Managerial Finance

The determinants of banks' profits in Greece during the period of EU financial

integration
Kyriaki Kosmidou,
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MF
34,3
The determinants of banks’
profits in Greece during the
period of EU financial integration
146 Kyriaki Kosmidou
Financial Engineering Laboratory,
Department of Production Engineering and Management,
Technical University of Crete, Chania, Greece
Abstract
Purpose – This paper aims to examine the determinants of performance of Greek banks during the
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period of EU financial integration (1990-2002).

Design/methodology/approach – The approach is to use an unbalanced pooled time series
dataset of 23 banks.
Findings – High return on average assets (ROAA) was found to be associated with well-capitalized
banks and lower cost to income ratios. Size was positive in all cases but statistically significant only
when the macroeconomic and financial structure variables entered the models. Turning to
macroeconomics and financial structure, the growth of gross domestic product (GDP) has a
significant and positive impact on ROAA, while inflation has a significant negative impact.
Originality/value – The paper’s value lies in showing that money supply growth has no significant
impact on profits, whereas the ratios banks’ assets to GDP, stock market capitalization to banks
assets and concentration are all statistical significant and negatively related to ROAA.
Keywords Greece, Banking, Performance criteria, European Union
Paper type Research paper

Introduction
Over the last years, a number of significant changes occurred in the Greek banking system
as a result of its adaptation to new conditions such as the deregulation of national markets,
the establishment of the single EU market and the internationalization of competition.
The major changes in the Greek banking system were realized after 1992, when the
Greek Parliament passed the Second Banking Directive concerning establishment,
operation and supervision of credit institutions. Moreover, over the last years, the
major Greek banks have enhanced their business abroad, mainly in the Balkans, and
have strengthened their position in the domestic market through mergers, acquisitions
and strategic alliances. The result was a substantial restructuring of the banking
sector and a new equilibrium in the Greek financial market. The wave of mergers and
acquisitions had an effect on the concentration in the Greek banking market which
remains high, although lower than in five other EU Member states (Netherlands,
Belgium, Sweden, Finland and Denmark).
As it concerns the type and ownership of banks, commercial banks are the ones that
dominate the Greek banking system. The most significant change relative to
ownership has been the withdrawal of the state from commercial banking in recent
years, which reduced the number of directly or indirectly state controlled banks from
ten in 1995 to three in 2003.
Managerial Finance It becomes obvious from the above, that a number of changes took place in Greece
Vol. 34 No. 3, 2008
pp. 146-159 prior to its entry into the euro zone. In addition, the adoption of the euro by Greece on
# Emerald Group Publishing Limited
0307-4358
January 2001 has accelerated other changes not only to monetary conditions, but also
DOI 10.1108/03074350810848036 to the operational environment as well. The increased competition, along with the
 stability and low inflation has led to a decline of the interest rate spread[1] while Banks’ profits in
another source of income generation from foreign exchange transaction has been lost.
Therefore banks were forced to generate new products and seek new customers.
Greece
It is reasonable to assume that all these changes must have some impact on the
profitability of Greek banks[2]. Therefore, knowledge of the underlying factors that
influence the profits of banks is essential.
The purpose of this paper is to extend earlier work on the determinants of
profitability of Greek commercial banks and examine to what extent the profits of
147
banks are influenced by internal factors (e.g. bank’s-specific characteristics) and to
what extent by external factors (e.g. macroeconomic, financial industry structure)
during the period of EU financial integration. The conclusions drawn could prove
useful not only for future decisions of Greek banks’ managers but also for the banking
sectors in other medium-sized economies that are undergoing structural changes such
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as most accession EU countries, particularly those in central and eastern Europe.

The rest of the paper is structured as follows: the literature review section reviews
the literature on the determinants of banks profitability as well as the studies on Greek
banking. The section determinants and variables selection describes the variables
selected to measure the performance of the banks along with those chosen to test the
factors that affect it. Data and methodology section describes the methodology and the
data used in the study. Results section presents the empirical results. Finally, in
conclusions and further research section, the concluding remarks are discussed.

Literature review
Studies on the Greek banking system
Up-to-date the number of studies that examined the Greek banking market is limited.
Most of these studies have focused on the comparative performance of banks and their
efficiency (cost efficiency and economics of scale) rather than on the determinants of
their profitability.
Zopounidis et al. (1995) demonstrated a multicriteria decision-making methodology
for the evaluation of the performance of a sample of 28 Greek banks over the period 1989-
1992. An additive utility model was assessed to obtain the final ranking of the banks.
The liberalization and the profitability of the Greek commercial banks during the
period 1989-1991 were examined by Alexakis et al. (1995). The results suggest that the
determinants of profitability of Greek commercial banks were highly different from
those in other countries during the periods of intense regulation in Greece.
Vasiliou (1996) applied the statistical cost accounting methodology to investigate
the profitability differences between high-profit and low-profit Greek banks over the
period 1977-1986. He concluded that asset management and to a lesser extent liability
management play a role in explaining interbank differences in profitability in Greece
during the period 1977-1986.
The cost structure and the scale economies in the Greek banking system during the
years 1980-1989 were examined by Karafolas and Mantakas (1996). They constructed a
model that uses a translogarithmic cost function which includes the size of assets,
capital, labor and technological progress. They found that although operating cost–
scale economies existed, total cost–scale economies were not present.
The competitive conditions in the Greek banking system over the period 1993-1995
were examined by Hondroyiannis et al. (1999) who used the Rosse-Panzar statistic and
found that bank revenues were earned as if under conditions of monopolistic
competition.
 MF Kosmidou and Spathis (2000) examined the impact of euro on Greek banks through
a cost–benefit analysis by estimating the costs, benefits and outcome that would arise
34,3 from the introduction of the euro. The results indicated that profits would rapidly
increase in the long-term period.
Vasiliou and Frangouli (2000) investigated the impact of financial variables (asset
utilization and leverage multiplier) and concentration ratio of the Greek commercial
banking market on banks’ return on equity over the period 1993-1997. The results
148 indicated that financial variables are very important determinants of banks’
profitability while market structure is found to have no influence on banks’
performance.
In a later study, Stathas et al. (2002) applied the multicriteria method PROMETHEE
to rank the banks according to their financial performance over multiple criteria
(liquidity, profitability, capital structure, investment activity, development) during the
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period 1995-1999.
The cost efficiency over the period 1993-1998 was estimated by Christopoulos et al.
(2002). They found that large banks are less efficient than smaller ones as well as their
economic performance, bank loans and investments are positively related to cost
efficiency. However, Spathis et al. (2002) used a multicriteria methodology to
investigate the differences of profitability and efficiency between small and large banks
over the period 1990-1999 and found that large banks are more efficient than small
ones.
Tsionas et al. (2003) applied Data Envelopment Analysis to estimate economic
efficiency, total factor productivity (TFP) change and technical change of the Greek
banking system for the period 1993-1998. The results indicated that most of the banks
operated close to best market practices, while allocative inefficiency costs appeared to
be more important than technical inefficiency costs. In addition, the positive but not
substantial TFP change of the Greek banking system was associated to efficiency
improvement for the medium-sized banks and to technical change improvement for
larger institutions.
In a more recent study, Mamatzakis and Remoundos (2003) used a methodology
based on the structure–conduct performance (SCP) framework to examine the
determinants of the performance of Greek commercial banks over the period 1989-
2000. They used financial ratios, bank’s size, status of ownership, stock market
performance, market concentration, money supply and consumer price index as
independent variables and found that profits are mainly explained by the financial
ratios. They also reported that economics of scale and the money supply significantly
influence profitability.

Determinants of bank performance

A review of literature and cross-reference studies provided many studies that
examined the determinants of banks’ profits. These studies consider internal factors,
such as management policy decisions and external factors like economic environment
and examine either a particular country or a number of countries.
Molyneux and Thorton (1992) were among the first who examined the determinants
of banks profitability in several countries using a sample of 18 European countries over
the period 1986-1989 and found a positive association between the return on equity and
the level of interest rates, bank concentration and the government ownership.
Berger (1995b) and Angbazo (1997) among others examined the US banking sector.
Berger (1995b) found that return on equity and capital-to-asset ratio are positively
 related over the period 1983-1992. The results of Angbazo (1997) for the period Banks’ profits in
1989-2003 indicate a positive association between the bank interest spread and the
default risk, opportunity cost of non-interest bearing reserves, leverage and
Greece
management efficiency. Similar studies were conducted in a number of emerging
countries such as Colombia (Barajas et al., 1999) and Malaysia (Guru et al., 1999).
In a most recent study Demirguc-Kunt and Huizingha (1999) considered a
comprehensive set of bank characteristics (such as size, leverage, type of business,
foreign ownership), macroeconomic conditions, taxation, regulations, financial 149
structure and legal indicators to examine the determinants of bank interest margins
and profitability in 80 countries over the period 1988-1995. They found that: (i) well-
capitalized banks have higher net interest margins and are more profitable, (ii) banking
sectors, where banking assets constitute a larger portion of the GDP, have smaller
margins and are less profitable and that a larger stock market capitalization to bank
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assets is related negatively to margins, (iii) bank concentration ratio positively affects
profitability, (iv) macroeconomic factors implicit and explicit financial taxation, deposit
insurance and the legal and institutional environment also explained variation in
interest margins.

Determinants and variables selection

As it was mentioned earlier, the purpose of this paper is to develop a model that will
reveal the factors that influence the profits and margins of Greek banks. In general, the
literature on banks performance mentioned that the profitability determinants can be
divided in two main categories namely the internal determinants (i.e. those factors that
are influenced by the bank’s management decisions and policy objectives) and the
external determinants (i.e. economic and industry conditions). The variables chosen to
measure the performance of banks along with those chosen to test the factors that
affect it are presented in Table I and discussed below. In addition, correlations between
the independent variables are presented in Table II.

Performance measures
This study uses the ratio of return on average assets (ROAA) as a measure of bank
performance. Return on assets is the net profit after tax divided by total assets and
indicates the returns generated from the assets financed by the bank. Average assets
are being used in this study, in order to capture any differences that occurred in assets
during the fiscal year.

Internal determinants
Five bank characteristics are used as internal determinants of performance. They are
the cost-to-income ratio, the ratio of equity to total assets, the ratio of bank’s loans to
customer and short-term funding, the ratio of loan loss reserves to gross loans and the
bank’s total assets which represent expenses management, capital adequacy, liquidity,
asset quality and size, respectively.
The cost-to-income ratio (COST) measures the overheads or costs of running the
bank, the major element of which is normally salaries, as percentage of income and it is
used to provide information on variation of bank costs over the banking system.
Although the relationship between expenditure and profits appears straightforward
implying that higher expenses mean lower profits and the opposite, this may not
always be the case. The reason is that higher amounts of expenses may be associated
with higher volume of banking activities and therefore higher revenues. Therefore, in
 MF Variables Description
34,3
Dependent
ROAA The return on average total assets of the banks
Independent
Banks characteristics (internal factors)
COST This is the cost-to-income ratio. It provides information on the
150 efficiency of the management regarding expenses relative to the
revenues it generates. Higher ratios imply a less efficient
management
EQAS This is a measure of capital adequacy, calculated as equity to total
assets. High capital–asset ratios are assumed to be indicators of
low leverage and therefore lower risk
LODEP This is a measure of liquidity calculated as loans to customers and
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short-term funding. Higher figures denote lower liquidity

LOSRES This is the ratio of loan loss reserves to gross loans. It indicates
how much of the total portfolio has been provided for but not
charged off and is used as a measure of bank’s asset quality and
risk. Given a similar charge-off policy the higher the ratio the
poorer the quality and therefore the higher the risk of the loan
portfolio will be
SIZE The accounting value of the bank’s total assets
Macroeconomic and financial structure (external factors)
GDPGR The annual change in the GDP (in constant US$ 1990)
INF The annual inflation rate
MSG The growth of the money supply as measured by currency
circulation (in constant US$ 1990)
MACPASS The ratio stock market capitalization to total assets of the deposit
money banksa. This variable serves as a proxy of financial
development as well as a measure of the size of financial market
and the relationship between bank and market financing (in
constant US$ 1990)
ASSGDP The ratio total assets of the deposit money banks divided by the
GDP (ASSGDP). It reflects the overall level of development of the
banking sector and measures the importance of bank financing in
the economy (in constant US$ 1990)
CONC The C5 concentration measure calculated by dividing the assets of
the five largest banks to the assets of all banks operating in the
market

Notes: The data for the calculation of internal factors and CONC were obtained from Bankscope
Database. The data for the external factors were obtained from Euromonitor International
Database which uses sources such as International Monetary Fund’s (IMF) International Financial
Statistics (IFS), International Financial Statistics and World Economic Outlook/UN/national
Table I. statistics and World Bank. aTotal assets of the deposit money banks is the summation of IFS lines
Variables description 22a through 22f

order to assess the efficiency in expenses management, we use a measure of costs

relative to income. It is expected that this variable will have a negative impact on
performance because efficient banks are expected to operate at lower costs.
The ratio of equity to total assets (EQAS) is used in this study as a measure of
capital adequacy. Capital adequacy refers to the sufficiency of the amount of equity to
absorb any shocks that the bank may experience. It is expected that the higher the
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LOSRES EQAS COST LODEP SIZE GDPGR INFL MSG ASSGDP MACPASS CONC

LOSRES 1
EQAS 0.1709614 1
COST
0.1116608 0.275658 1
LODEP
0.1289756 0.139973
0.2221155 1
SIZE 0.0791904
0.1613467
0.212275
0.080138 1
GDPGR
0.0157125 0.1507205 0.1346447 0.1770323 0.2585045 1
INFL
0.0451898
0.4084183
0.0193127
0.2327148
0.3810872
0.3714702 1
MSG
0.0435326 0.1545443
0.1628953 0.0223498 0.0708942 0.1387719
0.173176 1
ASSGDP
0.0347192
0.0166379 0.0259049 0.1787555
0.0143925
0.0239693
0.3177423
0.0067767 1
MACPASS 0.0569833 0.412443
0.1033535 0.0591764 0.3154898 0.1238301
0.7265586* 0.4830071
0.2500049 1
CONC
0.0154386 0.0285536 0.172672 0.0758561 0.1632959 0.7220657* 0.0393346
0.2269083
0.5206759
0.0843939 1

Note: *Significance at the 0.01 level (two-tailed)

correlations
Independent variables
Table II.
151
Greece
Banks’ profits in
 MF equity to assets ratio, the lower the need to external funding and therefore the higher
the profitability of the bank. In addition, well-capitalized banks face lower risk of going
34,3 bankrupt which reduces their costs of funding.
Another important decision that the managers of commercial banks must take
refers to the liquidity management and specifically to the measurement of their needs
related to the process of deposits and loans. For that reason the ratio of bank’s loans
divided by customers plus short-term funding (LODEP) is used as a measure of
152 liquidity. Higher figures denote lower liquidity. Without the required liquidity and
funding to meet obligations, a bank may fail. Thus, in order to avoid insolvency
problems, bank often hold liquid assets, which can be easily converted to cash.
However, liquid assets are usually associated with lower rates of return. It would be
therefore expected that higher liquidity would be associated with lower profitability.
The ratio loan loss reserves to gross loans (LOSRES) indicates how much of the
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total portfolio has been provided for but not charged off and is used as a measure of
bank’s asset quality. Given a similar charge-off policy, the higher the ratio the poorer
the quality and therefore the higher the risk of the loan portfolio will be. On one
hand, the risk-return hypothesis implies a positive relationship between risk and
profits. On the other hand, bad asset quality may have a negative impact on bank
profitability by reducing interest income revenue and by increasing the provisions
costs.
Bank’s size (SIZE) is considered to be an important determinant of its performance.
The reason is that large size may result in economies of scale that will reduce the cost
of gathering and processing information (Boyd and Runkle, 1993). The empirical
results are mixed, since some studies found economies of scale for large banks
(European Commission, 1997; Berger and Humphrey, 1997; Altunbas et al., 2001) and
other economies of scale for small banks or diseconomies for larger banks (e.g. Vander
Vennet, 1998; Pallage, 1991). As in most studies of banking, we use total assets of the
bank as a proxy for its size to account for size-related economies or diseconomies of
scale.

External determinants
The literature suggests that the environment in which banks operate influences them,
like any firm. Therefore, the financial market structure, the economic condition of the
country, the legal and political environment all may influence the performance of
the banks. In this study, two sets of external determinants are examined: the
macroeconomic and the financial structure indicators.
Gross domestic product (GDP) is among the most commonly used macroeconomic
indicators, as it is a measure of total economic activity within an economy. The gross
domestic product growth (GDPGR), calculated as the annual change of the GDP, is
used as a measure of the macroeconomic conditions. GDPGR is expected to have an
effect on numerous factors related to the supply and demand for loans and deposits. A
positive relation is expected between the performance of the banks and this variable.
Another important macroeconomic condition, which may affect both the costs and
revenues of banks, is the inflation (INF). As Staikouras and Wood (2003) point out that
inflation may have direct effects (e.g. rise in the price of labor) and indirect effects (e.g.
changes in interest rates and asset prices) on the profitability of the banks. According
to Perry (1992), the effect of inflation on bank performance depends on whether the
inflation is anticipated or unanticipated. In the former case (i.e. anticipated inflation)
the interest rates are adjusted accordingly resulting in revenues, which increase faster
 than costs, with a positive impact on profitability. In the later case (i.e. unanticipated Banks’ profits in
inflation) the banks may be slow in adjusting their interest rates, which results in a Greece
faster increase of bank costs than bank revenues that consequently have a negative
impact on bank profitability.
According to the quantity theory of money, changes in the supply of money lead to
changes in nominal GDP and the price level. Money supply refers to the quantity of
money available and it depends on the monetary policy that is being followed. The 153
money supply is basically determined by Central Bank’s policy; nevertheless it is
affected by the behaviour of households that hold money and banks in which money is
held. Mamatzakis and Remoundos (2003) used the supply of money as a measure of
market size and found that it significantly influences bank profitability. In this study,
we use the growth of the supply of money (MSG), and it is expected to have a positive
impact on banks profits and margins.
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We also examine how the performance of the banks is related to the relative
development of the banking industry and the stock market using the ratios total assets
of the deposit money banks[3] divided by the GDP (ASSGDP) and stock market
capitalization divided by total assets of deposit money banks (MACPASS) as well as
banking industry concentration (CONC). ASSGDP reflects the overall level of
development of the banking sector and measures the importance of bank financing in
the economy. Demirguc-Kunt and Huizinga (1999) found that banks in countries with a
more competitive banking sector, where banking assets constitute a larger portion of
the GDP, have smaller margins and are less profitable. MACPASS reflects the
complementarity or substitutability between bank and stock market financing.
Demirguc-Kunt and Huizinga (1999) found that stock market capitalization to bank
assets is negatively related to margins, and suggested that relatively well-developed
stock markets can substitute for bank finance. We therefore expect, both ratios to be
negatively related to bank’s performance. CONC is calculated as the total assets
held by the five largest commercial banks in the country divided by the total assets of
all commercial banks in the country. According to the SCP hypothesis, banks in
highly concentrated markets tend to collude and therefore earn monopoly profits
(e.g. Short, 1979; Molyneux et al., 1996). However, not all studies, have found evidence
to support the SCP hypothesis. From the 45 studies reviewed by Gilbert (1984) only 27
provide evidence that the SCP paradigm hold. Berger (1995a) points out that the
relationship between bank concentration and performance in the USA depend
critically on what other factors are held constant.

Data and methodology

Data
This study uses accounting data of individual banks as well as a number of country-
and market-specific data drawn from the years 1990-2002. Bankscope Database of
Bureau van Dijk’s company was used as a source of banks’ financial data and banking
sector concentration, while country- and market-specific data such as inflation, GDP,
stock market capitalization, etc. were obtained from Euromonitor International
Database. The time period was selected considering that it offers recent time series
observations and it constitutes a period of major changes for the Greek banking
system.
Banks should meet the following two conditions in order to be included into the
sample. First they had to be commercial banks. Second, they should have annual
 MF accounting statements (balance sheet and income statement) for at least one year
between 1990 and 2002 in the Bankscope Database.
34,3 The above procedure yielded an unbalanced panel data of 23 commercial banks over
the period 1990 to 2002, consisting of 154 observations. When the variable of
concentration is included in the study, the number of observations falls to 125. The
reason is that in that case only the period 1995-2002 is examined due to data
availability on Bankscope database.
154
Model formulation
In order to examine to what extent the profits of Greek commercial banks are
influenced by internal factors (e.g. bank’s-specific characteristics) and to what extent
by external factors (e.g. macroeconomic, financial industry structure), the following
model is considered:
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zit ¼ coit þ cmit Ymit þ cdit Ydit þ " ð1Þ

where coit is a constant, i refers to an individual bank, t refers to year, z is the dependent
variable that refers to the ROAA, Ym is a vector captured from the internal factors of a
bank and Yd is a vector captured from the external factors of a bank and " is an error
term.
The model (1) is estimated through fixed effects regression. Based on the Breusch-
Pagan test (Baltagi, 2001), we calculate the Lagrange Multiplier (LM) statistic.
Comparing the relevant statistic of each model with x20:1; n , where n refers to the number
of variables, we do not reject the null hypothesis that the errors are homoscedastic.
Therefore, we consider that the fixed effects method used in our analysis is
appropriate. Finally, White’s transformation is used to control the cross-section
heteroscedasticity of the variables.

Results
This section presents the empirical results of the regressions. Table III shows the
results of the regressions. The first column reports the results when only bank
characteristics (i.e. internal factors) are considered while the second when
macroeconomic variables and financial structure (i.e. external factors) indicators enter
the equation. As expected, we observe slightly differences in the coefficients and the
significance of the variables when the external factors are introduced. The explanatory
power of the model (in terms of adjusted R2) that examines the determinants of ROAA
increases slightly when the external factors are considered.
The first bank level variable is the ratio loan loss reserves to gross loans. The
impact of loan loss reserves to loans on ROAA is negative and statistically significant
whether we consider bank characteristics alone or not. This is reasonable since loan
loss reserves is the cumulative stock of loans loss reserves that changes according to
the amount of new loan provisions added each year. Provisions are subtracted from
operating profit before provisions, taxes and extraordinary items to arrive at operating
profit before taxes and extraordinary items and consequently after subtracting taxes
and extraordinary items to profits after tax, the numerator of ROAA. Bank
management may use provision charges to smooth out profits. Banks can reduce the
variability of reported income by making higher provisions than necessary when credit
quality and net income are high, during favorable economic conditions. In this case,
provisions would not have to increase as much if credit quality was to deteriorate or
 Dependent variable ROAAa Dependent variable ROAAb Banks’ profits in
Greece
LOSRES
0.225265 (0.0017)*
0.103891 (0.0448)*
EQAS 0.351498 (0.0000)** 0.415789 (0.0000)**
COST
0.758659 (0.0000)**
0.647711 (0.0000)**
LODEP
0.107983 (0.0000)** 0.008185 (0.7932)
SIZE 0.013775 (0.4603) 0.095324 (0.0001)**
GDPGR 0.339281 (0.0000)** 155
INF
0.294034 (0.0000)**
MSG
0.016322 (0.5300)
ASSGDP
0.683984 (0.0000)**
MACPASS
0.248818 (0.0000)**
CONC
0.421234 (0.0000)**
Adjusted R2 0.628694 0.636916
Breusch-Pagan test (LM) 6.417 (x20.1,5 ¼ 9.236) 8.928 (x20.1,11 ¼ 17.275)
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Prob (F statistic) 0.0000** 0.0000**

Notes: a23 Banks, period 1990-2002, No. of observations ¼ 154, p-values in parentheses; b23 Banks, Table III.
period 1995-2002, No. of observations ¼ 125, p-values in parentheses; *Significant at the 5 per cent Unbalanced pooled
level, ***significant at the 1 per cent level ROAA models

economic conditions are hard. As mentioned in the 2002 Governor’s annual report of
the Bank of Greece, the favorable economic environment facilitated banks to follow
such a policy over the last years in order to upgrade the quality of their loan portfolios
by increasing their loan loss provisions and write-offs.
The ratio equity to assets is positively related to bank’s performance and
statistically significant. This is consistent with previous studies (e.g. Berger, 1995b;
Demirguc-Kunt and Huizinga, 1999; Abreu and Mendes, 2001) and implies that well-
capitalized banks face lower risks of going bankrupt, which reduces their costs of
funding.
Unsurprisingly, the poor expenses management is one of the main contributors to
poor profitability performance as the relatively high significant coefficient of the cost-
to-income ratio shows. Regarding Greek bank’s operating expenses, it should be
mentioned that they account for significantly higher percentage of their total assets
than in other EU countries. Probably, the main reason is that administrative and
personnel expenses are relatively inelastic and almost double than in other EU
countries (Bank of Greece, 1998, 1999).
Concerning the liquidity results, the relation with ROAA is negative and significant
when we consider only bank’s characteristics, while it becomes positive but
insignificant when the macroeconomic and financial structure variables enter the
equation. As higher figures of the ratio of bank’s loans to customers plus short-term
funding (LODEP) denote lower liquidity, the results imply that less liquid banks have
lower ROAA which is inconsistent with our expectations. However, Bourke (1989) also
found a significant positive relationship between liquidity and bank profitability.
The relation between size and bank’s performance is positive, a fact that supports
the results of Spathis et al. (2002) who examined the differences of profitability and
efficiency between small and large Greek banks over the period 1990-1999 and found
large banks to be more efficient. However, it should be mentioned that the effect of size
is insignificant for ROAA when we consider only bank-specific characteristics and
 MF becomes significant only when the macroeconomic and financial structure variables
enter the equation.
34,3 Turning to the macroeconomic and financial industry structure variables we
observe that GDPGR has a significant and positive impact on ROAA, while inflation
has a significant negative impact. The money supply growth has no significant impact
on profits. The results about GDPGR support the argument of the association between
economic growth and the financial sector performance. It is worthwhile to point out
156 that Greek banks operated under conditions of relative high GDP growth over the last
years as Greece achieved an average growth rate considerably higher than in the EU as
a whole. Referring to the inflation, it seems that while it might bring higher revenues it
might also bring higher costs with the second increasing more than the first. Although
this contradicts with the findings of some studies (e.g. Claessens et al., 1998; Demirguc-
Kunt and Huizinga, 1999), it is consistent with the results of Abreu and Mendes (2001)
Downloaded by Oxford Brookes University At 16:57 14 June 2018 (PT)

that examined Portugal, Spain, France and Germany over the period 1986-1999.
The financial structure indicators, banks’ assets to GDP (ASSGDP), market
capitalization to banks assets (MACPASS) and concentration are all statistical
significant and negatively related to ROAA. The results about ASSGDP are consistent
with the findings of Demirguc-Kunt and Huizinga (1999) who found that in countries
where banking assets constitute a larger portion of the GDP, banks have smaller
margins and are less profitable. This effect was smaller in richer countries that already
had relatively developed banking sectors. The negative and significant impact of
MACPASS to bank’s performance is also consistent with the results of Demirguc-Kunt
and Huizinga (1999) implying that the stock market development offers substitution
possibilities to potential borrowers, which consequently decreases banks’ profits.
Finally, it seems that concentration is less beneficial in terms of profitability to the
Greek commercial banks than competition.

Conclusions and further research

Over the last years a number of important changes occurred in the Greek banking
industry, leading to increased competition and pressure bank profitability.
This paper analyzed how the bank’s management decisions and policy objectives
and the overall banking environment affected the performance of banks in terms of
their ROAA during the period 1990-2002. An unbalanced pooled time series dataset of
23 Greek commercial banks operating during the above period provided the basis for
the econometric analysis.
The results indicate that individual bank characteristics explain a substantial part
of the within-country variation in bank ROAA. High ROAA was found to be associated
with well-capitalized banks, with efficient expenses management (lower cost-to-income
ratio). Size was positive in all cases but statistically significant only when the
macroeconomic and financial structure variables entered the models.
It seems that despite the improvements, Greek banks must keep up their
modernization, since they will soon have to compete with other EU banks of a
significantly higher size. Although the personnel expenses are slowly decreasing over
the last years, they remain higher than in other EU countries, indicating that the Greek
banking system remains overstaffed. Therefore, in order to be competitive and
profitable, Greek banks have not only to expand their operations and improve the
quality of their services but to reduce their operating costs as well.
Referring to macroeconomic and financial structure indicators, GDPGR has a
significant and positive impact on ROAA, while inflation has a significant negative
 impact. The money supply growth has no significant impact on profits. The financial Banks’ profits in
industry structure indicators, banks’ assets to GDP (ASSGDP), market capitalization to Greece
banks assets (MACPASS) and concentration are all statistical significant and
negatively related to ROAA.
Future research could include more variables such as taxation and regulation
indicators, exchange rates as well as indicators of the quality of the offered services.
Another possible extension could be the examination of differences in the determinants
of profitability between small and large or high-profits and low-profits banks. A
157
statistical cost accounting methodology could also be used.

Notes
1. The spread between the interest rate on short-term lending to enterprises and the
interest rate on savings deposits declined to 6.6 per cent in January 2001 from 10 per
Downloaded by Oxford Brookes University At 16:57 14 June 2018 (PT)

cent in January 1998.

2. The profits after tax as a percentage of average total assets increased from 0.48 per cent
in the period 1988-1900 to 0.94 per cent in the period 1991-1994 followed by a decrease to
0.69 per cent over the period 1995-1997. Pre-tax profits in 1999 were 100 per cent higher
than in 1998, probably due to the appreciation of equity prices in 1999, while in 2002, the
return on total assets fell from 1.4 per cent in 2001 to 0.7 per cent (Bank of Greece, 1998,
1999, 2002).
3. Total assets of the deposit money banks are the summation of International Monetary
Fund’s International Financial Statistics lines 22a through 22f.

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Further reading
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Kosmidou, K., Pasiouras, F. and Floropoulos, J. (2004), ‘‘Linking profits to asset liability
management of domestic and foreing banks in the UK’’, Applied Financial Economics,
Vol. 14 No. 18, pp. 1319-24.

Corresponding author
Kyriaki Kosmidou can be contacted at: kikikosmidou@yahoo.com, kosmidou@dpem.tuc.gr

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