Nardos Kefle Thesis After Defence

ST.
MARY’S UNIVERSITY
SCHOOL OF GRADUATE STUDIES
FACTORS AFFECTING PROFITABILITY IN THE CASE OF

COMMERCIAL BANK OF ETHIOPIA
BY NARDOS KEFLE
ADVISOR: SIMON TAREKE (ASST. PROFESSOR)
JUNE 2023
ADDIS ABABA, ETHIOPIA
0
FACTORS AFFECTING PROFITABILITY IN THE CASE OF COMMERCIAL BANK
OF ETHIOPIA
BY NARDOS KEFLE
ID NO. SGS/0161/2013B
THESIS SUBMITTED TO ST. MARY UNIVERSITY, SCHOOL OF GRADUATE

STUDIES IN PARTIAL FULFILMENT OF THE REQUIREMENTS FOR THE
DEGREE OF MASTER OF ACCOUNTING AND FINANCE
JUNE 2023
ADDIS ABABA. ETHIOPIA
i
ST. MARY’S UNIVERSITY
SCHOOL OF GRADUATE STUDIES
THESIS TITLE
FACTORS AFFECTING PROFITABILITY IN THE CASE OF COMMERCIAL BANK

OF ETHIOPIA
BY NARDOS KEFLE
APPROVED BY BOARD OF EXAMINERS
Dean, Graduate Studies Signature
Advisor Signature
External Examiner Signature
Internal Examiner Signature
ii
DECLARATION
I, the undersigned, declare that this thesis entitled “FACTORS AFFECTING

PROFITABILITY IN THE CASE OF COMMERCIAL BANK OF ETHIOPIA” is my
original work, prepared under the guidance of the research advisor. All sources of materials used
for the thesis have been duly acknowledged. I further confirm that the thesis has not been
submitted either in part or in full to any other higher learning institution for the purpose of earning
any degree.
NARDOS KEFLE
Name Signature
St. Mary’s University
JUNE 2023
Addis Ababa
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ENDORSEMENT
This is to certify that this project work, “FACTORS AFFECTING PROFITABILITY IN THE
CASE OF COMMERCIAL BANK OF ETHIOPIA undertaken by Nardos Kefle for the partial
fulfillment of Masters of Accounting and Finance [MBAAF] at St. Mary University, is an original
work and not submitted earlier for any degree either at this University or any other University.
Research Advisor
SIMON TAREKE (ASS. PROFESSOR) Date
iv
ACKNOWLEDGEMENTS
First and for most, my heartily thanks go to Almighty God, for his kindly provision of
knowledge, wisdom, inspiration and diligence required for the successful completion of this
research and for bringing my dreams into reality.
I am deeply indebted to my advisor Simon Tareke (Ass. Professor) whom during this period
has not only kept me on track, but also provided invaluable advice and support.
I am thankful to my mom W/ro Hiwot Mengistu, Misrak Mengesha for all their unfailing
support during this research study. Many thanks to my collogue Sintayehu Tolossa for his
great advise during this research study.
Thank you
NARDOS KEFLE
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ACRONYMS/ABBREVIATIONS
AS Asset Size
BJ Bera-Jarque
CBE Commercial Bank of Ethiopia
CLRM Classic Linear Regression Methods
CR Credit Risk
DW Durbin-Watson
GDP Gross Domestic Product
INF Inflation
LOAN Loans and Advances
NIE Non –interest expense

NII Non –interest income
NIM Net Interest Margin
OE Operating efficiency
OLS Ordinary least square
ROA Return on asset
Std.Dev. Standard deviation
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TABLE OF CONTENTS
Contents Pages
ACKNOWLEDGEMENTS ....................................................................................................... v
ACRONYMS/ABBREVIATIONS........................................................................................... vi
TABLE OF CONTENTS .........................................................................................................vii
LIST OF TABLES .................................................................................................................... ix
LIST OF FIGURES ................................................................................................................... x
ABSTRAT .................................................................................................................................. xi
CHAPTER ONE ........................................................................................................................ 1
1. INTRODUCTION ................................................................................................................. 1
1.1 Background of the Study .................................................................................................. 1
1.2 Statement of the Problem ................................................................................................. 2
1.3 Research Questions .......................................................................................................... 3
1.4 Objective of the Study ...................................................................................................... 4
1.4.1 General objective ....................................................................................................... 4
1.4.2 Specific objective ...................................................................................................... 4
1.5 Hypotheses of the Study................................................................................................... 4
1.5 Significance of the Study ................................................................................................. 5
1.6 Scope of the Study............................................................................................................ 6
1.7. Limitation of the Study ................................................................................................... 6
1.8. Organization of the Paper ................................................................................................ 6
CHAPTER TWO ....................................................................................................................... 7
2. LITERATURE REVIEW ...................................................................................................... 7
2.1 Theoretical Review .......................................................................................................... 7
2.1.1 Concepts and Definitions........................................................................................... 7
2.2 Empirical Literature Review ...................................................................................... 13
2.2.1. Empirical literature review from other countries. .................................................. 13
2.2.2 Empirical studies in Ethiopia ................................................................................... 15
2.3 Summery of Literature and Knowledge Gap ................................................................. 18
CHAPTER THREE ................................................................................................................. 20
3. RESEARCH METHODOLOGY ................................................................................. 20
3.1 Research Design ......................................................................................................... 20
3.3. Data Source and Collection Method .......................................................................... 20
3.5. Data Analysis ............................................................................................................. 21
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CHAPTER FOUR .................................................................................................................... 23
4. RESULT AND DISCUSSIONS .......................................................................................... 23
4.1. Descriptive Statistics ................................................................................................. 23
4.2 Correlation Analyses between Study Variable .............................................................. 25
4.2.1 Correlation analysis between ROA and explanatory variables ............................... 25
4.3. Econometric Analysis ................................................................................................... 26
4.3.1. Test for unit roots ................................................................................................... 26
4.3.2-Tests for the Classical Linear Regression Models (CLRM) assumptions .................. 28
Test for Heteroscedasticity ............................................................................................... 28
Test of auto correlation ..................................................................................................... 28
Normality test: Bera-Jarque (BJ) test ............................................................................... 29
Serial correlation............................................................................................................... 29
Model stability.................................................................................................................. 30
4.4. Regression Analyses (OLS) Model ............................................................................... 30
CHAPTER FIVE ..................................................................................................................... 35
5. SUMMARY, CONCLUSION AND RECOMMANDATION ........................................... 35
5.1. Summary and Conclusion ............................................................................................. 35
5.2 Recommendation ............................................................................................................ 35
6. References ............................................................................................................................ 37
7. ANNEXES .............................................................................................................................. i
Annex I: Test for Unit root Result .............................................................................................. i
Annex II: OLS Estimate..........................................................................................................xii
Annex III: Normality test Estimate .........................................................................................xii
Annex IV: Serial Correlation test Estimate .......................................................................... xiii
Annex V: Heteroskedasticity Test Estimate ......................................................................... xiii
Annex VI: CUSUM Test Estimate ........................................................................................ xiv
Annex VII: Variance Inflation Factors Test Estimate ........................................................... xiv
Annex VIII: Estimation Equation Test Estimate .................................................................... xv
Annex IX: Estimation Correlation Test Estimate ................................................................... xv
viii
LIST OF TABLES
Name Pages
Table 4.1. Descriptive statistics for the dependent and explanatory variables ................... 34
Table 4.2. Correlation matrix: ROA and explanatory variables ........................................... 25
Table 4.3: Unit root test summery .......................................................................................... 28
Table 4.4 Heteroscedasticity Test: Breusch-Pagan-Godfrey .............................................. 40
Table: 4.5 Serial correlation ....................................................................................................... 29
Table: 4.6 OLS model estimation result for Dependent variable D (ROA) ...................... 32
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LIST OF FIGURES
Name Pages
Figure 2.1: Theoretical model on determinants of profitability. ...................................... 19

Figure 4.1 ROA Vs Explanatory variables ....................................................................... 35
Figure 4.2 ROA Vs Macroeconomic variables ................................................................. 36
Figure 4.3 Trends of variable at level ............................................................................... 38
Figure 4.4 Trends of variable at first difference ............................................................... 39
Figure 4.5 Correlogram LM test ...................................................................................... 41
Figure; 4.6 Normality test: Bera-Jarque (BJ) test ............................................................. 34
Figure 4.7: CUSUM test of model stability ..................................................................... 45
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ABSTRAT
This study's goal is to examine factors that affect Commercial Bank of Ethiopia (CBE)
profitability using 32 years’ time series data for the industry from 1990 through 2021. The
study included secondary sources of data and quantitative research methods. The secondary
data was evaluated using regression models for the Return on Asset indicator of bank
performance. The OLS method was used to examine the effects of the following factors
separately: Bank Size, Inflation Loans and Advances to Total Asset Non-Interest Income,
Credit Risk and Economic growth rate, and Non-interest Expenses. The empirical finding
demonstrates that variables including bank size, non-interest income, credit risk, and GDP
growth rate have a direct and significant effect on CBE. The profitability of the banks was
adversely and significantly affected by factors including inflation, and non-interest expenses.
As a result, the effect this element has on the banks' overall financial performance should
worry the banks. Finally, depending on the results of the analysis, the researcher has drawn
conclusions and offered suggestions.
Key Words: Return on Asset, Profitability, Internal Factors, External Factors, Commercial
Bank of Ethiopia and OLS.
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CHAPTER ONE
1. INTRODUCTION
1.1 Background of the Study
Financial institutions play a crucial role in extending the financial services available in a nation,
making them structures for significant economic development in every region (Dawood,
2014).Depository institutions, or commercial banks, as well as other saving institutions that
provide statutory contributions to clients, like insurance companies and pension funds, as well
as fund intermediaries, like investment companies, mutual funds, and account companies, are
examples of financial institutions (Mishkin & Eakins, 2012).
Commercial banks make up the majority of financial institutions in many countries.

Commercial banks are businesses that deal with money; they take deposits from the general
public and disburse loans and advances. Their primary profit-driven activities include lending
money, taking deposits, and providing other financial services such electronic money transfers,
overdraft services, and foreign exchange (Ponce, 2011).
As they distribute money effectively, they are an essential part of the financial system. In
contemporary economies, one of the most significant factors is bank profitability. Commercial
banks are spending money on liabilities while earning money from their investments.
Consequently, the management of a bank's liabilities and assets has a significant effect on its
profitability. Numerous macroeconomic and banking-related issues also affect the banks'
capacity to turn a profit. It is possible to evaluate the performance of banks along a number of
dimensions. This essay focuses on Ethiopia's commercial bank's profitability performance. In
the competitive financial environment, bank profitability is a key indicator of bank stability
(Tefera, 2014).
The stability of financial institutions depends on their ability to generate profits, which is also
essential for the economy's overall productive growth and the advancement of the whole
country. On the other hand, poor financial institution performance will result in a financial
disaster, as the world witnessed during the financial crises of 1997 and 2008. San and Heng
(2013).
As the country's financial services were expanded by financial organizations, each region's
economy benefited greatly (Dawood, 2014). These companies included fund intermediaries
like investment companies, mutual funds, and account companies, as well as depository
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institutions like commercial banks that provided statutory contributions to clients like
insurance companies and pension funds. Commercial banks made up the majority of financial
institutions in several countries. These banks were businesses that dealt with money by taking
public deposits and disbursing loans and advances while their primary objectives were financial
gain. They were a vital part of the financial system since they efficiently distributed funds and
offered financial services like electronic money transfer, overdraft services, and foreign
exchange. Since commercial banks had liability costs and earned income from their
investments, bank profitability was crucial in modern economies. As a result, in addition to
various other bank business and macroeconomic issues, the management of obligations and
assets had a significant effect on bank profitability. As it offered crucial information on their
stability in the cutthroat financial market, the research focused on the profitability performance
of commercial banks in Ethiopia (Tefera, 2014). Financial institutions' success was dependent
on their profits, which were also crucial for the economy's total productive growth and the
advancement of the whole country. The globe witnessed the financial crises of 1997 and 2008
because of the poor performance of financial institutions, on the other hand (San & Heng,
2013).
Profit fluctuations over time have been noted in the financial statements of Ethiopian banks.
This involves looking into the elements that affect banks' long-term profitability. Additionally,
banks and other financial institutions like microfinance institutions are not included in the
extensive empirical literature on the factors that affect this industry's profitability (Vejzagic &
Zarafat, 2014; B. Williams, 2003), and very few studies have been done on the profitability of
the banking sector in Ethiopia. This study, which evaluates the profitability status of
commercial banks in Ethiopia and identifies factors that affect bank profitability in Ethiopia,
is therefore this research carried out to close this gap.
1.2 Statement of the Problem
The best performance of any industry in general and of any firm in particular has a role in both
driving the growth of the entire industry, which ultimately results in the success of the economy
as a whole, and in raising the market value of that particular firm. Measuring the performance
of financial institutions has become more important in the literature on corporate finance
because, in their role as intermediaries, these businesses not only offer ways to save money and
transfer risk, but also assist in directing money in the right direction from surplus to deficit
economic units to support investment activities. Profitability is one of the bank's most
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important goals and evidence of the management's effectiveness because it allows the bank to
draw in capital and investments. Banks operate in a highly competitive environment, and the
increased use of information and communication technology has an effect on their ability to
make money (Abdulfeta, 2017). Although the notion of profitability differs among research,
the issues determining profitability are empirically thoroughly investigated in banking
literature. One of the most important goals for banks is profitability since it demonstrates the
effectiveness of its management and its capacity to draw capital and investments. Most banking
regions use return on asset and return on owners' equity to gauge profitability (Abdulfeta ,
2017). Few researches on the factor determining profitability in Ethiopia have been conducted,
taking into account a variety of types and numbers of factors (Samuel, 2015). This study comes
to the conclusion that operating efficiency, liquidity risk, and finance cost are the three main
factors that determine profitability. Additionally, he pointed out that several bank stage
indicators like total asset and capital adequacy ratio have broad-based positive effects on profit.
In his analysis of the variables influencing financial institution profitability in Ethiopia,
(Amdemikeal, 2012) looked at the capital strength, income diversification, bank size, and gross
domestic product, all of which had a statistically significant and amazing association with bank
profitability. On the other hand, the profitability of banks is negatively and statistically
significantly correlated with factors like operational effectiveness and asset quality. (Selamait,
2016) examined specific factors that affect the profitability of commercial banks in the context
of an Ethiopian business financial institution. She conducted research on assets, side income,
department expansion, and noninterest rates, finding that they have a significant effect on the
profitability of the bank. The study aims to close the gap by providing complete information
about controversial in identifying major factors that determine banks profitability in previous
studies. As a result, the goal of this study is to investigate the factors that affect the profitability
of Commercial Bank of Ethiopia by using an econometrics model to estimate factors that affect
the bank's profitability, which is proposed to fill a knowledge gap.
1.3 Research Questions
 What effect does bank size have on the Ethiopian commercial bank's profitability?
 How does commercial bank of Ethiopia profitability respond to changes in credit risk?
 How do the macroeconomic variables GDP growth rate and inflation affect the
profitability of Ethiopia's commercial banks?
 What effect does non-interest income have on the Ethiopian commercial bank's
profitability?
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 How do non-interest expenses affect the Ethiopian commercial bank's profitability?
 How do loans and advances affect the Ethiopian commercial bank's profitability?
1.4 Objective of the Study
1.4.1 General objective
The main objective of this study was to analyze the variables that affect the Ethiopian
commercial banks' profitability.
1.4.2 Specific objective
The specific objectives of the study are:

 To investigate how internal factors like; bank size, credit risk, loans and advances non-
interest income and expense affect profitability of commercial of Ethiopia.
 To determine how external factors, such as inflation and real GDP, affect the
profitability of Commercial bank of Ethiopia.
 To draw attention of managements those banks towards proper handling of the
relationships between performance and these variables.
1.5 Hypotheses of the Study
In line with the broad purpose statement the following hypotheses were also of formulated for
investigation. Based on the objective, the present study seeks to test the following hypotheses:
HO1: Bank size: According to the study by susan (2014) Bank size (asset size) which is
measured by total assets has positive effect on profit of Kenyan top six commercial banks. We
predict there is positive relation between asset size and CBE profitability.
HO2: Credit Risk (CR): To proxy this variable the study used the loan-loss provisions to total
loans ratio. Positive relation between banks ability to managing credit and profitability in
Ethiopian bank indicates that increased managing risks means reducing operating expense with
result in higher profitability for the bank (Ayele, 2012). Based on previous research we predict
there is positive relationship between operating efficiency and CBE profitability.
HO3. Non-Interest Income: The concept of revenue diversifications follows the concept of
portfolio theory, which states that banks can reduce firm-specific risk by diversifying their
portfolios. Moreover, the decline in interest margins during the last decade has changed the
traditional role of banks and forced them to search for new sources of revenue. In this context,
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using annual bank level data of all Philippines commercial banks Sufian & Chong (2008),
found a positive relationship between the ratio of total non-interest income to total assets, a
proxy for income diversification and bank profitability. Based on the prior research we expect
there is positive relationship between income diversification and CBE profitability.
HO4: Non-Interest Expense: Increase ATM machine increase in the number of branches of
the bank, which leads to increase in the profits (ROA). Abdulfeta, (2017), based on his study
we predict there is positive relation on CBE profitability but this variable are new not used in
our country researches thus it is expected to have positive /negative relation on CBE
profitability.
HO5: Loans and Advances (LOAN): This measures the source of revenue by dividing the
total amount of loans by the total amount of assets. The majority of interest-bearing assets are
loans. Deposits: Savings deposits, fixed deposits, and demand deposits are the three types of
deposits that commercial banks accept. However, the only deposits that pay interest are
savings and fixed deposits. Generally supposed that Loans and Advances positively related to
bank profitability, (Hirindul.k & Kushani. 2017). Thus based on the previous studies we
predict sign is positive relationship between deposit fund and CBE profitability.
HO6: Inflation: The relationship between bank profitability and inflation, stating that the
effect of inflation on bank profitability depends on how inflation affects both salaries and the
other operating costs of the bank. In this context, Staikouras & Wood (2003) point out that as
inflation may have direct effects, that is, increase in the price of labor, and indirect effects, that
is, changes in interest rates and asset prices, on the profitability of banks.
HO7: Real GDP growth used to measure economic growth. According to a previous study,
GDP growth projected to have a positive impact on bank profitability. This is so because,
according to Vong and Hoi Si Chan (2008), the default risk is smaller in upturns than in
downturns. In addition to increasing demand for both interest-bearing and non-interest-bearing
activities, a stronger economy may also result in higher bank profits.
1.5 Significance of the Study
This study was expected to provide information on the factors affecting the profitability of
commercial bank of Ethiopia' and this will be help the management to focus on the problem
area and brainstorm for possible solution and provide detailed information for arrangement
to make a decision related profitability activities of the bank. Farther more it helps the
5
management to visualization and prepares the plan future activities in the area. In addition,
future researcher will use the output of this research as springboard and additional sources of
that want to do further study in this topic.
1.6 Scope of the Study
The research aimed to find variables that affect the profitability of commercial bank of
Ethiopian
examined utilizing multiple linear regulation analyses model based on findings of the research
to meet policy and implication The study examined secondary data, which included bank
reports and annual audit financial statements. The records used by the researchers covered a
32-year span, from 1990 to 2021. The scope of the analysis is limited factors influencing the
profitability of bank of commercial of Ethiopia. Focus to use only time serious data for analysis.
Moreover, this paper focuses only on commercial bank of Ethiopia.
1.7. Limitation of the Study
In the process of conducted this study, there are certain constraints which limit the scope of the
study. Some of these constraints are the following:
 Because of the restricted supply of data limited to data 1990 to 2021

 Shortage of time and finance the study limited to CBE
 Shortage of sufficient reference materials
1.8. Organization of the Paper
There are five chapters in the paper. The first chapter covers the introduction section, which
includes the study's history, the problem statement for the research question, the study's
objectives, importance, scope, and constraints. The review of related literature covered in the
second chapter. While the fourth chapter covered the data analysis and discussion, the third
chapter concentrated on the study methodology, data collecting and methods, sample, and
sampling strategies. Finally, in the fifth chapter, conclusions and suggestions are given.
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CHAPTER TWO
2. LITERATURE REVIEW
2.1 Theoretical Review
2.1.1 Concepts and Definitions
Profitability: In the literature on finance and accounting, profitability has received a lot of
attention. When the money generated by a company activity outweighs the costs, costs, and
taxes required to support the activity, a financial benefit is attained. Furthermore, profitability
is the final metric of a company's financial success in relation to the money put in it. The size
of the net profit accounting determines this economic performance (Pimentel et al., 2005).
Profitability, according to Akintola and Skitemore (1991), has measured as a percentage of

profit on turnover (POT) or returns on capital investment (ROI). After all expenses, including
debt interest payments, have been subtracted from sales revenue, profit represents the return to
stock investors. "Profit" is defined as the sum of the profits of all profitable businesses less the
losses of all unsuccessful businesses. Profitability is one of the most crucial financial
management goals because it is a key factor in determining performance and one of financial
management's main aims is to maximize owners' wealth, according to Hifza Malik (2011). A
company that is not profitable will not last. Therefore, a highly lucrative company can provide
its owners with a significant return on their investment. Therefore, a business entity's primary
objective is to create a profit in order to ensure the viability of the company under the current
market conditions. Commercial bank of Ethiopia are the highest profitability in Ethiopia that
profitability arise by giving banking service. Such as accepting deposits, making business
loans, and offering basic investment products that operated as business for profit.
Profitability Measurement: Profitability analysis categorizes, measures, and evaluates the

performance of the firm in terms of the profits it makes, whether in respect to the shareholders'
capital investment or business expenditures, or in relation to sales, profit, (or loss), or both.
The profit made by a company can be used to determine whether an investment was successful
because most business owners invest in order to profit. In a research by Basil and Taylor (2008),
the return on equity ratio (ROE) was also utilized as an index for business profitability.
According to John (2009), profitability ratios are a class of financial indicators that used to
evaluate a company's capacity to create profits in relation to its expenses and other pertinent
charges incurred during a specific period. Hamdan Ahmed Ali Al-Shami (2008), asserts that
7
there are various metrics for gauging profitability, including return on assets (ROA), return on
equity (ROE), and return on invested capital (ROIC). ROA is a measure of a company's
profitability in relation to its total assets. In contrast to ROE, which evaluates a firm's
profitability and displays how much profit a company earns with the money shareholders have
invested, it offers us a sense of how well management is utilizing its assets to generate earnings.
ROIC is a metric used to evaluate how effectively a corporation uses the funds under its control
to make lucrative investments. This metric reveals how effectively a business uses its resources
to produce returns. As a result, the researcher also employed ROA to assess the profitability of
the business.
Return on Asset (ROA): This ratio demonstrates how effectively a corporation uses its
available assets to produce profit. It determines the amount of profit a business is making as a
percentage of its assets (Weston and Brigham, 1977). The greater the performance, the higher
the ROA value, which may be calculated as follows:
ROA = (Earnings Available For Common Stockholders / Total Asset)*100 OR
ROA= Net Income\total asset of the bank
2.1.2 Factors affecting bank profitability
Theoretically factors affecting bank profitability are mainly divided into two categories
as internal and external variables. The internal (bank-specific factors) are factors that are
related to internal efficiencies and managerial decisions. As stated in the above section the
efficiency and portfolio theory highly assume as bank performance influenced by those
internal factors that related to internal efficiencies and managerial decisions. Such factors
include determinants such as income diversification (non-interest income) and operating
efficiency, asset size, deposit fund. Accordingly, out of the external factors (variables) that
can affect bank profitability are economic growth and inflation will be the main one.
Bank Size: Conflicting conclusions can be drawn from empirical research regarding the
connection between bank profitability and size. Although some research indicate a beneficial
relationship, others indicate a negative relationship or none at all. Examples of studies that
found a correlation between bank size and profitability include Demirguc-Kunt and Huizinga
(1999), Pasiouras and Kosmidou (2007), Bikker and Hu (2002), and Flamini et al. (2009). The
justification for this viewpoint is that lending rates will remain high while deposit rates will
decline because major banks control a larger portion of the domestic market and operate in a
8
monopolistic environment. Because large banks are safer than smaller banks, their rates are
lower, and as a result, larger banks may generate higher profits.
There is no empirical support for the claim that large commercial banks were more profitable
than medium and small-sized banks in any of the income groups, according to a study by
Dietrich and Wanzenrid (2014) on the factors determining commercial banking profitability in
low, middle, and high-income countries. While other studies (such as Berger et al., 1987;
Micco et al., 2007) have revealed a negative or no relationship between bank growth and
profitability, they contend that banks' profits do not rise enough to cover the increased expenses
of expansion. For instance, large banks in Africa often have high operational costs since there
is a substantial information asymmetry, there is little financial intermediation, and the financial
market is small. Thus, the upfront costs associated with product development, diversification,
and branch expansion may be too high (Shehzad et al., 2013; Ahokpossi, 2013; Berger et al.,
1987).
Cost recovery may also be affected by increased market imperfections and uncertainty. This is
the version of the work that has been approved for publication in the Academy of Management
Proceedings since the anticipated economies of scale might not materialize. According to a
study by the Academy of Management, profitability and bank size are negatively correlated.
Due to the inconsistent evidence in the literature, this study did not predict a relationship
between bank size and profitability.
Credit Risk: The ratio of loan loss provisions to all loans and advances is used to calculate it.
A measure of both capital risk and bank credit quality, loan loss provisions are recorded on a
bank's profit and loss statement. According to Vong and Hoi Si Chan (2008), banks will likely
have a larger loan-loss provision ratio if they operate in riskier conditions and do not have the
knowledge to manage their lending operations. On the other hand, research indicates that a rise
in credit risk exposure typically accompanied with a fall in company profitability. As a result,
Athanasoglou et al. (2005) stated that by strengthening credit risk screening and monitoring,
banks would boost profitability. Additionally, central banks generally establish a set of
requirements for the amount of loan-loss provisions that the nation's banking sector must adopt.
Given these guidelines, bank management should modify the portfolio of provisions kept for
loan losses, and credit risk is typically modeled as a fixed variable in studies. All of the
literature reviewed for this study, including works by T. Atemnkeng and N. Joseph (2000),
9
Athanasoglou et al. (2005), Kyriaki Kosmidou et al. (2006), Athanasoglou et al. (2006),
Uhomoibhi T. Aburime (2008), Vong and Hoi Si Chan (2008), Valentina Flamini et al. (2009),
Non-interest Income: The importance of fee-based services offered by banks and the
diversification of their product lines are properly reflected by the non-interest revenue to gross
income ratio. Even though they boost a bank's revenue, fee-based services sometimes result in
lesser profitability than interest on loans. The ratio is consequently expected to affect
profitability because when banks migrate from interest-earning services to non-interest-earning
ones, profitability may suffer. Vong and Hoi Si Chan (2008) found a negative link between the
profitability of Macao commercial banks and income from fee-based services.
Non-interest Expenses: The expense management variable, which is defined as the ratio of
non-interest expenses to total assets, provides data on changes in operational costs. The entire
cost of ownership of a bank, without interest costs, includes operating costs as well as other
expenses like taxes and depreciation. These just show the outcome of the bank management's
choice in operating expenses. Because greater expense management will result in higher
efficiency and, ultimately, larger profits, it is expected that the ratio of these operational
expenses to total assets, which incorporates expense management, will be negatively linked
with profitability. Vong and Hoi Si Chan (2008), Athanasoglou et al. (2005), A. Dietrich and
G. Wanzenried (2009), and all point to a negative Deposit Fund:
In order to provide loans and generate interest, commercial banks generally rely on the money
that their clients (the general public) deposit with them. Interest is the largest expense for the
banking sector because it is paid on a variety of deposits. Commercial banks accept a variety
of deposits, including current or demand deposits, fixed or time deposits (term deposits), and
saving deposits. The majority of countries do not pay interest on current or demand deposits;
instead, depositors have the freedom to write a cheque at any time to withdraw all or part of
their funds. Interest-bearing accounts known as Fixed, Time, and Term Deposits are held with
banks for set periods of time and incur higher interest charges for the bank.
On the other hand, saving a deposit is an individual deposit that can be withdrawn at any time.
There are some limitations on the quantity and frequency of withdrawals. Because withdrawals
might happen at any time, commercial banks are required to hold a specific proportion of their
assets in liquid form. When examining the impact of deposits on the profitability of commercial
banks, empirical evidence from Naceur and Goaied (2001) is mentioned by Uhomoibhi T.
Aburime (2008). The best performing banks are those that have maintained a high level of
10
deposit accounts relative to their assets. As the ratio of total deposits to total assets improves,
the amount of money the bank may use for lucrative operations like lending and investing
increases. As a result, in the current environment, this should increase the bank's returns on
assets. Additionally, because deposits are the primary and potentially the least expensive source
of capital for banks (Anna P. I. Vong and Hoi Si Chan 2008), they have a positive impact on
banking performance as long as there is a sufficient demand for loans in the market. However,
if there isn't enough demand for loans, more deposits may actually lower earnings because this
type of finance carries a cost of its own.. Despite conflicting findings from various studies,
Anna P. I. Vong and Hoi Si Chan (2008), Uhomoibhi T. Aburime (2008), and Saira Javaid et
al. (2011) found a correlation between bank profitability and operating expense levels that was
positive.
Loan and advance: Customer deposits are a bank's liability. For banks, it serves as their
principal source of finance. Since banks have larger deposits, they may offer their customers
more loan alternatives. It will then be able to turn a profit in the future. It is generally accepted
that, provided there is a sufficient market demand for loan opportunities, customer deposits
have a positive relationship with bank profitability. Lower levels of deposits have a detrimental
effect on the profitability of banks whereas higher levels of deposits can increase earnings.
Banks can obtain more loan opportunities because they have greater deposits. Therefore, the
bank may make more money. Therefore, the profitability of the bank is positively correlated
with consumer deposits. (Lee & Hsieh, 2013).
By dividing the whole loan amount by the total asset amount, this calculation determines the
source of income. Loans make up the majority of assets that carry interest. Deposits: The three
categories of deposits that commercial banks take are savings deposits, fixed deposits, and
demand deposits. Savings and fixed deposits are the only deposits that pay interest,
nevertheless. Furthermore, the most widely used indicator of bank liquidity is the ratio of loans
and advances to deposits. The ratio can also show the extent to which a bank engaged in credit
activities that carried a default risk.
2.1.3 External determinant

Economic Growth (Real GDP): It is often referred to as "constant-price," "inflation-
corrected," or "constant dollar" GDP. It estimates the value of all products and services
generated by an economy in a particular year (expressed in base-year prices). It is an inflation-
adjusted metric. Additionally, it measures services. These include what your bank, hairdresser,
11
and even humanitarian groups like Goodwill have to offer. Even when troops are moved
abroad, military services are also provided. It also assesses housing services provided to and
by persons who own and occupy their homes, such as housekeeping.
Real GDP growth is used to measure economic growth. According to a previous study, GDP
growth is projected to have a positive impact on bank profitability. This is so because,
according to Vong and Hoi Si Chan (2008), the default risk is smaller in upturns than in
downturns. In addition to increasing demand for both interest-bearing and non-interest-bearing
activities, a stronger economy may also result in higher bank profits.
One of the main metrics used to evaluate the state of an economy is GDP. GDP is the most
widely used macroeconomic statistic to gauge total economic activity inside an economy,
according to Fadzlan & Royfaizal (2008), and its growth rate represents the stage of the
business cycle. The stock market is typically significantly impacted by a major change in GDP,
whether it is up or down. It is simple to comprehend why a poor economy typically results in
lower company profits, which in turn results in lower stock values. Investors are concerned
about low GDP growth, which economists cite as one indicator of whether an economy is in a
recession (www.investopedia.com). There are also empirical shreds of evidence that found,
real GDP has a positive effect on the profitability of financial institutions, such as Cecila
(2014), Doreen (2013), and Doumpos et al., (2012).
Inflation Rate: Inflation is the rate of price growth over a predetermined period. Inflation is
sometimes quantified in generic terms, such as the general increase in prices or the increase in
the cost of living across a country. Inflation is calculated using the Consumer Price Index (CPI),
which is a weighted average of prices for different goods. The index is made up of a certain
selection of goods that are determined to be representative of a common consumption basket.
Therefore, depending on the country and the general consumption habits of the population, the
index will cover a number of commodities. Since some items may have a fall in price while
others may experience an increase, the overall value of the CPI will rely on the weight of each
commodity in relation to the full basket. Annual inflation is the percentage change in the CPI
from the same month the year prior.
The relationship between the inflation rate and bank profitability is not clearly demonstrated
by empirical evidence. For instance, studies by Dietrich and Wanzenried (2014), Ahokpossi
(2013), and Flamini et al. (2009) all find substantial positive connections between bank
profitability and inflation rate. The authors contend that banks in sub-Saharan Africa can
12
effectively forecast the projected rate of inflation and consequently modify their interest rates.
While Sufian and Habibullah (2009) found a negative correlation between inflation and NIM
in their research of the Bangladeshi banking sector, Goddard et al. (2011) revealed a negligible
correlation between inflation and the persistence of banks' profitability. They argued that this
might be the case because banks were unable to estimate expected inflation rates with sufficient
accuracy. Based on the aforementioned justifications and the contradictory evidence in the
literature, our study did not foresee a clear connection between the inflation rate and bank
profitability.
Additionally, the inflation rate (INFL) is a crucial macroeconomic factor that can have an
impact on banks' expenses and income. In this regard, after introducing the topic of the
connection between bank profitability and inflation, some authors claim that the impact of
inflation on bank profitability is dependent upon how it affects both salaries and other
operating costs of the bank. In this regard, Staikouras & Wood (2003) point out that inflation
may have both direct and indirect effects on banks' profitability, including an increase in the
cost of labor and changes to interest rates and asset values. According to Perry (1992), the
consequences of inflation on bank performance differ depending on whether the inflation was
predicted or not. The interest rates are changed as expected, which causes revenues to grow
faster than costs and, as a result, has a favorable effect on bank profitability.
INFLATION =ANNUAL INFLATION RATE
2.2 Empirical Literature Review
2.2.1. Empirical literature review from other countries.
Mwangi, Muturi, and Ombuki (2015) employed panel data regression estimation and
generalized methods moments (GMM estimation approach) with secondary data in their
analysis of the research. The secondary data was gathered using reports from the Kenya Central
Bank Supervision department for the years 2012 and 2013. The explanatory research approach
It was proposed that the ratio of deposits to assets has no bearing on the decision of
microfinance organizations to accept deposits. The results of the analysis with 95% confidence
excluded this null hypothesis. The deposit-to-asset ratio has a favorable and significant impact
on the MFIs' return on investment, with a coefficient of 0.362.In their 2008 analysis of Tunisian
banks, Naceur and Goaied employed balanced panel data to look at the variables influencing
bank performance between 1980 and 2000. Net interest margin and return on assets were
employed as dependent variables. The final findings demonstrate a favorable correlation
13
between banks with high capital levels and other banks, suggesting that well-capitalized
financial institutions save money on capital expenditures by minimizing the costs of
bankruptcy for both their clients and themselves. They also found that, while the size ratio is
considerable, it has a negative impact on net interest margins, whereas bank loans have a
positive and significant impact since rising stock market prices increase bank profitability. The
concentration ratio and the connection between the stock market and banks are expertly
explained by the author as having a detrimental and significant impact.
Anwar (2014) examined the elements that raise Islamic banks' profitability with a particular
emphasis on the Gulf African bank. The study used survey research, questionnaires to gather
data, and the Chi-square test to determine whether the study variables were associated with
each other. The research's conclusions showed a strong correlation between Islamic banking
products, Shariah compliance, client happiness, and the success of Islamic banks in Kenya. It
was determined that the main elements affecting the profitability of Islamic banks were Shariah
compliance, Islamic banking products, and client happiness.
The internal variables that affect bank profitability in Zimbabwe were studied by Chinoda
(2014). The study employed secondary data from the banks' financial reports and a sample of
five commercial banks that were chosen at random. Using the general linear regression model,
the study indicated that operating costs had a negative correlation with the profitability of
commercial banks in Zimbabwe, whereas the size of the bank, liquidity, GDP, and inflation
had positive correlations with ROA. The study suggested that in order to promote financial
intermediation, efforts to prevent inflation should be prioritized.
Using external (market) and internal metrics of profitability, Lipunga (2014) assessed the
factors that affected the listed banks' profitability in Malawi over a five-year period between
2009 and 2012. Earning Yield (EY) and return on assets (ROA) were used in the study's
multivariate regression and correlation analysis to identify the internal and external variables
of profitability. The findings of the regression analysis showed that, while capital adequacy
had a negligible effect on return on assets, the size of the bank, management effectiveness, and
liquidity did. Additionally, the study found that capital adequacy, managerial effectiveness,
and bank size all have a considerable impact on earnings yield, whereas liquidity has little
bearing on it.
14
Rono, Wachilonga, and Simiyu (2014) evaluated the impact of interest rate spread on quoted
banks' performance. The study used a descriptive methodology and secondary data from yearly
reports that were released between 2007 and 2012. The study discovered that commercial banks
use various interest rate spreads to pay their costs and make a profit using the Pearson product
moment correlation. In addition, the study discovered a negligible relationship between interest
rate spread and non-performing loan expenditure. However, there was a strong relationship
between interest rate spread and ROA and ROE.
For a three-year period between 2010 and 2012, Kyalo (2013) looked at the variables
affecting the profitability of banks in CBE. The study found that capital invested has a
considerable impact on ROE, whereas operational effectiveness, GDP, and inflation had little
bearing on ROE on equity. According to the study, Ethiopian commercial banks should
concentrate more on both bank-specific elements and the external environment when
developing strategies to improve their financial performance.
Sawe (2011) examined both internal and external factors that affect Kenyan commercial
banks' profitability. The study employed a panel data methodology. The study found that the
key variables affecting a bank's profitability were its capitalization ratios, size, liquidity,
expense control, inflation, market share, and loan loss provisions. The study also found that
the coefficients for interest rates, GDP per capita, market concentration, and currency rates
had the least impact on banks' profitability. In their study, Kosmidou and Pasiouras (2008)
looked at the impact of market structure, bank-specific characteristics, and macroeconomic
factors on bank profits in the United Kingdom from 1995 to 2002. The study's conclusions
showed that banks' capital strength had a favorable and significant impact on their
profitability. The study established that efficiency in expenses management and bank size
significantly affected the profitability of commercial banks.
2.2.2 Empirical studies in Ethiopia
Alemu (2015) looked at eight Ethiopian banks' profitability predictors between 2002 and 2013.
The study employed a fixed-effect regression model and multiple linear regressions to examine
the data. The study discovered a relationship between management effectiveness, staff
effectiveness, inflation, and the foreign exchange rate. A negative and statistically significant
association between profitability and operational effectiveness, liquidity risk, funding cost, and
banking sector development was also found in the study's findings. Finally yet importantly,
15
bank profitability and bank capital its adequacy levels have a significant and statistically
significant correlation with the gross domestic product.
The main objective of Birhanu's (2012) research was to ascertain if bank-specific and
macroeconomic factors might have an impact on the financial institutions in Ethiopia. In order
to compare the influence of internal and external factors from 2000 to 2011, the study used
the average return on asset and the net interest margin profitability proxy as proxies for
profitability. The result validates the prediction, with the exception of the bank's size, expense
management, and credit risk, which have a negative impact on the bank. All other bank
attributes, however, have a large and favorable impact on bank earnings.
The majority of the studies analyzed in this study evaluated macroeconomic, industry-specific,
and bank-specific parameters to determine a bank's profitability. Determinants of commercial
bank profitability: an empirical study on Ethiopian commercial banks by Demena (2011);
Determinants of commercial bank profitability: an empirical review of Ethiopian commercial
banks by Belayneh (2011); Factors Affecting Profitability: An Empirical Study on Ethiopian
Banking Industry by Amdemikael (2012); Determinants of commercial bank profitability: an
Empirical Study on Ethiopian Commercial Banks by Demena (2011); Determinants of
commercial bank profitability: an EmpiricalIn his research, Damena (2011) looked at the
factors that affect the profitability of commercial banks in Ethiopia. The study used balanced
panel data from seven commercial banks in Ethiopia from 2001 to 2010. The research
employed the Ordinary Least Square (OLS) technique to examine how several internal and
external variables affected the key profitability metric, or ROA. The estimation outcomes
demonstrated that, with the exception of saving deposits, all bank-specific characteristics
significantly impact commercial banks' profitability in Ethiopia. Another key determinant of
profitability was market concentration. The only macroeconomic factor that significantly
affects bank profitability is economic growth.
A studied by Belayneh (2011) on the factors influencing the profitability of commercial banks
in Ethiopia used balanced panel data from seven commercial banks in Ethiopia that spans the
years 2001 to 2010. The research employed the Ordinary Least Square (OLS) technique to
analyze the impact of several internal and external variables on significant profitability
indicators, including ROA, All bank-specific indicators, with the exception of saving deposits,
have a considerable impact on commercial banks' profitability in Ethiopia, according to the
study's estimation results. Market concentration is a significant determinant of profitability. The
16
only macroeconomic factor that significantly affects a bank's "profitability" is economic growth.
Amdemikael (2012)'s study looked at the factors that affect the profitability of commercial
banks in Ethiopia. The study used balanced panel data from eight commercial banks in
Ethiopia that spans the years 2001 through 2011. In-depth interviews and documentary
analysis are combined in the study's mixed methods research technique to examine the effects
of both internal and external variables on the study's primary profitability measure, ROA. The
study's conclusions demonstrate a statistically significant and favorable association between
the size of the bank, income diversification, and gross domestic product and the profitability
of the bank. On the other side, the profitability of a bank is negatively and statistically
significantly correlated with factors like operational effectiveness and asset quality. However,
the relationship for liquidity risk, concentration and inflation is found to be statistically
insignificant.
Birhanu (2012), investigated the factors that affect the profitability of commercial banks in
Ethiopia. The study used balanced panel data from eight commercial banks in Ethiopia that
spans the years 2001 through 2011. The impact of several internal and external variables on
profitability indicators, such as ROAA, was examined in the article using the Ordinary Least
Square (OLS) technique. The results indicate that, with the exception of bank size, expense
management, and credit risk, all bank-specific characteristics significantly and favorably affect
bank profitability in the expected manner.
However, factors like bank size, spending management, and credit risk have a negative and
considerable impact on the profitability of commercial banks. Additionally, there is no proof to
substantiate the existence of market concentration. Last but not least, GDP has a favorable and
considerable impact on the bank's asset return and interest margin. However, only the interest
margin is significantly and favorably impacted by interest rate policy. Habtamu (2012)
investigated the factors that affect the profitability of private commercial banks in Ethiopia.
The study used balanced panel data from seven commercial banks in Ethiopia from 2002 to
2011. The research examined the effects of several internal and external variables on
profitability indicators, such as ROA, ROE, and NIM, using the Ordinary Least Square
technique. The results indicate According to the empirical findings, macroeconomic factors
such as GDP level and regulation, as well as bank-specific characteristics such as income
diversification, management effectiveness, bank size, and efficiency, have a significant impact
on the profitability of private commercial banks in Ethiopia.
17
2.3 Summery of Literature and Knowledge Gap
The empirical literatures that have been discussed so far have demonstrated that both internal
and external factors affect a bank's profitability. However, the majority of the literatures that
have been studied so far seem to have concentrated on research done in the banking industry
of other nations except Ethiopia. Despite the fact that multiple investigations were carried out
by various researchers, a study of the available literature demonstrates the existence of
contentious findings.
Ethiopian commercial banks' profitability was evaluated in the studies by (Amdemikeal, 2012),
(Samuel, 2015), (Sori Tefera, 2014), and (Dawit Beleta, 2017) considering both internal and
external criteria. In light of this, this research attempts to focus on income diversification using
banks' efforts to increase non-interest income and expense management using non-interest
expenses to the study of determinants of profitability of banks in Ethiopia that has not been much
tested in comparison with other countries. Accordingly, as far as the researcher's knowledge goes,
all studies conducted in the Ethiopian banking sector have clearly failed to identify major
determinants of profitability. Additionally, the literature review's indication of the findings from
many researchers exposes the existence of conclusions from various studies that have been
conducted so far that are controversial in identifying major factors that determine banks
profitability. As a result, the goal of this study is to investigate the factors that affect the
profitability of Commercial Bank of Ethiopia by using an econometrics model to estimate
factors that affect the bank's profitability, which is proposed to fill a knowledge gap.
2.4 Conceptual Framework
The conceptual framework helps to identify the variables that are used in the research process
and shows how particular variables are connected in the study.
Different empirical evidences revealed that internal, industrial, and macroeconomic issues
affected the profitability of commercial banks. However, the focus of this study is both on
internal or bank-specific factors and on external factors that affect profitability in commercial
banks of Ethiopia. These factors include Bank Size, Credit Risk, Non-Interest Income, Non-
Interest Expense, Loan and advance and external variables used in this study includes Inflation
rate and Economic growth (GDP). As a measure of profitability of Commercial Bank of
Ethiopia Return on Asset (ROA) used as dependent variable.
18
As discussed above this conceptual framework depicts a relation that exists between study
variables. The study seeks to identify determinants of banks profitability by using time series
data from 1990-2021 from National Bank of Ethiopia. The research aimed to find out factors
that affect profitability of commercial bank of Ethiopia using multiple regression model (OLS)
based on findings of the research to meet policy and implication. As shown in figure below.
Figure 1: Theoretical model on determinants of profitability.
Independent Variables Dependent Variable Independent

Variables
Bank Size
Bank specific Determinants
Inflation
Macroeconomic
Credit Risk Profitabilit
Determinants
rate
y of
Non-Interest
Income commercia
l bank of Economic
Non-Interest Ethiopia growth
Expense (GDP)
(ROA)
Loan and
advance
Source: Developed based on pieces of literature
19
CHAPTER THREE
3. RESEARCH METHODOLOGY
3.1 Research Design
In order to determine the factors affecting the commercial bank of Ethiopia's profitability, the
study used both descriptive and explanatory research designs. The descriptive research design
was used to examine the factors that influence bank profitability. A descriptive sketch is used
because it is a graphing theory that is developed via the collection, evaluation, and presentation
of accumulated data. As a result, it made it possible for this lookup to convey information about
the how and why of future lookups. A descriptive diagram frequently guarantees a complete
understanding of the situation, guarantees that there can be no bias in the collection of
information, and guarantees that the information collection from a large target population is
economical (Tefera, 2014). Once as a result, a descriptive model will be able to identify the
factors influencing the profitability of commercial banks in Ethiopia and Explanatory research
is conducted to determine the scope and type of a cause-and-effect relationship, which can only
be verified if specific causal evidence is present (Kothari, 2004). Therefore, researchers utilize
this technique to describe, explain, and understand things, as well as to improve the purpose
and effect of variables and give themselves an additional opportunity to explore new things.
3.2. Population & Sampling Technique
The entire group of people or subjects with the same characteristics served as the study's
population, which was very important since it allowed the researcher to draw statistical
inferences or conclusions. The audited financial records of Commercial Bank of Ethiopia from
1990 to 2021 made up the study's population.
3.3. Data Source and Collection Method
The researcher used secondary sources to collect quantitative data. The bank's financial
statements and yearly audit reports served as secondary data sources. In the study, secondary
data sources were used. Information was acquired by the researchers from secondary sources.
The study examined secondary data, which included bank reports and annual audit financial
statements. The records used by the researchers covered a 32-year span, from 1990 to 2021.
20
3.4 Variable Measurement and Model Specification
Several important factors need to be considered in specifying an empirical model. These

include a choice of suitable dependent and explanatory variables, measurement of these
variables, and model specifications. To check the fitness of the model, the researchers
performed stationary test (Unit root test) of time serious data, Autocorrelation, normality test,
Heteroskedasticity test as well as multicolinearity test. According to the test results, the model
found to be suitable for the data under study. The software (E-views 10) outputs for these tests
put in the appendix part of the paper.
3.5. Data Analysis
In this study, quantitative data were examined utilizing multiple linear regression analyses and
descriptive statistical techniques. The illustrative statistics (mean maximum, minimum, and
standard deviation). Return on Asset (ROA) multiple linear regression models for bank
profitability metrics. To investigate the connection between Ethiopia's commercial bank's
profitability I introduce a explanatory variable that represents seven factors (Bank Size,
Inflation Rate, Loan and Advance, Non-Interest Income, Non-Interest Expense, Credit Risk,
and Economic Growth Rate) that affect a bank's profitability. As a result, the empirical model
estimated for this study is as follows.
ROA=α +β1(BSt) +β2 (INFt)+ β3LOAN + β4NII + β5NIE +β6CR +β7GDP +Ɛt
Where
ROA= Return on Asset= ROA= Net Income÷ Total Asset
BS=Bank Size Bank size is measured by logarithm of total assets (log A). Bank size accounts
indicates the existence of economies or diseconomies of scale (Naceur & Goaied, 2008).
INF=inflation (annual inflation rate)
Loans and Advances (LOAN): This measures the source of revenue by dividing the total
amount of loans by the total amount of assets. The majority of interest-bearing assets are loans.
Deposits: Savings deposits, fixed deposits, and demand deposits are the three types of deposits
that commercial banks accept. However, the only deposits that pay interest are savings and
fixed deposits.
21
Non-Interest Income (NII): The importance of fee-based services for commercial banks and
their product diversification is captured by non-interest income to total income ratio.
Non-Interest Expense (NIE): In addition to interest expenses paid for saving and fixed
deposits, commercial banks incur operating costs and depreciation expenses.
Credit Risk (CR): To proxy this variable the study used the loan-loss provisions to
total loans ratio.
Economic Growth (GDP): Measured by annual Growth rate of Real GDP
 α = constant
 β1 – β7= Coefficient of the Regression Equation
 ε= Error term
22
CHAPTER FOUR
4. RESULT AND DISCUSSIONS
4.1. Descriptive Statistics
The study uses return on asset (ROA) to measure profitability performance of commercial bank
of Ethiopia as depicted in table 4.1. The banks under review generated a ROA of 1.63 on
average, with a range of 0.47 to 2.06 and a standard deviation of 1%. With a wide standard
deviation of 0.58 (58%) from the mean and a profit range of -0.47 cents to 2.06 birr over the
study period, this shows that banks generate 2.07 birr for every birr invested in their asset. In
their study of banks in sub-Saharan African countries, Flamini et al. (2009) discovered a rate
of return on asset (ROA) of 2%, which was thought to be higher than the ROA of banks in
other parts of the world. We may therefore conclude that Ethiopian Commercial Bank was
successful enough to raise its rate of return on assets.
Table 4.1. Descriptive statistics for the dependent and explanatory variables
ROA BS INF LOAN NII NIE CR GDP

Mean 1.63104 2.46252 11.2759 4.51104 7.78766 7.70248 1.70311 6.78468
Median 1.82852 2.46892 9.02500 4.51341 7.72249 7.49289 1.46132 8.50500
Maximum 2.06994 2.62516 44.3600 4.60457 9.61249 10.2343 3.19345 13.5700
Minimum -0.47886 2.27892 -8.48000 4.40745 5.76832 5.72358 0.61484 -8.67000
Std. Dev. 0.58664 0.11577 11.5968 0.05130 1.14441 1.57455 0.82732 5.70975
Observations 31 32 32 24 32 32 24 31
Source; own computation using E-views 10, 2023
Bank size of CBE was proxy to their natural logarithm values (BS). The average value of
this variable was 2.463 birr during the study period with standard deviations of 0.116
birr. This shows that there was moderate discrepancy between banks in terms of total assets
when their natural logarithms values have taken. The minimum and maximum values
were 2.27892 and 2.62516 birr respectively.
The most widely used indicator of bank liquidity is the ratio of loans and advances to deposits.
The ratio can also show the extent to which a bank engaged in credit activities that carried a
default risk.
Since Loan advances measures, the source of revenue by dividing the total amount of loans by
the total amount of assets the average loan and advances to deposits for CBE was ratio of 4.51,
with lowest and highest values ratio of 4.40 and 4.60, respectively, according to the descriptive
23
statistics in Table 4.1. The standard deviation is 0.051, which shows that there is some minor
fluctuation in the liquidity position of the banks. This finding suggests that banks focus on
lending, which is a significantly riskier way to use depositor money than other methods. The
maximum figure also prompts a surprise about how banks participate in high-risk activities and
lend more than their whole amount of deposits.
Non-Interest Income for CBE has an average value of 7.78%, minimum and maximum values
of 5.76% and 9.61%, respectively, and a standard deviation of 1.14%, indicating a significant
degree of variance. Non-Interest Expenses have an average value of 7.70%, a maximum and
minimum value of 10.23% and 5.72%, and a significant standard deviation value of 1.57%
from the mean. According to Table 4.1's credit risk metrics, the average credit risk for CBE for
the past 32 years has been 1.70. With a standard deviation of 0.82, the greatest CR is 3.19 and
the minimum CR is 0.61. The standard deviations and the gap between the least and maximum
values (1%) and (53%), respectively, showed that the CR ratio was a highly variable. The
overall conclusion was that the buildup of credit risk, which previous research (Alemayhu,
1991; Zerayhu, 2005; Abraham, 2006; Teklebrhan, 2010) stated to be a serious issue for the
banking industry, had improved over time. Gethun (2012) and Melkamu (2012), who looked
at non-performing loans at the Commercial Bank of Ethiopia in recent years, said that they
showed a dramatic drop, as seen in figure 4.1 below.
Figure 4.1 ROA Vs Explanatory variables
ROA Vs Explanatory Variables

15
10
-5
-10
ROA BS LOAN NII NIE CR
24
In terms of macroeconomic indicators, the average real GDP growth rate is 6.78%, with
minimum and maximum values of -8.67% and 13.57%, respectively. This shows that economic
growth during the research period was very modest. Finally yet importantly, the average
inflation rate for the period was 11.27%, with minimum and maximum values of -8.48 and
44.36, respectively, and a huge standard deviation of 11.29%, which shows a great degree of
fluctuation in Ethiopia's inflation rate. (See figure 4.2 and table 4.1)
Figure 4.2 ROA Vs Macroeconomic variables
ROA Vs Macro economic variables

50
40
30
20
10
-10
-20
ROA INF GDP
4.2 Correlation Analyses between Study Variable
4.2.1 Correlation analysis between ROA and explanatory variables
The ROA measures a bank's ability to make a profit from its assets, and it is connected with
other explanatory variables that can be either positive or negative. As a result, multicollinearity
is not an issue in our study, which improved the reliability of the regression analysis. Table 4.2
demonstrates a positive association between return on assets and bank size, inflation, non-
interest income, and GDP. The profitability parameters of loan to advances, none interest
expense (NIE), and credit risk (CR) do not correlate favorably.
25
Table 4.2. Correlation matrix: ROA and explanatory variables
ROA 1.00000
BS 0.09152 1.00000
INF 0.52521 0.27813 1.00000
LOAN -0.38347 0.68952 -0.0933 1.00000
NII 0.22876 0.91082 0.35362 0.61666 1.00000
NIE -0.03536 0.95209 0.28775 0.69454 0.89048 1.00000
CR -0.52614 -0.5129 -0.3737 -0.02017 -0.5360 -0.4036 1.0000
GDP 0.59787 0.01097 0.20295 -0.35590 0.06861 -0.0749 -0.330 1.000
4.3. Econometric Analysis
4.3.1. Test for unit roots
The data set deployed for this study is a time series data. According to Harris (1995) when
dealing with time series data, it is important to test the stationary or non-stationary nature of
the data set for the reason that non-stationary variables might lead to spurious regression. Thus,
before checking the unit root the variables need to be checked whether they have trend graph
or not. The E-view 10 software gives the following trend result.
Figure 4.3 Trends of variable at level
12
10
-2
90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 20
BS CR GDP
INF LOAN NIE
NII ROA

Above, figure 4.3 showed that the variables ROA, BS, INF, LOAN, NII, NIE, CR and GDP
exhibit trending which is prone to noise or other rapid phenomena resulting in unstable
behavior. Therefore, once the graph is trending, we need to check the existence of unit root for
all variables. A unit root is a feature of some stochastic processes that can cause problems in
26
statistical inference involving time series models. Unit-root processes have a permanent impact
on the mean i.e. no convergence over time (Harris 1995).
To test the stationary nature of the variables, the Augmented Dickey-Fuller (ADF), the
modified version of the Dickey-Fuller, test is used. According to Dickey and Fuller (1984) the
ADF test, null hypothesis is that, the variable assumed to have/contain a unit root. The time
series nature of the data tested against the alternative, where a stationary process generates the
variable. Hence, the result showed that all variables which are ROA, BS, INF, LOAN, NII,
NIE, CR and GDP, have p-value 0.9938, 0.5136, 0.0645, 0.7317, 0.4855, 0.7676, 0.9918 and
0.9999 (see table 4.3) respectively above 5% level of significance indicating existence of unit
root in all explanatory variables.
Having checked the existence of unit root, therefore, we needed to take the first differencing
as a corrective measure for the above problems associated with the variables. Hence, the unit
roots are removed leading to rejection of the null hypothesis (below 5% significance level) for
all variables in the model. Finally, all variables become stationary I (1) the graph smoothed as
shown in figure 4.4 below.
Evident from table (4.3) below shows order one of integration among the time series. The ADF
regression results suggest that, the variables ROA, BS, INF, LOAN, NII, NIE, CR and GDP
are I(1) and no more higher order has been confirmed, we employ multiple regression analysis
(OLS) for analysis’s of relation between dependent variable and explanatory variable.
Figure 4.4 Trends of variable at first difference l

4
-1
-2
-3
-4
90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 20
D(ROA) D(BS) D(INF)

D(LOAN) D(NII) D(NIE)
D(CR) D(GDP)
27
Table 4.3: Unit root test summery

At Level At First Difference
Variables T-values Probabilities Variables T-values Probabilities Decision
LNROA 0.914266 0.9938 D(LNUN) -7.244644 0.0000 I(1)
LNBS -1.512780 0.5136 D(LNBS) -9.590846 0.0000 I(1)
LNLOAN -1.010662 0.7317 D(LNLOAN) -4.567705 0.0017 I(1)
LNCR -1.559697 0.4855 D(LNCR) -5.794103 0.0001 I(1)
LNII -0.920529 0.7676 D(LNINF) -9.339470 0.0000 I(1)
LNNIE 0.772974 0.9918 D(LNNIE) -10.44782 0.0000 I(1)
LNINF -2.578561 0.0645 D(LNINF) -4.006610 0.0074 I(1)
LNRGDP 3.131621 0.9999 D(LNRGDP) -6.061479 0.0001 I(1)
4.3.2-Tests for the Classical Linear Regression Models (CLRM) assumptions
As stated in the chapter, five diagnostic tests were carried out in this study to ensure that the data
met the requirements of the ordinary least square regression model. The results of the model
misspecification test presented below:
Test for Heteroscedasticity
The chi-square is 5.11 and the p-value is 0.64, both of which are beyond the 5% level of
significance, according to the E-view 10 results' test for the presence of heteroskedasticity (see
table 4.4). Since heteroskedasticity was assumed to be absent, we decided against rejecting the
null hypothesis. As a result, it is clear that the CLRM's homoscedasticity assumption has not
been broken, leading to the production of precise and efficient estimators.
Table 4.4 Heteroscedasticity Test: Breusch-Pagan-Godfrey
Heteroskedasticity Test: Breusch-Pagan-Godfrey
F-statistic 0.588561 Prob. F(7,12) 0.7538

Obs*R-squared 5.111594 Prob. Chi-Square(7) 0.6463
Scaled explained SS 1.982533 Prob. Chi-Square(7) 0.9608
Source; own computation using E-views 10
Test of auto correlation

As shown in figure 4.3 Correlogram LM test below, which indicates that all regressors are
inside the boundary, the test for autocorrelation reveals that there is no autocorrelation in the
model. As a result, we were able to demonstrate that there is no model stability issue based on
28
the test results from autocorrelation.
Figure 4.5 Correlogram LM test
Source; own computation using E-views 10
Normality test: Bera-Jarque (BJ) test
According to the study's normality tests, which are depicted in figure 4.4, the Bera-Jarque
statistic's P-value of 0.62 indicated that the data were compatible with the assumption of a
normal distribution.
Figure; 4.6 Normality test: Bera-Jarque (BJ) test
7
Series: Residuals
6 Sample 2000 2021
Observations 18
5
Mean 0.075046
4 Median 0.084947
Maximum 0.541642
3 Minimum -0.307559
Std. Dev. 0.195080
2 Skewness 0.197502
Kurtosis 3.791811
1
Jarque-Bera 0.587245
0 Probability 0.745558
-0.4 -0.3 -0.2 -0.1 0.0 0.1 0.2 0.3 0.4 0.5 0.6
Serial correlation
However, tests for autocorrelation were carried out to determine whether the error terms are
auto-correlated. A p-value of 0.1898, which is significant at levels above 5%, was found in the
29
autocorrelation test findings (see table 4.6). As a result, the null hypothesis, which assumed
there was no problem with serial correlation, was not rejected.
Table: 4.5 Serial correlation

Breusch-Godfrey Serial Correlation LM Test:

Model stability
Finally, we tested the model's stability and normalcy using the Histogram and CUSUM tests,
respectively. Figure 6 below illustrates the results of the CUSUM test, which show that even
though the model sits between the boundary lines, we may still use it because it is stable.
Additionally, as demonstrated in figure 4.6 below, the residuals pass the model's normality test
using the histogram. As a result, after our model successfully passed all necessary tests, we are
happy to use the OLS model findings.
Figure 4.7: CUSUM test of model stability
12
-4
-8
-12
09 10 11 12 13 14 15 16 17 18 19 20 21
CUSUM 5% Significance

4.4. Regression Analyses (OLS) Model
The estimation results of the ordinary least square model used in this experiment are shown in
table 4.6 below. The R-square Statics of the model is 82.15%, and its corrected R-square Statics
was 72.41%. The R-squared calculation shows that the change in the independent variable
explains 72.41 % of the change in the dependent variable that result from the interaction
30
between the size of the bank, the rate of inflation, loans and advances, non-interest revenue,
non-interest expenses, credit risk, and the rate of real economic growth. The independent
variables (bank size, inflation rate, loan and advance, non-interest income, non-interest
expense, credit risk, and economic growth rate) explain 82.15% of changes in the dependent
variable, ROA, according to the adjusted R-squared analysis; however, those same independent
variable changes also account for 72.41% of changes in the dependent variable. Although the
remaining 17.85% and 25.59% of the change are explained by other variables that are not part
of this study model.
The independent variables bank size (BS), non-interest income (NII), credit risk (CR), and
economic growth rate (GDP) had a positive connection with profitability, with their respective
coefficients being 10.00, 0.33, 0.15, and 0.38, respectively. This demonstrated a direct
correlation between return on asset (ROA) and each of the independent variables previously
discussed. According to the regression results shown in the above regression table, all of the
repressors included in this study are generally significant.
Table: 4.6 OLS model estimation result for Dependent variable D(ROA)
Variable Coefficient Std. Error t-Statistic Prob.
D(BS) 10.00067 1.842675 5.427257 0.0001

D(INF) -0.143513 0.034092 -4.209537 0.0010
D(LOAN) -4.703249 0.766586 -6.135321 0.0000
D(NII) 0.332691 0.089673 3.710026 0.0026
D(NIE) -0.708869 0.104069 -6.811531 0.0000
D(CR) 0.148133 0.069896 2.119330 0.0539
D(GDP) 0.381001 0.190968 1.995102 0.0674
R-squared 0.821523 Mean dependent var 0.107601
Adjusted R-squared 0.724172 S.D. dependent var 0.496628
S.E. of regression 0.260826 Akaike info criterion 0.435375
Sum squared resid 0.748332 Schwarz criterion 0.781630
Log likelihood 3.081629 Hannan-Quinn criter. 0.483119
Durbin-Watson stat 1.419571
The OLS model equations formulated looks like the following.

ROA=α +10.00*BSt - 0.14*INFt - 4.70*LOAN + 0.33*NII -0.71*NIE +0.15*CR +0.38 *GDP +Ɛt
Other factors including inflation, loans and advances to total assets, and non-interest expenses
exhibited a negative link with profitability because their respective coefficients were 0.14, -
31
4.70, and -0.71, respectively. This demonstrated that return on asset (ROA) and all of the
independent factors described above have a symbiotic relationship.
Bank Size (BS)
As shown by the regression results, the profitability of Ethiopia's commercial bank is

statistically significantly effected by bank size. The natural log of net income to total assets, a
metric of bank size, has a favorable effect on CBE's profitability. Additionally, the variable has
statistical significance of 1% (p=0.0001) additionally, the positive correlation between asset
size and profitability made it evident that for every 1% increase in asset size, CBE's profitability
increased by 10.00. This suggests that a bank with a large size has an advantage over smaller
businesses in terms of economies of scale, which results in efficiency. Because of the
crowding-in effect, a large bank would typically draw more customers, improving overall
performance (Roman & Sargu, 2015). The findings of Khanal (2019), Assfaw (2019), Sopan
and Dutta (2018), Teshome (2017), Zaghdoudi and Hakimi (2017), Singh and Sharma (2016),
Deléchat et al. (2012), and P. Vodová (2013), who discovered that bank size has a significant
positive effect on banks' profitability, are consistent with the prior expectation and this result.
Inflation (INF)
Profitability and inflation have a negative association that is statistically significant at the 1%
level. A negative correlation between inflation and bank profitability would imply that
commercial banks in Ethiopia were either unable to anticipate or mispredicted the effect of
inflation on their operating costs to boost profits throughout the study period. The findings of
(Athanasoglou et al., 2008) and prior studies (Kussa 2013; Ally et al.; Tariq et al.; and
Amdemichael 2012) are found to be consistent with this negative relationship with
profitability. This could be as a result of a lower real interest rate that is obviously lower than
the real inflationary rate as a result of unexpected inflation, which caused costs to rise more
quickly than income. The regression result of this study provides us a positive and significant
value at 5%, with a coefficient of -0.14 and probability value of 0.001 and indicated that
commercial bank of Ethiopia a 1% raise in as inflation the CBE profitability decrease by 0.14
unit.
Loans and Advances to Total Asset (LOAN)
The ratio of loans and advances to total assets, which is the sum of all loans. The output of the
model demonstrated that the profitability of banks in Ethiopia is adversely and statistically
32
significantly affected by LOAN, which assesses the capacity to pay current commitments using
current assets. The outcome demonstrates that greater liquidity causes less profitability. The
outcome is consistent with the hypothesis and Berhe and Kaur's (2017) findings, which found
that profitability is inversely correlated with liquidity. But in contrast to the conclusions of
Suheyli (2015), Abate and Yuvaraj (2013), John et al. (2013), and Agnes (2012), they
suggested that the more resources that are tied up to meet the liquidity position, the worse off
society will be.
The natural log of the total number of loans is used to compute the ratio of loans and advances
to total assets. The model's output, which evaluates the ability to meet current obligations using
current assets, showed that the profitability of banks in Ethiopia is negatively and statistically
significantly effected by LOAN. The result shows that worse profitability results from more
liquidity. The result is in line with the theory and Berhe and Kaur's (2017) findings, which
showed that profitability and liquidity have an inverse relationship. But in contrast to the
conclusions of Suheyli (2015), Abate and Yuvaraj (2013), John et al. (2013), and Agnes (2012),
they stated that the more resources that are tied up to satisfy the liquidity situation, the higher
is the profitability.
Credit Risk (CR)
Surprisingly, a proxy data of loan loss provisions ratio, which is a forward-looking measure of
credit risk, is found to have a considerable positive effect on profitability evaluated by ROA in
the study for evaluation of credit risk. At a p- value 0.053, the CR coefficient of 0.15 is
significant. This may imply that the Commercial Bank of Ethiopia's loan operation is riskier
than managers believe, even though it has the potential to be highly profitable. Despite such
expectations, the sharp decline in NPL (Getahun, 2012; Melkamu, 2012) may also indicate that
the managers understood the risk associated with the lending business and strengthened their
ability to manage credit risk on top of allowing high loan loss provisions for loans and
advances.
Non- Interest Income (NII)
Non-Interest Income, which assesses a bank's capacity for income diversification, was found
to have a positive and statistically significant relationship with CBE profit in the study. At a
5% level of significance, the NII coefficient of 0.33 is significant. According to the portfolio
theory, which asserts that banks can lower firm-specific risk by diversifying their portfolios,
33
the concept of revenue diversifications follows. Additionally, the reduction in interest margins
over the past ten years has altered the conventional function of banks and compelled them to
look for alternative revenue streams. Sufian & Chong (2008) discovered a positive correlation
between bank profitability and the ratio of total non-interest income to total assets, a proxy for
revenue diversification, using annual bank level data from all commercial banks in the
Philippines. The ratio of non-interest income to total assets is incorporated in the regression
analysis as a stand-in for income diversification in the current study as a result of the work by
Sufian and Chong (2008). According to balanced portfolio theory, the variable is anticipated
to show a positive association with bank profitability.
Non-Interest Expense (NIE):
Commercial banks in Ethiopia also pay operating costs and depreciation costs in addition to
interest payments for savings and fixed deposits. The OLS estimate's findings revealed a
negative and substantial relationship between non-interest expense and CBE profit. At the 1%
level of significance, the NIE coefficient of 0.71 is significant. The finding is in line with the
findings of (Ayele.2012) and (Selamait, 2016) which predict there is a negative relationship
between operating expense and CBE profitability and that Noninterest expense does
significantly influence profitability of the bank. The negative relationship between noninterest
expense and profitability in Commercial Bank of Ethiopian indicates that reducing operating
expense will result in higher profitability for the bank.
Real GDP growth rate (GDP)
Finally, the real GDP growth rate was discovered to have a favorable and statistically
significant effect on the success of Ethiopian commercial banks. At a p value of 0.06, CR has
a significant positive coefficient of 0.38. This finding is consistent with theory and empirical
data suggesting that there may be a pro-cyclical relationship between the real GDP growth rate
and bank profitability. This would imply that when the GDP growth rate is good, it has a
positive effect on bank profitability and when it is negative, it has a negative effect. This study's
key finding is that Ethiopia's economy has grown favorably in recent years, which may have
had a good effect on the country's banks' profitability. This finding supported by researches of
(Athanasoglou and Staikouras, 2006; Demirguc-Kunt and Huizinga, 1999, Flamini, et al 2009;
Naceur, 2003).
34
CHAPTER FIVE
5. SUMMARY, CONCLUSION AND RECOMMANDATION
5.1. Summary and Conclusion
This study's primary goal is to identify the variables influencing CBE profitability. Determine
and assess the effects of internal and external factors were specific goals. Multiple linear
regressions were used to assess time-series data for CBE from 1990 to 2021. Secondary data
was analyzed in this study to better understand the key determinants of CBE profitability. In
this data analysis, the profitability measure of ROA was calculated using OLS regression
techniques based on the financial statements of CBE.
The study discovered that the main determinants of the profitability of Ethiopia's commercial
bank are both internal and external factors. The independent variables that have a positive
association with profitability, such as bank size (BS), non-interest income (NII), credit risk
(CR), and economic growth rate (GDP), have a considerable and immediate effect on CBE.
The profitability of the banks was significantly and adversely effected by factors including
inflation, loans and advances to total assets, and non-interest expenses. As a result, the effect
this element has on the banks' overall financial performance should worry the banks.
5.2 Recommendation
It is crucial to determine the factors that most affect the total profitability of the commercial bank
of Ethiopia in order to withstand risky surprises and maintain financial stability. In light of the
study's findings, the researcher would like to make the following recommendations.
 Because there is a strong correlation and a large effect on banks' profitability,
management bodies of CBE should continue to enhance bank size, diversify noninterest
income, and improve credit risk management system. The study offers advice for
managers to concentrate on effectively managing the level of non-interest expenses by
resource allocation and utilization, including human resource and technological
improvements and other duplication of capital costs in banking since improved
management of these expenses could increase the profitability as well as the
performance of the commercial bank of Ethiopia.
35
 The Commercial Bank of Ethiopia should also work to increase capacity to pay current
commitments using current assets reduce noninterest expenses (huge capital
investment), which assesses the capacity to pay current commitments using current
assets. The outcome demonstrates that greater liquidity causes less profitability. The
outcome is consistent with the hypothesis and Berhe and Kaur's (2017) findings, which
found that profitability is inversely correlated with liquidity. But in contrast to the
conclusions of Suheyli (2015), Abate and Yuvaraj (2013), John et al. (2013), and Agnes
(2012), they suggested that the more resources that are tied up to meet the liquidity
position, the worse off society will be.
 Which have a substantial negative effect on the profitability of the banks, and loans
and advances to total assets. This might stand up to operational and unusual losses.
This might safeguard depositors, support financial system stability and efficiency, and
increase profits.
 The study makes recommendations for management to concentrate on the size of the
bank. A larger bank may be able to gain from greater management, superior
capabilities in product creation, marketing, commercialization, financial scope,
specialization, stronger negotiating power, stronger competitive power, and a larger
market share.
 The ability of internal variables to explain variation in ROA for commercial banks in
Ethiopia is significantly more significant than the ability of external variables.
However, among the external variables examined in this study, the rate of economic
growth and inflation stand out as significant key drivers of CBE profitability. This is a
loud warning to CBE that while formulating a plan to increase profits or performance,
they cannot overlook the external indications. Therefore, when designing strategies to
increase their performance or profits, Commercial Bank of Ethiopia should not just
think about internal structures and policies; they also need to take the external
environment into account. The study sought to investigate the effect of factor
effect on the profitability of commercial bank of Ethiopian. For future researcher
they should increase the number of observations.
 Future research could cover cross-countries to capture country differences and to
uncover differences from financial system and regulation factors, as well as increase
the number of observations by expanding the period with unbalanced data and
increasing the sample size for a more thorough investigation.
36
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40
7. ANNEXES
Annex I: Test for Unit root Result
A) Return on Asset (ROA)

 At level
Null Hypothesis: ROA has a unit root
Exogenous: Constant
Lag Length: 3 (Automatic - based on SIC, maxlag=7)
t-Statistic Prob.*
Augmented Dickey-Fuller test statistic 0.914266 0.9938

Test critical values: 1% level -3.752946
5% level -2.998064
10% level -2.638752
*MacKinnon (1996) one-sided p-values.
Augmented Dickey-Fuller Test Equation

Dependent Variable: D(ROA)
Method: Least Squares
Date: 06/03/23 Time: 13:54
Sample (adjusted): 1994 2021
Included observations: 23 after adjustments
ROA(-1) 0.179902 0.196772 0.914266 0.3727

D(ROA(-1)) -1.030591 0.264290 -3.899465 0.0011
D(ROA(-2)) -0.406638 0.301204 -1.350044 0.1937
D(ROA(-3)) -0.650797 0.235919 -2.758557 0.0129
C -0.421217 0.309839 -1.359473 0.1908
R-squared 0.801833 Mean dependent var -0.118203

Log likelihood -15.67034 Hannan-Quinn criter. 1.859502
F-statistic 18.20817 Durbin-Watson stat 1.807165
Prob(F-statistic) 0.000004
 At first difference
Null Hypothesis: D(ROA) has a unit root

Exogenous: Constant
t-Statistic Prob.*
Augmented Dickey-Fuller test statistic -7.244644 0.0000

5% level -3.012363
10% level -2.646119
i
Dependent Variable: D(ROA,2)
Date: 06/03/23 Time: 13:55
D(ROA(-1),2) -4.265362 0.588761 -7.244644 0.0000

D(ROA(-1),3) 1.886888 0.455310 4.144187 0.0007
D(ROA(-2),3) 0.858601 0.202411 4.241864 0.0005
C -0.065029 0.131453 -0.494690 0.6272

B) Bank Size
 At level
Null Hypothesis: BS has a unit root

Exogenous: Constant
t-Statistic Prob.*

5% level -2.963972
10% level -2.621007

Dependent Variable: D(BS)
Date: 06/03/23 Time: 13:53
BS(-1) -0.057915 0.038284 -1.512780 0.1420

D(BS(-1)) -0.511265 0.155404 -3.289917 0.0028
C 0.165161 0.090982 1.815311 0.0806

S.E. of regression 0.029684 Akaike info criterion -4.101792
Sum squared resid 0.023790 Schwarz criterion -3.961673
Log likelihood 64.52689 Hannan-Quinn criter. -4.056967
ii
 At first difference
Null Hypothesis: D(BS) has a unit root

Exogenous: Constant
t-Statistic Prob.*

5% level -2.963972
10% level -2.621007

Dependent Variable: D(BS,2)
Date: 06/03/23 Time: 13:54
D(BS(-1)) -1.522591 0.158755 -9.590846 0.0000

C 0.027833 0.006218 4.475853 0.0001

C) Loan and Advances (LOAN

 At level
Null Hypothesis: LOAN has a unit root

Exogenous: Constant
t-Statistic Prob.*

5% level -2.998064
10% level -2.638752
iii
Dependent Variable: D(LOAN)
Date: 06/03/23 Time: 14:00
LOAN(-1) -0.139527 0.138055 -1.010662 0.3237

C 0.634983 0.622814 1.019539 0.3195

 At 1st difference
Null Hypothesis: D(LOAN) has a unit root

Exogenous: Constant
t-Statistic Prob.*

5% level -3.004861
10% level -2.642242

Dependent Variable: D(LOAN,2)
Date: 06/03/23 Time: 14:01
D(LOAN(-1)) -0.983224 0.215256 -4.567705 0.0002

C 0.003751 0.006655 0.563562 0.5793

iv
D) Credit Risk (CR)
 At level
Null Hypothesis: CR has a unit root
Exogenous: Constant
t-Statistic Prob.*

5% level -3.004861
10% level -2.642242

Dependent Variable: D(CR)
Date: 06/03/23 Time: 14:06
CR(-1) -0.099645 0.063887 -1.559697 0.1353

D(CR(-1)) 0.538133 0.185809 2.896167 0.0093
C 0.161372 0.135890 1.187513 0.2497

Null Hypothesis: D(CR,1) has a unit root

Exogenous: Constant
t-Statistic Prob.*

5% level -3.012363
10% level -2.646119

Dependent Variable: D(CR,2)
Date: 06/03/23 Time: 14:07
v
D(CR(-1) -1.276489 0.220308 -5.794103 0.0000

C -0.002767 0.069589 -0.039762 0.9687

E) Non Interest Income (NII)
 At level
Null Hypothesis: NII has a unit root

Exogenous: Constant
t-Statistic Prob.*

5% level -2.963972
10% level -2.621007

Dependent Variable: D(NII)
Date: 06/03/23 Time: 14:02
NII(-1) -0.051896 0.056376 -0.920529 0.3654

D(NII(-1)) -0.468557 0.162840 -2.877409 0.0077
C 0.632218 0.389357 1.623749 0.1160

vi
Null Hypothesis: D(NII) has a unit root
Exogenous: Constant
t-Statistic Prob.*

5% level -2.963972
10% level -2.621007

Dependent Variable: D(NII,2)
Date: 06/03/23 Time: 14:02
D(NII(-1)) -1.494247 0.159993 -9.339470 0.0000

C 0.282931 0.087073 3.249361 0.0030

F) Non Interest expense (NIE)
 At Level

Null Hypothesis: NIE has a unit root
Exogenous: Constant
t-Statistic Prob.*

5% level -2.963972
10% level -2.621007

Dependent Variable: D(NIE)
Date: 06/03/23 Time: 14:02
vii
NIE(-1) 0.041146 0.053230 0.772974 0.4463

D(NIE(-1)) -0.627085 0.160667 -3.903015 0.0006
C 0.030872 0.363505 0.084928 0.9329

At 1st difference
Null Hypothesis: D(NIE) has a unit root

Exogenous: Constant
t-Statistic Prob.*

5% level -2.963972
10% level -2.621007

Dependent Variable: D(NIE,2)
Date: 06/03/23 Time: 14:03
D(NIE(-1)) -1.589852 0.152171 -10.44782 0.0000

C 0.303766 0.085953 3.534086 0.0014

viii
G) Inflation
 At level
Null Hypothesis: INF has a unit root

Exogenous: Constant
t-Statistic Prob.*

5% level -3.144920
10% level -2.713751

Warning: Probabilities and critical values calculated for 20 observations
and may not be accurate for a sample size of 12

Dependent Variable: D(INF)
Date: 06/03/23 Time: 14:03
INF(-1) -1.967944 0.549926 -3.578561 0.0373

D(INF(-1)) 1.625182 0.481044 3.378447 0.0431
D(INF(-2)) 0.943184 0.420892 2.240919 0.1109
D(INF(-3)) 1.252189 0.335936 3.727464 0.0336
D(INF(-4)) 0.949869 0.313291 3.031901 0.0562
D(INF(-5)) 0.626033 0.213347 2.934347 0.0608
D(INF(-6)) 0.488457 0.186817 2.614626 0.0794
D(INF(-7)) 0.125198 0.112532 1.112553 0.3470
C 5.025672 1.381393 3.638120 0.0358

Log likelihood 5.706767 Hannan-Quinn criter. 0.414225
Null Hypothesis: D(INF) has a unit root

Exogenous: Constant
t-Statistic Prob.*

ix
5% level -3.040391
10% level -2.660551


Dependent Variable: D(INF,2)
Date: 06/03/23 Time: 14:03
D(INF(-1)) -1.735240 0.433094 -4.006610 0.0013

D(INF(-1),2) 0.476728 0.303202 1.572309 0.1382
D(INF(-2),2) 0.026108 0.151611 0.172202 0.8657
C 0.085301 0.153070 0.557264 0.5861

H) GDP
 At level
Null Hypothesis: GDP has a unit root

Exogenous: Constant
t-Statistic Prob.*

5% level -3.144920
10% level -2.713751


Dependent Variable: D(GDP)
Date: 06/03/23 Time: 14:05
x
GDP(-1) 2.266737 0.723822 3.131621 0.0259
D(GDP(-1)) -3.262678 0.861663 -3.786490 0.0128
D(GDP(-2)) -2.780795 0.894888 -3.107423 0.0266
D(GDP(-3)) -2.120521 0.836887 -2.533821 0.0523
D(GDP(-4)) -1.120024 0.583373 -1.919913 0.1129
D(GDP(-5)) -0.646722 0.363989 -1.776764 0.1358
C -5.422343 1.709494 -3.171899 0.0248

Null Hypothesis: D(GDP) has a unit root
Exogenous: Constant
t-Statistic Prob.*

5% level -3.012363
10% level -2.646119

Dependent Variable: D(GDP,2)
Date: 06/03/23 Time: 14:05
D(GDP(-1)) -1.605824 0.264923 -6.061479 0.0000

C -0.113535 0.110376 -1.028615 0.3166

xi
Annex II: OLS Estimate
Dependent Variable: ROA

Date: 04/13/23 Time: 14:11
BS 10.00067 1.842675 5.427257 0.0001

INF -0.143513 0.034092 -4.209537 0.0010
LOAN -4.703249 0.766586 -6.135321 0.0000
NII 0.332691 0.089673 3.710026 0.0026
NIE -0.708869 0.104069 -6.811531 0.0000
CR 0.148133 0.069896 2.119330 0.0539
GDP 0.381001 0.190968 1.995102 0.0674

Annex III: Normality test Estimate

7
Series: Residuals
6 Sample 2000 2021
Observations 18
5
Mean 0.075046
4 Median 0.084947
Maximum 0.541642
3 Minimum -0.307559
Std. Dev. 0.195080
2 Skewness 0.197502
Kurtosis 3.791811
1
Jarque-Bera 0.587245
0 Probability 0.745558
-0.4 -0.3 -0.2 -0.1 0.0 0.1 0.2 0.3 0.4 0.5 0.6
xii
Annex IV: Serial Correlation test Estimate
Breusch-Godfrey Serial Correlation LM Test:

Test Equation:
Dependent Variable: RESID
Date: 04/13/23 Time: 14:18
Sample: 1999 2021
Included observations: 20
Presample and interior missing value lagged residuals set to zero.
BS 0.519169 1.856822 0.279601 0.7850

INF -0.004812 0.034661 -0.138829 0.8921
LOAN -0.195406 0.772312 -0.253014 0.8049
NII 0.029493 0.085325 0.345655 0.7361
NIE -0.057840 0.106819 -0.541478 0.5990
CR -0.008880 0.067052 -0.132437 0.8970
GDP -0.079617 0.187351 -0.424962 0.6791
RESID(-1) -0.548722 0.327106 -1.677504 0.1216
RESID(-2) -0.462378 0.347798 -1.329444 0.2106

Adjusted R-squared -0.276803 S.D. dependent var 0.130014
Annex V: Heteroskedasticity Test Estimate

Heteroskedasticity Test: Breusch-Pagan-Godfrey

Scaled explained SS 1.982533 Prob. Chi-Square(7) 0.9608
Test Equation:
Dependent Variable: RESID^2
Date: 04/13/23 Time: 14:19
Sample: 1999 2021
C -1.459445 1.062630 -1.373427 0.1947

BS 0.279706 0.309157 0.904737 0.3834
INF 0.002379 0.005308 0.448265 0.6619
LOAN 0.245386 0.224350 1.093766 0.2955
NII -0.009955 0.014016 -0.710284 0.4911
NIE -0.025597 0.019951 -1.282969 0.2237
CR -0.007140 0.010778 -0.662498 0.5202
GDP -0.015156 0.029907 -0.506790 0.6215
xiii
Adjusted R-squared -0.178666 S.D. dependent var 0.022324
Annex VI: CUSUM Test Estimate

12
-4
-8
-12
09 10 11 12 13 14 15 16 17 18 19 20 21
CUSUM 5% Significance
Annex VII: Variance Inflation Factors Test Estimate

Variance Inflation Factors
Date: 04/13/23 Time: 14:20
Sample: 1990 2021
Coefficient Uncentered
Variable Variance VIF
BS 3.395450 16703.37
D(INF) 0.001162 1.039085
LOAN 0.587654 9681.987
NII 0.008041 402.9000
NIE 0.010830 540.8132
CR 0.004885 14.04346
GDP 0.036469 145.7974
xiv
Annex VIII: Estimation Equation Test Estimate
Estimation Command:
=========================
LS ROA BS INF LOAN NII NIE CR GDP
Estimation Equation:
=========================
ROA = C(1)*BS + C(2)*D(INF) + C(3)*LOAN + C(4)*NII + C(5)*NIE + C(6)*CR + C(7)*GDP
Substituted Coefficients:
=========================
ROA = 10.0006690253*BS - 0.143512705384*D(INF) - 4.70324923969*LOAN + 0.332690883175*NII -
0.708869454006*NIE + 0.148132915637*CR + 0.381000993247*GDP
roa = 10.0006690253*bs - 0.143512705384*d(inf) - 4.70324923969*loan + 0.332690883175*nii -
0.708869454006*nie + 0.148132915637*cr + 0.381000993247*gdp
Annex IX: Estimation Correlation Test Estimate

Mean 1.631048 2.462523 11.27594 4.511045 7.787664 7.702482 1.703117 8.007083
Median 1.828582 2.468924 9.025000 4.513417 7.722497 7.492891 1.461325 9.115000
Maximum 2.069945 2.625161 44.36000 4.604570 9.612498 10.23433 3.193450 13.57000
Minimum -0.478866 2.278925 -8.480000 4.407451 5.768321 5.723585 0.614846 -3.460000
Std. Dev. 0.586640 0.115771 11.59683 0.051304 1.144416 1.574550 0.827326 4.306848
Skewness -2.460353 -0.069996 0.992364 -0.108109 -0.195151 0.281365 0.553987 -1.333045
Kurtosis 9.435953 1.578426 4.104832 2.458527 1.941093 1.603130 1.879287 4.214234
Jarque-Bera 54.69570 1.700393 6.879730 0.283286 1.061351 1.889925 2.069671 8.582400

Probability 0.000000 0.427331 0.032069 0.867931 0.588208 0.388694 0.355285 0.013688
Sum 32.62096 49.25045 360.8300 90.22089 155.7533 154.0496 34.06235 192.1700

Sum Sq. Dev. 6.538790 0.254657 4169.080 0.050011 24.88407 47.10494 13.00491 426.6257
Observations 31 32 32 24 32 32 24 31
xv

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ST.

FACTORS AFFECTING PROFITABILITY IN THE CASE OF

ADVISOR: SIMON TAREKE (ASST. PROFESSOR)

ADDIS ABABA, ETHIOPIA

THESIS SUBMITTED TO ST. MARY UNIVERSITY, SCHOOL OF GRADUATE

ADDIS ABABA. ETHIOPIA

SCHOOL OF GRADUATE STUDIES

FACTORS AFFECTING PROFITABILITY IN THE CASE OF COMMERCIAL BANK

APPROVED BY BOARD OF EXAMINERS

Dean, Graduate Studies Signature

External Examiner Signature

Internal Examiner Signature

I, the undersigned, declare that this thesis entitled “FACTORS AFFECTING

St. Mary’s University

SIMON TAREKE (ASS. PROFESSOR) Date

NIE Non –interest expense

Figure 2.1: Theoretical model on determinants of profitability. ...................................... 19

1.1 Background of the Study

Commercial banks make up the majority of financial institutions in many countries.

1.2 Statement of the Problem

1.3 Research Questions

1.4.1 General objective

1.4.2 Specific objective

The specific objectives of the study are:

1.5 Hypotheses of the Study

1.5 Significance of the Study

1.6 Scope of the Study

1.7. Limitation of the Study

 Because of the restricted supply of data limited to data 1990 to 2021

1.8. Organization of the Paper

2.1 Theoretical Review

2.1.1 Concepts and Definitions

Profitability, according to Akintola and Skitemore (1991), has measured as a percentage of

Profitability Measurement: Profitability analysis categorizes, measures, and evaluates the

ROA = (Earnings Available For Common Stockholders / Total Asset)*100 OR

ROA= Net Income\total asset of the bank

2.1.2 Factors affecting bank profitability

2.1.3 External determinant

2.2 Empirical Literature Review

2.2.1. Empirical literature review from other countries.

2.2.2 Empirical studies in Ethiopia

2.4 Conceptual Framework

Figure 1: Theoretical model on determinants of profitability.

Independent Variables Dependent Variable Independent

Source: Developed based on pieces of literature

3.1 Research Design

3.2. Population & Sampling Technique

3.3. Data Source and Collection Method

Several important factors need to be considered in specifying an empirical model. These

3.5. Data Analysis

ROA= Return on Asset= ROA= Net Income÷ Total Asset

INF=inflation (annual inflation rate)

Economic Growth (GDP): Measured by annual Growth rate of Real GDP

4. RESULT AND DISCUSSIONS

4.1. Descriptive Statistics

ROA BS INF LOAN NII NIE CR GDP

Figure 4.1 ROA Vs Explanatory variables

ROA Vs Explanatory Variables

ROA BS LOAN NII NIE CR