scenarios could lead to the biased estimation of effect of
individual entity. The panel data methodology will allows us to control omitted variable
that vary across banks but are constant over time. To estimate these panel models above,
this study will approach a number of econometric estimation model as follows.
3.1.1. Panel regression model’s approaches:
Firstly, the common constant method, Pooled Ordinary Least Square or so-called
Pooled OLS is brought to consideration generally. The equation below described the
general model for the common constant linear regression method:
Yit = α0 + α1Xit + uit, where i = 1,....,N; t = 1,....,T

(3.1)

The common constant method, so-called the pooled OLS method, could estimate
a common constant α for all cross–section data. In other words, this estimation assumes

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