Bank profitability

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Research in International Business and Finance 21 (2007) 222–237

Factors influencing the profitability of domestic and foreign commercial banks in the European Union
Fotios Pasiouras a,b,∗ , Kyriaki Kosmidou a,c

Financial Engineering Laboratory, Department of Production Engineering & Management, Technical University of Crete, University Campus, 73100 Chania, Greece Department ofEconomics, Finance & Accounting, Faculty of Business, Environment & Society, Coventry University, Priory Street, CV1 5FB Coventry, UK c Department of Economics, University of Crete, 74100 Rethymno, Greece Received 5 October 2005; received in revised form 11 January 2006; accepted 12 March 2006 Available online 15 June 2006


Abstract Using bank level data this paper examines how bank’s specificcharacteristics and the overall banking environment affect the profitability of commercial domestic and foreign banks operating in the 15 EU countries over the period 1995–2001. The results indicate that profitability of both domestic and foreign banks is affected not only by bank’s specific characteristics but also by financial market structure and macroeconomic conditions. All the variables, with theexception of concentration in the case of domestic banks profits, are significant although their impact and relation with profits is not always the same for domestic and foreign banks. © 2006 Elsevier B.V. All rights reserved.
JEL classification: G21; C23 Keywords: Banks; European Union; Profitability

1. Introduction Over the last years a number of factors have contributed to the growing competition inthe European Union (EU) banking sector. One of the most important factors is deregulation, promoted by the Second European Directive on Banking and Financial services, concerning establishment, operation and supervision of credit institutions. This Directive sets out the principles of banking in

Corresponding author. Tel.: +30 28210 37360. E-mail address: (F.Pasiouras).

0275-5319/$ – see front matter © 2006 Elsevier B.V. All rights reserved. doi:10.1016/j.ribaf.2006.03.007

F. Pasiouras, K. Kosmidou / Research in International Business and Finance 21 (2007) 222–237


the Single European financial market and provides equal competitive conditions for all European banking institutions. As a result banks now compete in previously inaccessible domesticand foreign markets. Furthermore, a number of recent technological advances offered more opportunities for economies of scale and scope while the adoption of euro accelerated the changes in the industry. For instance, income generation from foreign exchange transactions has been lost while the pricing of banking products and services has become more transparent, enhancing competition.Furthermore, the macroeconomic policies that were followed in most countries gradually reduced inflation and interest rates. Finally, in more and more European countries non-financial firms were allowed to offer traditional banking services, leading to further increase in competition. Therefore, banks were forced to generate new products and seek new customers. This is reflected in the continued diversificationacross geographical areas and business lines. Many banks have been forced to increase in size in order to compete in the enlarged European market and the banking industry experienced an unprecedented level of consolidation through mergers and acquisitions. It is reasonable to assume that all these changes posed great challenges to banks in the EU as the environment in which they operated changedrapidly, a fact that consequently had an impact on their performance. As Golin (2001) points out adequate earnings are required in order for banks to maintain solvency, to survive, grow and prosper in a suitable environment. Given the relation between the well-being of the banking sector and the growth of the economy (Rajan and Zingales, 1998; Levine, 1997, 1998), knowledge of the underlying...