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The persis tence of bank profit1 

Abstract

This paper exam ines the s t r ength of compet i t ion in 65 n a t iona l bankin g indu st r ies .

Coun tr y-level dyn am ic pan el est imates of the persisten ce of bank pr ofi t are r eported and

comp ar ed. The persisten ce of bank pr ofi t appear s to be weaker for bank s in developing

coun tr ies th an for those in deve loped count r ies . Pers is tence i s re la t ively h ig h in Nort h

America and Western Eu r ope an d relat ively low in East Asia, the Pacific and Su b-Sahar an

Afr ica . The per s is tence of profi t is s t r onger when ent r y barr iers a re h igh , an d wh en

comp eti t ion is low accor ding to both st r uctu r e- an d cond u ct-based competi t ion in dicators.

Keywords: Bank ing , competi t ion, dyn am ic pan el est imation, entr y, profi tabil ity,

 per s is ten ce

J EL: G21 L11

1 Special thanks to Barbara Casu, Francesco Cesarini, Franco Fiordelisi, Claudia Girardone, Roberto Violi and Giuseppe Zadra for detailedcomments on the paper. Also thanks to participants at the ABI Einaudi Workshop on European Bank Competition held at ABI Piazza delgesu 49, 18 September 20009, Rome. All errors and omissions as usual rest with the authors. The financial support of the Istituto (formerly,Ente) Luigi Einaudi, sponsoring the research project “Competition in European Banking” is gratefully acknowledged” 

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The persis tence of bank profit

1. Introduction

The compet it ive land scape of banking has been t r ans form ed over the past th ree

decades by for ces su ch as der egu lation, techn ological cha ng e and th e globalization of goods

an d finan cial mar k ets. These developm ents h ave imp acted upon t he operations , efficiency,

 pr od u ct iv it y , m ar g in s an d p r ofit abi li ty of ba n k s in a ll cou n tr ies (Dem ir g u c-Ku n t an d

Hu izan ga , 1998; Claessens et a l . , 1998; Levin e, 2003; Clark e et a l . , 2003; Car bo and

Fernan dez, 2007; Maudos an d Fern anad ez de Guevara , 2004; 2007; Berg er , 2007)2. Bank s

nowadays opera te in pr oduct and g eogr aphica l mar ke ts very d i f ferent f rom th ose tha t

exis ted th i r ty year s ag o. Bank s u se a r ang e of convent iona l an d inn ovat ive technologies to

serve the ir customers .

To date, most academic r esearch on competi t ion and i ts effects on ban k per for ma nce

is based on th eor etical models that a r e stat ic in n atu r e (Claessens an d Laeven, 2004; Sh affer

2004; Goddar d an d Wilson, 2009; Dick an d Han na n, 2009). Static models are us eful in

ident i fy ing causa l r e la t ionsh ips between key var iables when mar k e ts a re in equi libr ium ,

 bu t th ey pr ovid e on ly a s n apsh ot p ic tu r e of a dy n am ic com pet it ive p r oces s (Ger os k i, 1990).

There is n o cer ta in ty th a t cond uct or perform ance measur es observed a t any poin t in t im e

represent equil ibrium values. For example, an empirical association between high

concent ra tion an d h igh pr ofi tabil ity (implici t in SCP-based models) may s imply appear by

chance , f rom observa t ions ta ken d ur ing a per iod wh en th e re levant mar ke t i s in a s ta te of

disequil ibriu m. If so, cross-sectional data does not captur e (un less by luck) th e long -ru n

equi libr iu m re la t ionship . Fu r th ermor e , cross-sect iona l da t a u sua l ly does n ot conta in

su fficient inform ation on wh ich to base r eliable policy decisions to pr omote competi t ive

2 Berger et al . (1995) and Jones and Cri tchfield (2005) provide an exhau st ive analysis of s tructur al and s trateg ic

chang e in US banking . Goddard et al . (2007) provide an overview of European ban king . DeYoung et al . (2004) and

Berg er et al . (2004) analyze the response of banks to chang es in th eir competit ive environm ent. Vander Vennet  

(2002), St iroh and Str ahan (2003) and Maudos and Fern andez de Guevara (20 04) assess the impact of these

chang es on ban k performan ce. Cetorel l i (2004) exam ines the effect of bank competi t ion on th e s ize dis tr ibut ion of

non-finan cial fi rms. Beck et a l . (2004) and Cetorel l i and Str ahan (2006) analyse the effect of bank competi t ion on

the avai labi li ty of credi t to sm all, medium and large fi rm s. Black an d Strah an (2002), Bonaccorsi Di Pat ta an d

Dell‟Aricca (2004) an d Zarutsk ie (2003) assess the implicat ions for borr owing , investmen t , entr epreneur ship an dnew firm creat ion.

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methodology th a t i s preva lent in m uch of the l ite ra tur e based on the s t r uc tur e condu ct

 per for m an ce pa r ad ig m (S CP) an d th e New In du s t r ia l Or g an iza t ion (N EIO) li ter a tu r e.3 

In i ts str ong est form , the persisten ce of pr ofi t hyp othesis developed by Mueller

(1977, 1986) con sists of two cond it ions . Fir st , entr y an d exit ar e sufficiently free to

elimina te any fir m‟s abn orm al pr ofit qu ickly. Second, al l firm s‟ pr ofi t r ates tend to

converg e toward s an ident ica l long -ru n averag e va lue . The second condi t ion is s t r onger

th an t h e first ; and u nd er a less r estrict ive ver sion of th e per sistence of profi ts hypoth esis,

abnormal pr ofi t ra tes d iss ipa te qu ickly an d converg ence of prof it r a tes i s toward s long-ru n

averag e values tha t may d iffer between fir m s. Th e emp irical an alysis in th is paper

concent ra tes upon th is la t ter form ulation of th e persisten ce of pr ofi t hypoth esis. The

a l tern a t ive hypothesis i s tha t s ome incum bent f irm s enjoy r egula tory pr otec t ion , or p ossess

th e capabil ity to pr event imitat ion or block entr y. If so, abnor m al profi t tends to persist

f rom year to year , and converg ence is e ither s low or , in th e most ext r eme case , non -

existent .

A nu mber of s tudies ha ve tes ted the pers is tence of pr ofi t s hyp othesis for th e (non-

 ba n k ) m an u fa ct u r in g an d ser vices sector s (Mu el ler ; 1 986; Ger os k i an d J acq u em in , 1988;

Warin g , 1996 Goddar d an d Wilson, 1996, 1999; McGahan an d Port er, 1999; Glen et a l .,

2001, 2003; Maray um a an d Odagir i 2002) . This l i tera t ur e typica lly observes pa t te rn s in th e

time-series variat ion of firm -level pr ofit r ate data , an d dr aws infer ences about th e natu re of

compet i t ion (whether barr iers to ent r y exis t , and i f so, whether th ey a re temporary or

 per m an en t). Mos t s tu d ies r ep or t an ave r ag e per s is t en ce of p r of it es t im ate, in th e for m of a

fir st-ord er au toreg ressive coefficient in a t im e-series r egr ession of firm -level norm alized

 pr of it r a t es , in th e r an g e 0 .4 to 0 .5 . Som e stu d ies r ep or t ei th er lower or h ig h er va lu es .4

 The

 per s is ten ce of p r of it h as been fou n d to be lower in develop in g cou n tr ie s th an in develop ed

coun tr ies . This pa t te rn i s a t t r ibuted to lower sun k costs of ent ry , fas te r economic growth ,

th e role of govern m ent, and th e pr esence of larg e cong lomerat e firm s in developing

3 For an overview, see Berg er (1995), Berger et al . (2004), Dick and Hann an (2009), Goddard et al . (2001, 2004b),

Claessens and Laeven (2004), Shaffer (2004).

4 Goddard a nd Wilson (1999) an d Lipczyns ki et al. (2009) review evidence on the per sistence of profit in

manufacturing and services .

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coun tr ies wh ich ten d to incr ease th e in tensity of competi t ion experienced by domestic firm s

(Glen et a l . , 2001; Steph an an d Tsapin , 2008).

The evidence for th e persistence of pr ofi t in bank ing is r elat ively scant.5 Using a

sam ple of larg e US ban k s observed over t he period 1986 -91, Levonian (1993) find s th at

despite res t r a in ts on compet i t ion imposed by bank regu la t ion , abnormal pr ofi t s tend to be

temporar y , ra th er th an perman ent . The pace of converg ence, however , i s s lower th an t ha t

sug gested by most man ufac tur ing s tudies . Roland (1997) exam ines the pers is tence of

 pr of it s of US ba n k h old in g com pan ies , u s in g qu ar t er ly da ta fo r th e per io d 1986 -92. Th e

 per s is ten ce of p r of it is s t r on g er fo r ba n k s wit h be low -aver ag e per fo r m an ce . Ber g er et a l.

(2000) use a non-par am etric meth odology to exam ine the persisten ce of bank pr ofi t . The

str eng th of pers istence is foun d to differ between bank s init ia l ly located in th e top an d

 bot tom decil es of th e d is t r ibu t ion of ba n k s by per for m an ce.

Goddar d et a l . (2004a) est imate th e pers isten ce of pr ofi t for a s am ple of Eur opean

 ba n k s fr om six cou n t r ie s , u sin g a m od el th at in cor por a tes ba n k -s pecif ic va r ia bles in clu din g

size, diver sification, r isk an d owner sh ip type. The persisten ce of pr ofi t is h igh er for mu tu al

(savings and coopera t ive) bank s th an for comm erc ia l banks. By coun try , pers is tence i s

h igh est for Fran ce, where a s t rong regu la tory t r adi t ion may ha ve insula ted bank s f rom the

full r igou rs of comp eti t ion.

Sever al recent stu dies focu s on ind ividual count r ies. Agostt ino et a l. (2005 ) report

est imates of the persisten ce of pr ofit for I ta l ian bank s for th e period 1997 -2000. Pers istence

is posit ively associated with own ersh ip concentr ation. Knap p et a l . (2006) report

 per s is ten ce es t im ates fo r a sam ple of US ba n k s , s u g g es t in g th a t p r of it s ta k e a s lon g a s five

years to converg e towar ds averag e indu st ry nor ms. Pers is tence est imates for Turk ey and

Greece are r eported by Bek tas (200 7) and Ath an asog lou et a l . (2008), respectively. In a

recent c ross-coun try s tu dy for Su b-Sahar an Afr ica, Flamini (2009) f inds tha t s t ron g

 per s is ten ce is a ssocia ted pos it ively wit h ba n k s ize, d iver s if ic a t ion an d pr iva te ow n er sh ip .

Overall , the emp irical eviden ce to date focuses on a r elat ively sm all nu m ber of

coun tr ies, and iden tifies posit ive au tocorr elat ion in ban k p r ofit r ates obser ved over t im e.

5 St i roh and Strah an (2003) tes t the effect iveness of deregu lat ion in improving the competi t ive process .

Deregulat ion increases both en try and ex i t , and r eal locates mar ket sh are fr om un profi table bank s to profi table ba n k s .

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The persisten ce of bank pr ofi t is dr iven by bank -specific an d indu str y char acterist ics, an d

ma croeconomic cond it ions . Sur pr ising ly, there is l it t le evidence on th e ext ent to wh ich

 ba n k r eg u la t ion an d su per vis ion d et er m in e d if fe r en ces in th e per s is t en ce of p r of it be tween

coun tr ies. A prin cipal objective of this pa per is to fi ll this g ap in t h e li teratu re.

3. Methods

This section describes th e emp irical m ethods u sed in this pap er. A two-stag e

approach is u sed to measur e the pers is tence of profi t , and invest iga t e the factors th a t

determ ine the persistence of pr ofit . At th e fir st stag e, dyn am ic pan el f ir st -order

au toreg r essive models ar e est imat ed for th e norm alized profit ra tes of ban k s in each of th e

65 coun tr ies. At the second stag e, th e first -order au toreg r essive coefficien ts obtained at th e

f irs t s tag e a re u sed as th e dependent var iable in a c ross-sec t iona l regr ession for th e

de term inants of the pers is tence of profi t in each countr y .

Stage 1 Est im at ing the persis tence o f prof it

In ord er to el imin ate th e effect of cyclical f lu ctuat ion s wh ich impact sim ilarly on th e

 pr of it r a t es of a ll of th e ba n k s wit h in ea ch cou n tr y , i,t

  is exp r essed as a deviation from th e

cross-sectional mean p rofi t rate in year t . Therefore i,t

 i s th e norm al ized pr ofi t ra t e of bank

i in y ear t . In th e theoretical model, th e ch an g e in t he n orm alized profi t rate of bank i

 between yea r t – 1 an d year t , denoted i,t

, is ass u med to be a fu nction of bank i‟s lag ged

norm al ized pr ofi t ra te ; the compon ent of cur rent and p ast en t r y wh ich im pacts d irec t ly on

 ba n k i‟s pr ofit abi li ty , den ot ed Ei,t – k 

 for k =0 ... ; an d an idiosyncr atic compon ent, denoted ui,t

:

i,t

 = i +  

0k k t,ik , j   E + u i,t   (1)

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In (1), th e coefficient s  j,k 

, which measur e the imp act of Ei,t – k 

 on i,t

, a re assu med to be the

same for a l l bank s th a t a r e loca ted in coun try j . Ent ry i s assu med to be a fun c t ion of past

realizations of bank i‟s n orm alized profi t ra te: 

Ei,t

 =  +  

1k k t,ik , j + e i,t   (2)

Subst itu t in g (2) in to (1) and re - par am et er iz in g y ie ld s an au tor eg r es sive m od el fo r ba n k i‟s

normalized profi t rate:

i,t

 = t,i1k 

k t,ik , ji   v~  

  (3)

When employing pan e l da ta wi th a sh or t t im e-dimension , it i s convenient to es t imate a

fir st-ord er au toreg ressive (AR(1)) specification for i,t

, with t he h igher -order lagg ed profi t

ra tes supp ressed:

t,i1t,i jit,i   v~   (4)

In (4), i~  denotes ban k i‟s long -ru n m ean norm al ized prof it ra te , and

 j in (4) r eplaces

 j,1 in

(3). The adjust men t of n orm alized ban k pr ofit ra tes described by (4) is inter pr eted as a

cons equence of the int eraction between pr ofi tabil i ty and th e en tr y th r eat , as postu lated in

th e contestable ma r kets l i teratu r e (Baum ol et a l. , 1982; Bratlan d, 2004).

Estim ation of th e pers istence of profi t coefficient s,  j  in (4), is implemen ted usin g Arellan o

an d Bover‟s (1995) sy stem GMM estimator , including both lagg ed differences an d levels of

the explana tory var iables as in st r um ents . The system GMM est imator redu ces potent ia l

 biases in fin it e sam ples , an d asym ptot ic im p r ecis ion a ssoc ia t ed wit h Ar ellan o an d Bon d‟s

(1991) differen ced GMM estima tor (Blun dell an d Bond, 1998).  The consistency of the

system GMM est imator depends both on the va lid ity of the assu mpt ion th a t th e er ror te rm

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is not au tocor related, and on th e validity of the instr u men ts. Two specification t ests ar e

repor ted . The f i rs t i s th e Hansen (1982) tes t , which is commonly u sed as a s tan dard tes t of

inst r um ent va lid ity .6 I t can also be viewed as a test of str u ctur al sp ecification (Roodm an ,

2006, 2008). Omitt ing impor tan t explan atory var iables, for exa mp le, could move

components of var ia t ion in to the err or te rm and m ake them corr e la ted with th e

inst r um ents , mak ing the m odel speci fica t ion ser iously b iased . The second te s t exam ines th e

hypothesis of no aut ocorr e la t ion in th e e rror te rm. The pr esence of f irs t -order

autocorr e la t ion in th e d i ffer enced r esidua ls does not imply th a t th e est imates a r e

inconsisten t , but th e pr esence of second -order au tocor r elat ion implies th at th e est imates ar e

inconsisten t . Th e second -order au tocorr elat ion test is r eported.7 

Stage 2 Invest igat ing the de term inants o f th e persis tence o f prof i t

At stage 2, the deter min ant s of variat ions in th e coun tr y -level persist ence of pr ofi t

coefficients ar e exam ined. The est imated  j obtained from s tag e 1 ar e th e dependen t variable

in a regr ession in which coun tr y and bank ing s ector char ac ter is t ics a re the independent

variables. The ind ependent var iables are g rou ped into th e following four categories:

macroeconomic and f inan c ia l system; r egula tory; inst i tu t iona l and exte rna l govern ance ;

and mar ke t s t ru c ture and compet it ion .

The macr oecon omic an d fina ncial system contr ol variables ar e  in flation, r eal GDP

 g row th a n d m ark et capitalization .  In f la t ion  i s t he ann ua l pe rcen tage chan ge in th e coun t ry

GDP deflator . Th e ban kin g ma r k et is less l ik ely to be competi t ive wh en i t is su bject to high

inflat ion, as t h e pr ices of fin an cial services, such as in terest r ates, are less infor ma tive

(Claessens an d Laeven, 2004), an d will in tu rn exacerbate credit mar k et frict ions (Boyd et

al , 2001). Ang elini an d Cetorelli (2003) find evidence of a neg ative relat ions hip between

6 The Sarg an t est is another tes t of over identifying condit ions as discussed in Ar el lano an d Bond (1991). This tes t ,

however, r equires homoscedast ic error s for consis tency, which is not necessari ly the case in our larg e cross-

coun try d ata sam ple. Hence we report Han sen s tat is t ics only.

7 The fai lure to pass ei ther of the tes ts in some cases sug gests th at th ese est imates ar e not completely free of

s tat is t ical problems. However, instead of using different methodologies for different coun tr ies , a consis tentmeth odology is adopted so that th e resul ts ar e compar able.

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inf la t ion and compet i t ion , sug gest ing an associa t ion be tween h igh inf la t ion and the

 per s is ten ce of p r of it .

A posit ive r elat ionsh ip is expected between real GDP grow th  and business

opportu ni t ies for banks. The incr eased business opportun i t ies may h e lp bank s to susta in

th eir pr ofi ts. Therefor e an association m igh t be expected between g rowth in GDP and t he

 per s is t en ce of p r of it . On th e ot h er h an d, th e ava il abi li ty of bu sin es s op por tu n it ies m ig h t

lead to an inten sification of competi t ion , in wh ich case a neg ative relat ion sh ip would be

expected between GDP gr owth a nd th e pers istence of profi t .

 Mar k et capit al iz at ion , the va lue of l is ted shar es on th e domest ic s tock ma rk e t

divided by GDP, is an indicator of th e size of the stock m ar ket r elat ive to th e econ omy.

Claessens an d Laeven (2004) ar g ue for a posit ive association between m ar k et capital ization

and compet i t ion , on t he basis tha t a h igh ly deve loped n on-bank ing f inan c ia l sector m ay

apply compet i t ive pressur e upon the ban king sector . Therefore a nega t ive re la t ionsh ip i s

expected between ma rk et capitalization an d th e persisten ce of pr ofi t .

The regu latory contr ol variables include pr oxies for r estr ict ions on bank activity,

capita l requir ements , and lega l barr iers to ent ry , obta ined f rom th e Bar th e t a l . (2004,

2006, 2008) data base.  A ct iv it y res t r ic t ion  is a measu r e of a bank ‟s abili ty to eng ag e in t h r ee

fee-based activit ies, secur it ies, insu r an ce an d r eal estate , in ad dit ion to inter est -based

 ba n k in g act iv it y .8 This indicator is scaled from 0 to 12, wher e a hig h er value ind icates mor e

onerous r est r ict ions. Rest r ic t ions on bank ac t iv ity mig ht impr ove the sa fety an d soun dness

of the bank ing system, by minimiz ing opportu ni t ies for bank s to take on excessive r i sk ,

elimina ting some conflicts of inter est , and simp lifying ban k su pervision. However,

restr ict ions m igh t also r educe or el imin ate oppor tu nit ies for bank s to realize econom ies of

sca le and scope , or to man age th e var iabil ity in earn in gs across pr oduct l ines .

Total fraction of entry denied  i s th e nu mber of ent r y appl ica t ions denied as a

fraction of th e nu mber of applications r eceived from d omestic an d foreign bank s  over t he

 per iod 2001 to 2005 . Th is m ea su r e r ef lect s on e a spec t of ba r r ie r s to en t r y , an d a p os it ive

8 Bank s in both developed an d developing coun tries h ave increased th e proport ion of their operat ing income

obtained from n on-interest sour ces in r ecent years . While part of the increase in n on-interest income is due to

diversificat ion int o lines of business such as in vestment banking , ventur e capital and insur ance under wr i t ing ,

gr owth in fee-paying and commission-paying services l ink ed to t radi t ional retai l banking services has also been

significant . Most evidence sugg ests that the sh ift towards non-interest income has n ot improved r isk-adjusted

retur ns (St iroh and Rum ble, 2006; Goddard et al . , 2008; St iroh, 2009).

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relat ionsh ip is expected between th is measu re an d the persist ence of pr ofit .  Dom es t ic

 f rac t ion of en t ry den ied and  for eig n f rac t ion of en t ry den ied are u sed as a l tern a t ive barr ier

to ent ry measur es in separa te es t imat ions .

Capital requirem ents  i s defined as th e minimu m capita l to asse t ra t io required by

govern ment r egula tory agenc ies . High er capital requirem ents incr ease the size of ent r y

 ba r r ie r s , t h u s in s u la t in g in cu m ben t ba n k s fr om com pet it ion , an d in cr ea sin g ba n k pr of it

 per s is ten ce.

 Fin an cial f reedom  i s a measu re of bank ing secur i ty as wel l as a m easur e of

independen ce from g overn m ent contr ol. Accordin g to th e Ind ex of Economic Freedom

 pu bl is h ed in 2009 , th is m ea su r e is det er m in ed by th e ex ten t of g over n m en t r eg u la t ion of

f inan c ia l se rv ices , the amou nt of s ta te in te rvent ion in f inan c ia l inst i tu t ions, en t ry barr iers

to the finan cial services area, an d g overn m ent in fluen ce on th e al location of cr edit . The

high er th e score , the less th e govern ment inf luence and hence the m ore f inan c ia l f reedom .

An association is exp ected between th e quali ty of th e coun tr y‟s inst i tut ional and

externa l g overnan ce f ramework and pers is tence of prof it . Govern ance ru les an d pr ac t ice

differ between coun tr ies, and ar e depend ent on th e level of economic an d finan cial

developm ent (La Porta et a l . , 1998, 2002; Ch ha ochh ar ia and Laeven , 2009). Four

inst i tu t iona l var iables a r e us ed , cover ing proper ty r ig hts , inst i tu t iona l deve lopment ,

economic freedom, an d GDP per capi ta . Protec t ion of proper ty r ight s i s an importan t pr e-

requ isi te for a well-fun ctionin g finan cial system . Th e  p rop er ty r ig h t s covariate , measured

on a sca le of 1 to 5 wi th h igh er scores indica t ing s t r onger pro tect ion , i s 6 m i n u s the

averag e proper ty r ight s f reedom index repor ted by the Heri tage Found at ion over th e per iod

1997-2007. The  K K Z in dex (Kaufm an et a l .,  2008 ) measur es the level of ins t i tut ional

deve lopment , based on s ix d im ensions of governa nce , wi th h igh er scores re f lec t ing a m ore

advanced level of development. Th e aver ag e valu e for th e period 1998-2007 is u sed. The

degr ee of freedom enjoyed by busin esses and in dividu als from g overn m ent int erference is

measu red by the econom ic freedom covariate . This indicator is 6 m i n u s  th e averag e

economic fr eedom ind ex r eported by th e Heritag e Fou nd ation over t he period 1997 -2007,

measu red on a sca le of 1 to 5 wi th h igh er scores re f lect ing gr ea ter f reedom. As a s tan dard

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measu re of econom ic developm ent, logar i thm of  per capit a GDP is fou nd by Claessens an d

Laeven (2004) to influen ce bank ing sector per forma nce.

 HHI , the Herf indah l-Hirschm an Index, is u sed as a concentr a t ion m easure for each

coun try‟s bankin g sector  .9

Accord ing to eith er th e collusion h ypoth esis or th e efficiency

hy pothesis, a posit ive relat ion sh ip is exp ected between concentr ation an d th e persistence of

 p r of it (Ber g er , 1995; God dar d et a l. , 2001). Accor d in g to th e „qu ie t li fe ‟ hypot h es is ,

however, a n egative relat ionsh ip between concentr ation an d persist ence of pr ofi t mig ht be

expected i f the man agers of la r ge bank s choose to set t le for a quie t l ife inst ead of pur suin g

 pr of it s (H ick s , 1935 ; Ber g er an d Han n an , 1998). Th e Pan za r an d Ros se (1 987)  H-s tat is t ic is

us ed as an al ter n ative cond u ct-based measu r e of competi t ive cond it ions.10

 Typically, th e

empir ical li teratu r e on ban k competi t ion th at u ses th e H-stat ist ic report s evidence of

mon opolist ic competi t ion (Car bo et a l . 2009 ; Goddar d an d Wilson, 2009).11

 

4. Data and results

9 For an industr y that consis ts of a s ing le monopoly producer, HH  1 . A monopolis t has a mar ket sh are of s

1  1 .

For an indu stry w ith N firm s, the maximu m possible value of the Herfindahl – Hirschman index i s HH  1 , and the

minimu m possible value is H H  1 /N. The max imum value of HH  1 occur s when the s ize dis tr ibut ion of the N

firm s is h igh ly skewed. In the most extr eme case, one dominant f i rm h as a mar ket shar e only fract ional ly smaller

than 1 , and N  1 very sm all f i rms each has a m ark et shar e only fract ional ly lar ger th an zero.

10 Under monopoly condit ions H

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Finan cial accou nt s data (un con solidated) for th e period 1997 to 2007 for 1 1,634  

 ba n k s fr om 65 cou n t r ie s a r e obta in ed fr om Ba n k scope. Th e sam ple select ion cr it er ia a r e a s

follows. Any coun tr y with five or m ore com m ercial bank s (domestic or foreig n) is selected

for t h e firs t-stage an alysis. Th e star t-year, 1997, is const r ained by the availabili ty of data

on Bank scope. To eliminat e outl iers, obser vations for wh ich the pr ofit ra te was mor e than

thr ee s tand ard devia t ions f r om th e sample mean of each coun try a re de leted . Coun tr ies for

which  j i s es t imated a t the f irs t s tag e using d a ta for fewer t han 15 bank s a r e el imina t ed

from the second-stage an a lysis .

The da ta for th e macroeconomic and r egula tory var iables u sed in th e second -stag e

an alysis ar e obtained from th e following sour ces. Macroeconomic data (inflat ion , GDP per

capita , r eal GDP g rowth , stock m ar ket capital ization) ar e obtained from th e World Bank ‟s

World Development In dicator s. The reg ulator y var iables (activity r estrict ions , capital

requir ements) and th e domest ic and fore ign ent r y var iables a re obta in ed from  Barth e t a l .

(2008). The fin an cial fr eedom , econom ic freedom and p r operty r igh ts var iables a r e obtained

from th e Economic Freedom Index of the Heritag e Fou nd ation; the KKZ index is obtained

from Ka ufm an n et a l . (2008 ). Full details of sour ces an d variable definit ions a re l isted in

Table 1.

Table 1 Data sources and variable definiti ons

The fina l sample for the f i rs t -s tage ana lysis i s an un balan ced pan e l wi th 46 ,959

 ba n k -yea r obser va t ion s (11 ,6 34 ba n k s). Th e p r of it r a t e m ea su r e is r et u r n on aver ag e eq u it y

(ROE), measu r ed by th e rat io of net income after tax to total equity. 1 2

 Taxes ar e dedu cted,

 beca u se if ef fect ive tax r a tes d if fe r be tween cou n tr ie s , en t r y an d ex it s h ou ld be d r iven by

after-tax pr ofi ts. The profi t rate of bank i located in coun tr y j a t year t , i,t

, is nor malized by

deduct ing the m ean pr ofi t ra te of a ll bank s loca ted in coun try j in year t .

12  The empirical analysis is also conducted us ing a retur n on averag e assets (ROA) profi tabi li ty measur e. To savespace these est imations are n ot reported, but th ey are avai lable from the au thors u pon request .

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Table 2 an d 5 collectively r eports d escriptive stat ist ics for r etur n on equity.

Summ ary da ta a r e tabula ted for a l l count r ies , based on averag es for th e per iod 1997-2007

in Table 5. Aver ag e profi tabil i ty varies sig nifican tly between cou nt r ies. The lowest aver ag e

ROE are -9.10% (Ur ug ua y) and -4.29 (Tha iland). Th e high est ar e 25.37% (Venezuela) and

23.84% (Nigeria). Aver ag e profi tabil ity was h igh er in developing cou nt ries (10.87%) than

in developed cou nt ries (6.51%). By region (Table 2), Nor th American bank s r eported th e

hig hest pr ofi tabil i ty on averag e (12.76%). East Asian a nd P acific r egion bank s r eported the

lowest pr ofi tabil i ty on averag e (1.06%). Table 3 r eports d escriptive stat ist ics for th e

dependent var iable and covar iates used in th e second -stag e analysis, wh ile Table 4 pr esents

the correlat ion matrices.

Insert Tables 2 and 3 Descriptive s tatis tic for profit rates an d other variables

Insert Table 4 Correlat ion Matrices

 Firs t -s tag e an aly sis : es t im at in g th e per sis t en ce of prof it

Table 5 r eports est im ates of the sh ort -r un pers istence of profi t coefficients by

country ,  j in (5). Coun tr ies for wh ich th e est imated per sistence of pr ofi t coefficien t l ies

outside th e ran g e (-1, 1) are omitt ed from Table 5.13

 

Insert table 5 P rofit persis tence parameters -- tw o step dynamic panel data model

In Table 5, th e est imated persist ence of profi t coefficien t is posit ive for 62 of the 65

coun tr ies, and n egative for th r ee cou nt ries (Costa Rica, Dominican Repu blic an d Sout h

Korea). The mean  j for the ent i re sam ple i s 0 .43 , somewhat h igher than the m ean va lue for

s ix Eu ropean countr ies of 0 .26 r epor t ed by Goddard e t a l . (2004a). The resul ts su gg est tha t

the e limina t ion of abnormal pr ofi t s thr oug h compet it ion i s by no m eans instan tan eous.

13

 Microeconomic theory pr edicts tha t th e dynam ic process of competi t ion wil l res tore pr ofi ts to a nor mal r etur n.Assuming tha t -1≤  ≥ 1 pr ofi ts will converge t o the equil ibrium ra te of retur n over t ime.  

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Barr ie rs to ent r y an d exi t a r e suff ic ient ly h igh to enable bank s to r e ta in a s ign i ficant

 por t ion of th ei r abn or m a l pr of it s fr om yea r to y ea r .

Table 5 r eports th e fr equen cy distribution of the est imat ed per sistence of profi t

coefficients,  j. For 40 of th e 65 coun tr ies, th e est im ated

 j l ies within th e int erval 0.2 to

0.6.14

 Developed cou nt ries ha ve sl igh tly hig her pers istence of profi t (averag e  j = 0.442)

than deve loping coun tr ies (averag e  j = 0.426), but th ese differ ences are n ot sign ificant.

Insert table 6 frequency distribution of the persis tence coefficients

Table 6 also reports th e averag e est imated  j for coun tr ies located in eigh t

inter nat ional „reg ions‟: Latin America and Car ibbean; East Asia an d th e Pacific; Nort h

America; West Eur ope; East E ur ope; Middle East an d Nort h Africa; Sub -Sahar an Africa;

an d Sou th Asia. There is con siderable r egional variat ion in th e averag e per sistence of

 pr of it . Th e h ig h es t aver ag e  j ar e obtained for N orth America (aver ag e = 0.680) and

Wester n E u rope (avera g e = 0.495). The lowest values are obtain ed for Eas t Asia and th e

Pacific (averag e = 0.288) an d Su b-Sahar an Africa (averag e = 0.296).

Second -stag e analysis: identi fy ing th e determ inant s of persisten ce of profi t

The second-stag e an alysis exa min es the deter min an ts of th e persist ence of pr ofi t .

Table 7 r eports th e est ima tion r esults. In colu mn 1, only th e macroeconom ic variables

(inflat ion, real GDP gr owth, stock m ar ket capital izat ion) are includ ed in th e est im ation. In

colum ns 2-7 , the r egula tory var iables (ent r y bar r ie rs , ac t iv ity r est r ict ions , barr ie rs to

domest ic bank s, and bar r ie rs to fore ign banks ) a re added, one a t a t ime. In colum ns 8 -11

the inst i tu t iona l and exte rn a l gover nan ce var iables (proper ty r igh ts , KKZ index, GDP per

capita an d economic freedom) ar e added. In column s 12 -13 th e indu st ry concentra t ion an d

comp eti t ion m easu res (HHI and H -stat ist ic) are added. Finally, in colum n 1 4 all covar iates

14 The definition of advanced and developing countries follows the IMF, International Financial Statistics (2008).

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ar e in clud ed in a m ultivar iate model of th e determ inan ts of per sistence of pr ofi t .

Windm eijer sma ll sam ple corr ection is used to obtain r eliable standa rd er ror s.15

 

Insert Table 7 Cros s country determinants of s hort run profits persis tence

Among th e macroecon omic var iables, inflat ion g enerally ha s a posit ive imp act on

th e per sistence of pr ofi t , a l thoug h on ly a few of the coefficient s ar e sign ificant. In colum n

4, ther e i s a s ign i ficant nega t ive re la t ions hip be tween s tock mar ke t capi ta l iza t ion an d t he

 per s is ten ce of p r of it . Th is wou ld su g g es t th a t th e m or e h ig h ly develop ed is th e n on -ba n k

fina ncial sector, the gr eater is the comp eti t ive pr essu re on th e bank ing sector . However,

th is f ind ing is r eversed in colum n 1 4. Overall , th erefor e, th ere is l it t le eviden ce for an y

relationsh ip between finan cial sector developmen t an d th e per sistence of ban k p rofi t . The

coeff ic ients on GDP gr owth a re pr edominan t ly nega t ive , and s ig ni f icant in man y cases .

This is consis tent wi th th e a rg um ent tha t g rea te r business opportu ni t ies a fforded by

high er economic growth lower th e opportu ni ty cost of en te r in g th e bank ing sector , thereby

redu cing entr y barr iers. Subsequ ently, in creased competi t ion weakens th e abil i ty of

incumbent bank s to su sta in th e ir prof itab il ity .  

The coefficients on th e thr ee lega l barr ier s to ent r y indicators in colum ns 2 , 6 and 7

are posit ive and s ign i ficant . This sug gests th a t successfu l bank s in mar ke ts th a t a re

 pr ot ected by en t r y ba r r ie r s a r e m or e able to su s ta in th ei r p r of it abi li ty over t im e. Th e

remaining regulatory variables - activity restrict ions, capital regulation, and financial

freedom - seem to exert l it t le or n o influ ence on th e persistence of pr ofi t .

Overa l l, regu la t ion appears to impact on th e pers is tence of pr ofi t thr ough the

erect ion an d enforcement of lega l bar r ie rs to ent r y . High er ent r y barr iers tend to reduce

comp eti t ion, and incr ease profi tabil ity. The opposite is a lso tru e. For in cum ben t bank s,

however, other t ypes of reg ulation do not exert a ny discern able impa ct on competi t ion

measu red by the persisten ce of pr ofit .

15  The control variables are selected to avoid high correlation, and problems of multicollinearity are thereforeminimal .

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Among th e inst i tutiona l and extern al gover na n ce variables, the coefficient on th e

 pr op er ty r ig h t s m ea su r e is n eg a t ive an d s ig n if ican t in colu m n 11. Th is s u g g es ts th a t th e

st ron ger i s th e pro tect ion of proper t y r ight s , the lower i s the pers is tence of pr ofi t . With

st ron ger pr oper ty r igh ts , new entr ants m ay fee l more secur e in cond uct ing busin ess , so the

inten sity of competi t ion incr eases. The coefficients on t h e oth er inst i tu tional variables ar e

neg ative in colu mn s 9 and 10 , but th ese coefficient s ar e not sig nifican t.

There is no r elat ionsh ip between th e HHI index a nd t h e pers istence of profi t ,

according to the est imat ion r epor ted in colum n 12 . Differen ces between t h e objectives of

 ba n k s m ay r en d er th e r el a t ion sh ip be tween in d u s t r y s t r u ct u r e an d con cen tr a t ion t en u ou s.

For exam ple, some banks migh t sacr i f ice potent ia l prof it s in order to r educe r i sk by

mak ing more secur e investments; or a l tern a t ive ly , some bank s m ight s imply enjoy a quie t

l ife afforded by a lack of competi t ive discipline (Berg er an d Han na n, 19 9 8; Goddar d et a l . ,

2004b). Similarly, ther e is n o relat ions hip between t h e Rosse-Pan zar H-stat ist ic and th e

 per s is ten ce of p r of it , accor din g to th e es t im at ion r ep or ted in colu m n 13 . In colu m n 14 ,

however, wh ere both th e HHI index a nd t he H-stat ist ic are included, the coefficients on both

ar e sig nifican t. The relat ions hip between t h e HHI an d th e per sistence of profi t is n egative,

in accordan ce with th e „collus ion‟ hy pothesis of an association between concentr ation an d

entr y barr iers . Th e r elat ionsh ip between th e H-stat ist ic an d th e pers istence of pr ofi t is

neg ative. This findin g is also cons istent with an association between th e int ensity of

comp eti t ion an d th e persistence of pr ofi t .

In th e mu ltivar iate model r epor ted in colum n 14 , the coefficients on th e total

fraction of entr y denied, pr operty r igh ts an d GDP gr owth variables become insig nifican t. It

appears th a t th e mark e t s t ru c ture an d compet i t ion var iables tend to domina t e the ent r y

 ba r r ie r s , in st it u t ion a l an d m acr oecon om ic va r ia bles in ex pla in in g th e va r ia t ion in th e

 per s is ten ce of p r of it .

5. Conclus ion

Over th e past thr ee decades, bankin g m ar ke ts a r ound t he world have exp er ienced

funda menta l regu la tory an d s t ru c tura l chang e , wi th profoun d impl ica t ions for th e

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in tensi ty of bank compet i t ion . Using a la r ge c ross-coun try dynam ic pane l da ta se t , th is

 paper r ep or t s es t im ates of th e in t en sit y of com pet it ion , ba sed on a dyn am ic an aly sis of th e

 per s is ten ce of ba n k p r of it over t im e. In con t r ast wit h th e es sen t ia lly s t a t ic s t r u ct u r e -

conduct-performance (SCP) and new empirical industrial organization (NEIO) frameworks,

which domina te th e ana lysis of compet it ion in th e empir ica l ban king l ite ra tu re , th is paper

adopts a dyn am ic view of bank comp eti t ion. The present app roach is consistent with th e

view, a r t icu la ted in the contestable mark e ts l ite ra tu re , tha t thr ea tened or potent ia l en t ry i s

as importan t as ac tua l en t ry in de te rm ining the in tensi ty of compet i t ion .

A two-stag e ana lysis of the pers is tence of profi t i s repor ted usin g da ta on banks

from 65 coun tr ies over th e per iod 1997 to 2007. At th e fi rs t s t age , a f irs t -order

au toreg r essive model is used to est imate th e sh ort -ru n per sistence (speed of adju stm ent) of

 ba n k p r of it . Th e speed of con ver g en ce va r ies be tween cou n t r ie s , wit h ba n k s in develop ed

coun tr ies exhib it ing h igh er pers is tence of prof it on averag e than those in developing

countries. Although competi t ion exerts some discipline on bank profi tabil i ty, adjustment

towards equi l ibr ium af ter an abnorm al profi t has been earn ed is by no means

instan taneous. Bar r ie rs t o ent ry a nd exi t a r e suff ic ient ly h igh to enable banks to re ta in a

signi f icant por t ion of th e ir abnorm al prof it s f r om year to year .

At the second sta g e, th e determ inan ts of th e pers istence of pr ofi t are exam ined. The

estimated pers istence coefficients fr om th e first sta g e ar e used as th e dependen t variable in

regr essions wi th covar ia tes th a t m easur e macroeconomic condi t ions, bank regu la t ion , the

inst i tu t iona l environm ent and exte rn a l governan ce, and compet it ion . The resul ts su gg est

tha t the pers is tence of profi t i s s t rong er in m ark e ts tha t a r e she l tered f rom compet it ion by

legally imposed and enforced bar rier s to entr y.

From an ant i t r ust , reg ula tory and s upervisory persp ect ive , the approach tha t i s

adopted in t h is paper su gg ests tha t policy r ecommend at ions based on pr ofi t s preva il ing in

the bank ing sector a t any poin t in t ime ar e inadvisable , as cur rent pr ofi tabi li ty i s

essential ly a tr an sitory ph enomen on. A dyn am ic model of profitabili ty provides an

indication of th e efficiency of competi t ion in forcing th e adjustm ent or converg ence of

 pr of it s (a bove or be low th e n or m ) tow ar ds th ei r lon g -r u n eq u il ibr iu m va lu es . Th is ass is t s

the r egula tor in d is t ing uishin g between cases in which a compet i t ive equ i libr ium is l ike ly

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to be achieved r apid ly wi thout in te rvent ion , an d cases in wh ich regu la tory in te rvent ion

ma y be requ ired in order to achieve a comp eti t ive out come.

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Table 1 Variable definitions and sources

Variable name Description and source

Dependent Var iable

Return on average equity (ROE)2  Total net income after tax divided by average equity, as reported by Bankscope.

Bank market structure and competiti on 2 :

Herfindahl Index A measure of the degree of concentration in the banking industry, calculated by the sum of the squares of each bank's marketshares of the country of the year.

H-statisticA measure of the degree of competitiveness of the industry, with less than 0 being a monopoly, less than 1 while larger than

0 being monopolistic competition, and 1 being perfect competition .

Macroeconomic variabl es 5 :

Inflation rate Rate of inflation, calculated by log difference of GDP deflator.

GDP growth The growth in GDP.

Market Capitalization Total domestic stock market capitalization divided by GDP

Regulatory restricti ons:

Activity Restrictions1 

A measure of a bank's ability to engage in the businesses of securities underwriting, insurance, and real, and of the

regulatory restrictiveness of banks to own shares in non-financial firms (sum of Survey of Bank Regulation and Supervision

questions 4.1 through 4.4).Greater values signify more restrictions.

Financial freedom3 An indicator of financial freedom (ranging from 0 to 100). Calculated as 100 minus the financial freedom index of the

Heritage Foundation. Higher values signify less freedom.

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Capital requirements1 The minimum capital to asset ratio required by the government (Based on question 3.1 of Survey of Bank Regulation and

Supervision).

Fraction of entry denied1 A measure of the number of entry applications denied as a fraction of the number of applications received from domestic

and foreign entities (ratio of Survey of Bank Regulation and Supervision questions 1.9.1 and 1.10.1 to 1.9 and 1.10).

Domestic fraction of entry denied1

 

A measure of the number of entry applications denied as a fraction of the number of applications received from domestic

entities (ratio of Survey of Bank Regulation and Supervision questions 1.9.1 to 1.9).

Foreign fraction of entry denied1 A measure of the number of entry applications denied as a fraction of the number of applications received from foreign

entities (ratio of Survey of Bank Regulation and Supervision questions 1.10.1 to 1.10).

I nstitutional environment :

Economic freedom3  An indicator of economic freedom (ranging from 0 to 100). Greater values signify more freedom.

Property rights3 An indicator of the protection of private property rights (ranging from 0 to 100). Greater values signify better protection of

 property rights.

KKZ Institution index4 

An indicator of the quality of institutional development in the country. Calculated as the average of six indicators: voice and

accountability, political stability, government effectiveness, regulatory quality, rule of law, and control of corruption.

GDP per capita

5

  Logarithm of GDP per capita expressed in original values.

Data Sources:

1 Barth et al. (2008). Data available at: www.worldbank.org/research/projects/bank_regulation.htm  

2 Calculated based on Fitch IBCA's Bankscope Database

3 Economic Freedom Index of the Heritage Foundation

http://www.worldbank.org/research/projects/bank_regulation.htmhttp://www.worldbank.org/research/projects/bank_regulation.htmhttp://www.worldbank.org/research/projects/bank_regulation.htmhttp://www.worldbank.org/research/projects/bank_regulation.htm

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4 Kaufmann, Kraay, Zoido-Lobaton (2008) 

5 World Development Indicators, World Bank

Table 2 Summary statistics for ROE by region and development.

Region Number of countries ROE

Latin America and Caribbean 16 10.07

East Asia & the Pacific 11 1.06

 North America 1 12.76

West Europe 15 7.02

East Europe 11 11.47

Middle East & North Africa 2 7.10

Sub-Saharan Africa 6 13.22

South Asia 3 15.93

Advanced Countries 19 6.51

Developed Countries 46 10.87

Overall 65 10.10

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Table 3 Summary statistics for the persistence of profit, and covariates

MeanStandard

DeviationNumber of countries

Persistence of profit,  j  0.429 0.243 64

Inflation rate 0.078 0.129 62

Market capitalization 0.546 0.643 59

GDP growth 0.040 0.018 62

Herfindahl-Hirschman Index 0.177 0.135 60

Rosse-Panzar H-statistic 0.553 0.255 62

Activity restrictions 2.554 0.650 56

Capital requirements 0.089 0.014 55

Financial freedom 46.393 15.568 61

Total fraction of entry denied 0.070 0.135 48

Domestic fraction of entry denied 0.093 0.194 31

Foreign fraction of entry denied 0.057 0.131 42

Economic freedom index 63.452 9.000 61

KKZ Index 0.388 0.910 63

Property rights Index 59.061 23.035 61

GDP per capita 8.572 1.463 61

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Table 4 Correlation Matrices for the explanatory variables.

InflationMarket

capitalization

GDP

growthHHI

H-

statistic

Activity

restrictions

Captial

requirements

Financial

freedom

Totalentry

denied

Domesticentry

denied

Foreignentry

denied

Economic

freedomKKX

GDP per

capita

Inflation 1.00

Marketcapitalization

-0.28 1.00

0.03

GDP growth 0.05 -0.19 1.00

0.68 0.15

HHI -0.01 -0.14 0.11 1.00

0.92 0.30 0.41

H-statistic 0.08 -0.06 -0.16 0.06 1.00

0.54 0.64 0.23 0.66

Activity

restrictions0.09 -0.41 0.13 0.11 -0.07 1.00

0.50 0.00 0.36 0.43 0.63

Captialrequirements

0.54 -0.39 0.18 0.04 -0.08 0.03 1.00

0.00 0.00 0.19 0.80 0.55 0.84

Financial

freedom 0.23 -0.51 0.30 0.15 0.00 0.43 0.32 1.00

0.08 0.00 0.02 0.26 0.97 0.00 0.02

Total entry

denied-0.02 -0.15 0.25 0.10 0.05 0.16 0.06 0.31 1.00

0.88 0.31 0.09 0.53 0.73 0.28 0.68 0.04

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Domesticentry denied

0.21 -0.04 0.36 0.18 0.01 0.18 0.05 0.51 0.90 1.00

0.27 0.84 0.05 0.35 0.95 0.34 0.77 0.00 0.00

Foreign

entry denied-0.06 -0.19 0.30

-

0.06-0.02 0.13 0.16 0.17 0.81 0.45 1.00

0.73 0.24 0.06 0.71 0.89 0.44 0.34 0.31 0.00 0.02

Economic

freedom-0.38 0.71 -0.33

-

0.140.12 -0.34 -0.54 -0.80 -0.33 -0.42 -0.32 1.00

0.00 0.00 0.01 0.30 0.36 0.01 0.00 0.00 0.02 0.02 0.04

KKX -0.28 0.59 -0.38-

0.120.01 -0.46 -0.46 -0.67 -0.36 -0.38 -0.36 0.79 1.00

0.03 0.00 0.00 0.37 0.93 0.00 0.00 0.00 0.01 0.04 0.02 0.00

GDP percapita

-0.25 0.56 -0.47-

0.200.08 -0.49 -0.44 -0.67 -0.42 -0.42 -0.51 0.75 0.91 1.00

0.05 0.00 0.00 0.13 0.52 0.00 0.00 0.00 0.00 0.02 0.00 0.00 0.00

 Notes: p value of each pair of correlation coefficients is reported underneath each correlation coefficient.

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Table 5 First-stage estimation results: Short-run persistence of profit estimates and profit rates (ROE) by country

CountryCountry

typeRegion

No.of

banks

No.

of

obs

ROE

Mean

ROE

Std.

Dev.

Lambda

Lambda

Std.

Err.

Hansenp AR(2)

Argentina DC Latin America and Caribbean 94 543 -3.29 37.14 0.164 0.008 0.302 0.546

Australia AC East Asia & the Pacific 26 87 11.52 21.86 0.255 0.085 0.477

Austria AC West Europe 248 1361 7.10 8.08 0.477 0.039 0.570 0.107

Bahamas DC Latin America and Caribbean 16 89 19.83 17.67 0.353 0.098 0.988 0.294

Bangladesh DC South Asia 31 198 17.94 17.03 0.284 0.034 0.192 0.811

Belgium AC West Europe 62 344 9.80 19.07 0.539 0.004 0.522 0.547

Bosnia and Herzegovina DC East Europe 23 124 6.28 10.09 0.525 0.033 0.474 0.313

Brazil DC Latin America and Caribbean 151 861 14.14 23.34 0.311 0.021 0.102 0.818

Bulgaria DC East Europe 22 132 13.15 16.33 0.392 0.008 0.444 0.220

Cayman Islands DC Latin America and Caribbean 16 82 11.29 11.48 0.613 0.046 0.999 0.387

Chile DC Latin America and Caribbean 34 197 9.26 10.76 0.400 0.005 0.474 0.451

China DC East Asia & the Pacific 70 345 12.78 10.08 0.570 0.025 0.823 0.727

Colombia DC Latin America and Caribbean 27 169 9.39 30.87 0.324 0.003 0.957 0.449

Costa Rica DC Latin America and Caribbean 45 208 13.14 7.14 0.887 0.016 0.866 0.832

Croatia DC East Europe 41 226 8.03 12.92 -0.061 0.002 0.601 0.230

Cyprus AC East Europe 15 71 16.17 28.65 0.508 0.011 0.990 0.136

Czech Republic DC East Europe 24 130 9.53 18.78 0.201 0.003 0.998 0.102

Denmark AC West Europe 104 636 10.70 7.92 0.488 0.010 0.105 0.990

Dominican Republic DC Sub-Saharan Africa 33 175 9.92 28.90 -0.034 0.002 0.863 0.102

Ecuador DC Latin America and Caribbean 33 218 12.21 12.79 0.169 0.009 0.301 0.286

Egypt, Arab Rep. DC Sub-Saharan Africa 30 181 8.49 18.43 0.517 0.002 0.828 0.135

France AC West Europe 343 2022 9.17 19.08 0.446 0.024 0.331 0.031

Germany AC West Europe 2123 12178 5.41 5.57 0.178 0.017 0.000 0.002

Guatemala DC Latin America and Caribbean 32 205 12.14 14.46 0.808 0.008 0.803 0.614

Honduras DC Latin America and Caribbean 20 122 11.27 8.90 0.723 0.016 0.599 0.866

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Switzerland AC West Europe 442 2392 8.18 7.51 0.725 0.032 0.116 0.861

Taiwan, China DC East Asia & the Pacific 46 301 -0.80 17.44 0.325 0.022 0.356 0.101

Tanzania DC Sub-Saharan Africa 15 52 19.99 26.02 0.254 0.156 0.077

Thailand DC East Asia & the Pacific 21 135 -4.29 55.57 0.967 0.002 0.403 0.259

Tunisia DC Middle East & North Africa 15 94 6.95 7.12 0.630 0.028 0.840 0.034

Ukraine DC East Europe 33 188 11.71 11.34 0.454 0.017 0.599 0.796

United Kingdom AC West Europe 145 692 9.13 13.47 0.684 0.017 0.455 0.198

Uruguay DC Latin America and Caribbean 44 195 -9.10 82.89 0.589 0.010 0.692 0.665

United States AC North America 738 4319 12.76 9.27 0.680 0.041 0.098 0.004Venezuela DC Latin America and Caribbean 49 268 25.37 18.63 0.391 0.025 0.358 0.593

Vietnam DC East Asia & the Pacific 22 128 10.38 14.59 0.580 0.010 0.479 0.271

 Note:   is estimated by applying the system GMM estimator to Equation (4), with the profit rates being the ROE‟s (r eturn-on-average equity) as reported byBankScope. „AC‟ represents advanced countries, while „DC” represents developing countries.. 'Hansenp' is the p-value for the Hansen test for the validity of

the over-identifying restrictions in the System GMM estimation. 'AR(2)' is the p-value for the 2nd-order autocorrelation in the residuals from the System GMMestimation.

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Table 6 Frequency distribution of estimated short-run persistence coefficients

a) By frequency interval

Frequency intervalNumber of countries

AC DC all %

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Table 7: Second-stage regression results, determinants of the persistence of profit

Macro-

economic

conditions

Macroeconomic conditions and bank regulation

(1) (2) (3) (4) (5) (6) (7)

Constant 0.858* 0.714** 1.115 1.294 0.783 1.041*** 0.763

(2.82) (2.44) (1.93) (1.77) (1.51) (3.97) (2.02)

Inflation rate 2.512** 1.881 2.305 -0.252 2.613 -3.387 1.756

(2.19) (1.44) (1.25) (-0.27) (1.25) (-1.59) (1.28)

Marketcapitalization

0.0137 0.0758 0.00322 -0.0836* 0.0298 -0.0517 0.0637

(0.19) (1.28) (0.04) (-3.01) (0.25) (-0.25) (0.98)

GDP growth -20.91** -21.35* -23.29 4.167 -21.05** -15.39 -21.55**

(-2.19) (-2.78) (-1.66) (0.75) (-2.34) (-1.85) (-2.33)

Total entry denied 1.871***

(3.75)

Activity

restrictions-0.0711

(-0.72)

Capitalrequirements

-11.34

(-1.09)

Financial freedom 0.00133

(0.15)

Domestic entry

denied0.964**

(2.47)

Foreign entrydenied

1.804**

(2.54)

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 N 61 46 53 52 59 31 40

adj. R-sq 0.482 0.476 0.434 0.826 0.417 0.931 0.291

 Note: Dependent variable is  coefficients estimated from the first stage system GMM estimator. Since the dependent variable is anestimated parameter, all equations are weighted with the inverse of the standard errors of the dependent variable. The constant variable is

suppressed; however, the inverse of standard error of dependent variable is used instead. OLS with robust standard errors is applied in each

equation and t statistics of estimated coefficients are shown in parentheses.*,**,*** represents 10, 5, and 1 percent significant level,respectively

Institutional and External GovernanceMarket

StructureCompetition

ll

(8) (9) (10) (11) (12) (13) (14)

Constant 3.307 1.096* 2.632** 1.794* 0.663 1.355* -0.115

(1.91) (3.08) (2.62) (3.13) (1.87) (3.24) (-0.20)

Inflation rate 1.383 1.830** 1.892** 0.554 2.694** 1.627 0.560

(0.88) (2.06) (2.32) (0.45) (2.26) (1.53) (0.86)

Market

capitalization0.298 0.0842 0.0932 0.106 0.0260 -0.0366 -0.107*

(1.52) (1.28) (1.46) (1.85) (0.33) (-0.53) (-2.74)

GDP growth -25.89* -24.80** -27.17* -25.74* -19.22 -22.94** 2.181

(-3.05) (-2.46) (-2.72) (-3.07) (-1.98) (-2.64) (0.41)

Total entry denied -0.00136

(-0.00)

Economic freedom -0.0360

(-1.47)

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KKZ -0.211

(-1.60)

GDP per capita -0.170

(-1.99)

Property rights -0.0106** 0.0127

(-2.01) (2.45)

HHI 0.514 1.035***

(1.11) (3.64)

H-statistic -0.348 -1.100***

(-1.30) (-6.88)

 N 59 60 61 59 61 59 44

adj. R-sq 0.526 0.541 0.593 0.554 0.496 0.565 0.795

 Note: Dependent variable is  coefficients estimated from the first stage system GMM estimator. Since the dependent variable is an estimated parameter, all equations are weighted with the inverse of the standard errors of the dependent variable. The constant variable is suppressed;however, the inverse of standard error of dependent variable is used instead. OLS with robust standard errors is applied in each equation and t

statistics of estimated coefficients are shown in parentheses.*,**,*** represents 10, 5, and 1 percent significant level, respectively

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