THE INSTITUTE OF FINANCE MANAGEMENT

INTERNAL FACTORS AFFECTING FINANCIAL PERFORMANCE

OF COMMERCIAL BANKS IN TANZANIA:
A Case of Ten Largest Commercial Banks

By
Salha Othman

A Dissertation Submitted In Partial Fulfillment of the Requirement

for Award of the Degree of Master of Science in Finance and
Investment
August, 2021

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 DECLARATION
I, Salha Othman undersigned declare that, this Research report has not been submitted for any

degree at this or other university or college and that it is my own original work and all the

sources that I have used or quoted have been indicated and acknowledged by means of complete

referencing.

Signature: ………………………………

Date: ………………………………

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 CERTIFICATION
The undersigned certify that he/she has read and hereby recommends for acceptance by The

Institute of Finance Management a research report entitled: “Internal Factors Affecting

Financial Performance of Commercial Banks in Tanzania: A Case of Ten Largest

Commercial Banks’’, Fulfillment of the requirements for the degree of the Master of Finance

and Investment of the Institute Management

………………………………………………….
Dr. Jumanne Basesa

(Supervisor)

Date …………………………………………….

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 COPYRIGHT

© 2021

The dissertation is the copyright material protected under the Berne Convention, the Copyright

Act of 1999 and other international and national enactments. No part of this dissertation may be

reproduced, stored in any retrieval system or transmitted in any form by any form or by any

means without prior written permission of the author or the Institute of Finance Management.

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 ACKNOWLEDGEMENT
First and foremost, I would like to thank Almighty God for healthy and safety during the whole

process of report writing.

Further to this, the report would not have been completed without cooperation and support from

number of people. Thus, I would like to extend my sincere appreciation to Dr. Jumanne Basesa

for his tireless and all-time guidance.

Special thanks to my husband, my mother and sisters for their moral support and encouragement.

It had never been easy considering the breakout of Covid-19 disease.

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 DEDICATION
I dedicate this report to my precious daughter Nureen and my lovely son Fahim for their
reminisce motivation during the whole process to pursue my MSc-FI.

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 LIST OF ABBREVIATIONS
BOT Bank of Tanzania
CA Capital Adequacy
CAMEL Capital Adequacy, Asset quality, Management efficiency, Earnings ability
CAR Capital Adequacy Ratio
EACB East African Currency Board
IAS International Accounting Standards
IASB International Accounting Standard Board
IFRS International Financial Reporting Standards
LQR Liquidity
MFI Main Financial Institution
MNO Mobile Network Operators
MSc-FI Master of Science in Finance and Investment
NCA Non-Current Assets
NIE Non-Interest Expense
QA Quality Assets
ROA Return on Assets
ROE Return on Equity
SACCOs Savings and Credit Co-operatives
TZS Tanzania Shillings

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 ABSTRACT

The objective of the study was to determine internal factors affecting performance of commercial

banks in Tanzania case of ten largest commercial banks in Tanzania. Specifically, the study

examined effect of quality of assets on the performance of commercial banks, examine effect of

capital adequacy on the performance of commercial banks, examine whether liquidity level

affect performance of commercial banks and examine effect of non-interest expenses on the

performance of commercial banks in Tanzania.

The study adopted a descriptive research design. Comprised of ten largest commercial banks in

Tanzania for the period of 2010 to 2019. The study used secondary data for the variables

collected from banks annual reports. The secondary data obtained in this study was analyzed

using inferential analysis using Eview software whereby correlation and regression were

conducted to show the relationship between variables.

The empirical results show that assets quality has a significant effect on the performance of

commercial banks. Furthermore, the results show that capital adequacy has a significant effect on

the performance of commercial banks. Moreover, the results show that liquidity has a significant

effect on the performance of commercial banks and the results show that non-interest expenses

have no significant influence on the commercial bank's performance.

The study recommends that banks should consider asset quality because banks with high asset

quality are more profitable than others. Moreover, for banks to enhance performance need to

keep liquid assets because bank managers who invest their liquid assets can generate income and

boost their performance. Bank must ensure there is sufficient capital since maintaining a

sufficient capital base can help the banks to embrace competition and enhance performance.

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 TABLE OF CONTENTS
DECLARATION............................................................................................................................i
CERTIFICATION........................................................................................................................ii
COPYRIGHT...............................................................................................................................iii
ACKNOWLEDGEMENT...........................................................................................................iv
DEDICATION...............................................................................................................................v
LIST OF ABBREVIATIONS......................................................................................................vi
ABSTRACT.................................................................................................................................vii
LIST OF FIGURES......................................................................................................................xi
LIST OF TABLES.......................................................................................................................xii
CHAPTER ONE............................................................................................................................1
INTRODUCTION.........................................................................................................................1
1.1 Background of the Study.......................................................................................................1
1.1.1 Bank’s Internal Factors.......................................................................................................5
1.1.1.1 Capital Adequacy.............................................................................................................5
1.1.1.2 Assets Quality..................................................................................................................5
1.1.1.3 Management Efficiency...................................................................................................6
1.1.1.4 Earnings Ability...............................................................................................................6
1.1.1.5 Liquidity..........................................................................................................................6
1.1.2 Overview and Evolution of the Banking Industry in Tanzania..........................................7
1.1.2.1 Overview of the Banking Industry in Tanzania...............................................................7
1.1.2.2 Evolution of Banking Industry in Tanzania.....................................................................8
1.2 Statement of the Problem.....................................................................................................10
1.3 Objective of the Study.........................................................................................................11
1.3.1 The Main Objective of the Study......................................................................................11
1.3.2 Specific Objectives of the Study.......................................................................................11
1.4 Research Hypothesis............................................................................................................12
1.5 Significant of the Study.......................................................................................................12
1.6 Scope of the Study...............................................................................................................13
1.7 Limitation of the Study........................................................................................................14
CHAPTER TWO.........................................................................................................................15
LITERATURE REVIEW...........................................................................................................15

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 2.1 Introduction..........................................................................................................................15
2.3 Definition of Key Terms Relating to Research...................................................................16
2.3.1 Bank..................................................................................................................................16
2.3.2 Financial Institutions........................................................................................................16
2.3.3 Commercial Bank.............................................................................................................16
2.3.4 Microfinance Bank...........................................................................................................17
2.3.5 Mobile Network Operators (MNO’s)...............................................................................17
2.3.6 Mortgage Firms................................................................................................................17
2.3.7 Community Bank..............................................................................................................17
2.3.8 International Financial Reporting Standards No 9 (IFRS 9)............................................17
2.4 Theoretical Literature Review.............................................................................................18
2.4.1 The Signaling Theory.......................................................................................................18
2.4.2 The Risk Return Hypothesis.............................................................................................19
2.4.3 Efficiency Structure Theory.............................................................................................19
2.4.4 Market Power Theory.......................................................................................................20
2.5 Empirical Literature Review................................................................................................21
2.6 Narrations of the Variables..................................................................................................26
2.6.1 Dependent Variables.........................................................................................................26
2.6.2 Independent Variables......................................................................................................26
2.6.2.1 Capital Adequacy...........................................................................................................27
2.6.2.2 Asset Quality.................................................................................................................27
2.6.2.3 Liquidity........................................................................................................................28
2.6.2.4 Non-interest Expenses...................................................................................................29
2.7 Summary of the Literature Review......................................................................................29
2.2 Conceptual Framework of the Study...................................................................................29
CHAPTER THREE.....................................................................................................................31
RESEARCH METHODOLOGY...............................................................................................31
3.1 Introduction..........................................................................................................................31
3.2 Research Design..................................................................................................................31
3.3 Population Size....................................................................................................................31
3.4 Sampling Procedure and Techniques...................................................................................32
3.5 Data Collection....................................................................................................................32
3.6 Data Analysis.......................................................................................................................32
CHAPTER FOUR.......................................................................................................................34
DATA ANALYSIS AND INTERPRETATION OF FINDINGS.............................................34
4.1 Introduction..........................................................................................................................34
4.2 Correlation Analysis............................................................................................................34
4.3 Tests for Statistical Assumptions.........................................................................................36
4.3.1Test of Heteroscedasticity..................................................................................................36

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 4.3.2Test for Assumption of Autocorrelation............................................................................37
4.3.3 Test of Multicollinearity...................................................................................................37
4.4 Regression Analysis.............................................................................................................38
4.4.1 Model fitness....................................................................................................................39
4.4.2 Statistical Significance......................................................................................................39
4.4.3 Estimated Model...............................................................................................................39
4.5 Discussion of Findings........................................................................................................41
4.5.1 Effect of Liquidity on the performance of commercial banks..........................................41
4.5.2 Effect of capital adequacy on the performance of commercial banks..............................42
4.5.3 Effect of Asset quality on the performance of commercial banks....................................42
4.5.4 Effect of Non-interest expense on the performance of commercial banks.......................42
CHAPTER FIVE.........................................................................................................................43
CONCLUSIONS AND RECOMMENDATIONS....................................................................43
5.1 Introduction..........................................................................................................................43
5.2 Study Summary...................................................................................................................43
5.3 Conclusions..........................................................................................................................44
5.4 Recommendations................................................................................................................45
5.5 Area for Further Study.........................................................................................................46
REFERENCES............................................................................................................................47

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 LIST OF FIGURES
Figure 1. 1Earnings (Profit before Tax and Return on Assets).......................................................2
Figure 1. 2Provision for bad and doubtful debt and non-interest expense......................................3
Figure 2. 1Conceptual Framework................................................................................................30

LIST OF TABLES

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 Table 1. 1Earnings (Profit before Tax and Return on Assets).........................................................2
Table 1. 2Provision for bad and doubtful debt and non-interest expense.......................................3
Table 1. 3Categories of Banks and Financial Institution.................................................................7
Table 4. 1Correlations...................................................................................................................34
Table 4. 2Heteroskedasticity result................................................................................................36
Table 4. 3Multicollinearity Test....................................................................................................38
Table 4. 4Model fit........................................................................................................................39
Table 4. 5Regression Results.........................................................................................................40

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 CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

The importance of oxygen to the life of living organism can relate to the importance of banking sector to

the economy of a country. Banks acts as a bridge between the depositor’s finances and the investors.

However, this will occur in cases where operational cost incurred by commercial banks is already

covered. Profitability is thus a banking necessity for successful intermediation to occur (Siddiqui &

Shoaib, 2011).

The financial sector in Tanzania is dominated by commercial banks which have reported significant

growth and improved financial performance. Despite the growth, the sector still faces many challenges

including stiff competition from within, MFI’s, MNO’s, mortgage firms and SACCOs. The competition

which over the last few years resulted to increased innovations in the market. Therefore, in order to

survive and remain competitive, they need to be profitable since a profitable banking sector is better able

to withstand negative shocks and contribute to the stability of the financial system (Athanasoglou,

Brissimis and Delis, 2005).

Banks profits results from fees charged on bank’s service as well as interest levied on assets.

Furthermore, the main expense incurred by Banks includes interest paid on depositor’s funds. Therefore,

a positive difference between earnings and expenses represent profitability of any financial institution.

Bank’s assets that attract revenue include loans issued to customers, whereas main liabilities for Banks

are the depositors fund maintained by the bank as well as funds borrowed from other banks. Profitability

of the Banks are measured through ROA (Return on Assets) and ROE (Return on Equity), whereas ROA

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 emphasizes how well the Bank may utilize its assets to generate income and ROE is the amount of net

income returned as a percentage of shareholder’s equity (Mulualem, 2015).

For the past 10 years, Tanzania banking industry has experienced fluctuations in terms of earnings which

can be revealed as below:

Table 1. 1Earnings (Profit before Tax and Return on Assets)

201 201
Years 2010 2011 2012 2013 2014 2015 6 2017 8 2019
Profit Before Tax 460.5
(TZS Billions) 244.22 343 406.9 8 528 676 571 331 313 590
Return on Assets
(%) 2.16 2.53 2.58 2.55 2.51 2.49 2.09 1.24 1.04 1.86

Source: Bank of Tanzania, Banking Supervision Annual reports from 2010-2019

Figure 1. 1Earnings (Profit before Tax and Return on Assets)

Earning Trends from 2010 to 2019

800 3
Profit Before Tax- TZS Billions

Return on Assets -Percentage

700
2.5
600
2
500
400 1.5
300
1
200
0.5
100
0 0
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Years

Profit Before Tax -TZS Billions Return on Assets (%)

From the preliminary analysis it shows that, despite the Banking sector to remain profitable, the

trends on Bank’s profitability is fluctuating for the past ten years. From 2015 the trend have been

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 declining however during 2019 has increased. However, the variations of profitability differ

among the Banks since as per market share of Tanzania Banking sector, ten largest banks

holding 72.2 percent of the total assets. Financial Sector Supervision Annual Report 2019). This

shows the higher profitability is enjoyed by larger commercial Banks compared to Medium and

Small Banks who owns the remaining part of market share. This evidence that there are

significant factors that affect profitability performance of banking sectors, as other studies

pointed out being internal and external factors.

However, this study will evaluate internal factors that affect performance commercial banks case

of ten largest commercial banks in Tanzania because provision for bad and doubtful debts and

non-interest expense as detailed below, have been fluctuating for the past 10 years, which have

an impact on the performance of the banks.

Table 1. 2Provision for bad and doubtful debt and non-interest expense

Years 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Provision
for bad and
doubtful 135,8 103,1 100,8 162, 163,8 152,2 363,3 528,9 531,6 345,1
debts 62 18 55 353 36 32 79 31 44 51
1,28
Non-interest 709,1 874,8 1,087, 0,73 1,484 1,791 1,998 2,075 2,165 2,223
expense 41 37 277 4 ,494 ,615 ,933 ,411 ,218 ,319

Source: Bank of Tanzania, Banking Supervision Annual reports from 2010-2019

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 Figure 1. 2Provision for bad and doubtful debt and non-interest expense

Trends from 2010 to 2019

Provision for bad and doubtful debts- TZS

Non Interesr Expense- TZS Millions

600,000 2,500,000

500,000 2,000,000
400,000
1,500,000
Millions

300,000
1,000,000
200,000

100,000 500,000

- -
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Years

Provision for bad and doubtful debts Non-interest expense

The Bank’s internal factors are detailed explained as below.

1.1.1 Bank’s Internal Factors

Bank internal factors are components within Bank’s capacity, which can affect bank

performance. The factors can be deployed by different banks in different ways to bring different

results. Bank specific factors include capital adequacy, asset quality, liquidity, operational cost

efficiency and income diversification (Shipho 2011). Scholars refer bank internal factors as

CAMEL framework. CAMEL stands for capital adequacy, asset quality, management

efficiency, earnings ability, and liquidity (Mulualem, 2015)

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 1.1.1.1 Capital Adequacy

This can be defined as the level of capital required by commercial banks to meet its obligation

and cover the exposure risk of credit, operational, strategic and market. It represents amount of

own finance available to boost business activities. Furthermore, capital establishes liquidity for

commercial banks as deposits cannot be relied due to its dependency with external stakeholders.

Bank of Tanzania through Banking and Financial Institutions (Capital Adequacy) Regulations,

2014 and amendment in 2015 prescribed minimum core capital to be maintained by commercial

banks in Tanzania. Capital adequacy is measured based on capital adequacy ratio (CAR)

(Nyanga, 2012).

The minimum accepted Capital Adequacy Ratio is 12.5% for Tier 1 and 14.5% for Tier 2. The

higher ratio expresses the bank is in lower risk in case of insolvency and vice versa.

1.1.1.2 Assets Quality

Asset qualities represent likelihood of default for loans disbursed together with its marketability.

This reflects ability of management to identify and manage credit risk.

This can be assessed through Gross Non-Performing Assets and NPA (Non-Performing

Accounts) ratios.

Bank of Tanzania monitors this through circulars and regulations whereas currently approved

NPA ratio is 5%. A higher ratio indicates poor asset quality.

1.1.1.3 Management Efficiency

Management efficiency can be described as ability of board of directors and management to

identify, measure and control risk of bank’s operations through abide to pertinent laws and

regulations. This can be measured by different financial ratios like earnings growth rate, loan

growth rate and asset growth, these represent ability of management to utilize its resources

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 effectively, maximize income and minimize operation costs. Management efficiency

significantly determines level of operating expenses and in turn has an impact on bank’s

profitability (Ongore & Kusa, 2013)

1.1.1.4 Earnings Ability

Earnings ability expresses capacity of the bank to realize profit which will enable the bank to

fund various investments and remain competitive in the market. Earnings can be evaluated

through different ratios such as return on assets (ROA), return on equity (ROE) and Net Interest

Income.

These measures from 1 to 5 rating system, whereas rating of 1 show the bank has strong earning

that suffice and maintain adequate capital and loan allowance and can effectively support

operations. Rating of 5 shows consistent losses in banking industry and portrays a distinct threat

to a bank’s solvency through erosion of capital (Mulualem, 2015)

1.1.1.5 Liquidity

Liquidity can be referred to as ability of the bank to meets its obligations, especially depositors.

There is a direct relationship between liquidity and profitability of the banks. To measure

liquidity management should use as a proxy variable the ratio of liquid assets that is cash and due

from banks, available for sale securities, and government securities to the total assets (Ongore &

Kusa, 2013). Bank of Tanzania manages liquidity through Banking and Financial Institutions

(Liquidity Management) Regulations 2014, and circulars whereas the current limit set is 20%.

Lower liquidity ratio face risk of not having ability to finance their daily operations.

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 1.1.2 Overview and Evolution of the Banking Industry in Tanzania

1.1.2.1 Overview of the Banking Industry in Tanzania

Bank of Tanzania Act, 2006 mandated BOT to exercise principle functions of a central bank and without

prejudice to the generality of the foregoing, to formulate, implement and be responsible for monetary

policy, including exchange rate policy, to issue currency, to regulate and supervise banks and financial

institutions including mortgage financing, development financing, lease financing, licensing and

revocation of licenses and to deal, hold and manage gold and foreign exchange reserves of Tanzania

In 2019, BOT supervised 51 deposit taking financial institutions, whereas 38 of them were commercial

Banks and 13 were financial institutions. While in terms of ownership structure by December 2019, there

were 5 state- owned banks and financial institutions and 48 privately owned. (Source: Bank supervision

report-2019).

Table 1. 3Categories of Banks and Financial Institution

Categories of
Banking Institution 2010 2011 2012 2013 2014 2015 2016 2017 2018
Commercial banks 28 31 32 34 34 36 38 38 40
Development financial
institutions 0 0 0 0 0 2 2 2 2
Microfinance banks 1 1 1 2 3 3 4 5 5
Community banks 9 12 12 12 12 12 12 11 6
Financial Institutions 4 4 4 4 4 3 3 3 0
42 48 49 52 53 56 59 59 53

Source: Bank of Tanzania, Banking Supervision Annual reports from 2010-2019

1.1.2.2 Evolution of Banking Industry in Tanzania

History of the Bank of Tanzania/Banking industry in Tanzania can be described into three phases
as below;

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 Phase I Phase II Phase III

Period before EACB

1919 June 1966

Phase I:

Period before 1919, Tanganyika was under Germany rule and Zanzibar had its own government.

Thus, Tanganyika was using German Rupee made of silver while subsidiary coin was Heller

while Zanzibar was using Indian Silver rupee and its subsidiary coins. In addition, shells and

cattle used to serve as a store of value and sometime used as medium of exchange.

In 1905, commercial Bank was introduced, Deutsch-Ostafrikanische Bank opened its office in

Dar es Salaam.This bank had a concession from the German Government to issue its own notes

and coins, which helped the bank to meet the demand for coins in exchange for its notes. In

1911, Handelsbank fuer Ostafrika, another German bank that was an official savings bank

opened a branch in Tanga.

Phase II:

After World War I, Tanganyika became a mandate territory of the United Kingdom (UK) and its

monetary system was aligned to that of Kenya and Uganda, mainly in two aspects:

a. through the establishment of the EACB in December 1919 and

b. by auctioning off the assets of the German banks and permitting British banks to open

their offices.

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 The regulations defining the Constitution, Duties, and Powers of the EACB stated that it had

been constituted to provide for, and to control the supply of currency in the East African

Protectorate, the Uganda Protectorate, and any other dependencies in East Africa, which might

be added by the (UK) Secretary of State, to ensure that the currency was maintained in

satisfactory condition, and generally to watch over the interest of the dependencies as far as

currency was concerned.

Initially, the EACB operated in Tanganyika, Kenya, and Uganda. Zanzibar adopted its currency

in 1936.

The EACB was authorized to issue its own currency notes and mint coins according to the

designs approved by the Secretary of State for circulation in its area of operations. Exchange rate

between Board's currency and the pound sterling was fixed by the Secretary of State. The EACB

itself stopped functioning in 1966, when central banks came into existence in Tanzania, Kenya,

and Uganda

Phase III:

After the East African Currency Board was dissolved, Tanzania and the other nations formerly

under the board’s jurisdiction replaced the authority with their own independent central banks to

govern their respective currencies. The Bank of Tanzania came into being via the enactment of

the Bank of Tanzania Act 1965 with the first governor being Mr. Edwin I. Mtei. The Bank was

empowered to perform all the traditional bank functions including the issuing of new Tanzania

shilling in 1966.

In February 1967, the bank had to change from its traditional instruments of indirect monetary

policies as they became inoperative under the Arusha declaration.The Bank was then tasked with

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 implementation of policies such as the Annual Finance and Credit Plan in 1971, with the support

of administered interest rates was introduced as the main instrument of monetary policy, and the

Foreign Exchange Plan was created in order to control the use of foreign exchange.

Tanzania continued to go through changes, Bank of Tanzania Act was amended in 1978, 1995

and the last was on 2006 where more responsive regulatory role in relation to the regulation and

supervision of financial institutions and the implementation and formulation of its monetary

policy was enhanced.

1.2 Statement of the Problem

Preliminary analysis prescribes that, the Banking sector in Tanzania remain profitable over the

past 10 years, however the earnings are being fluctuating such that from 2015 earnings have been

deteriorating while in 2019 it has increased.

Numerous studies have been conducted on examining the determinants of profitability

performance in commercial banks in both developed and developing countries, some for internal

factors only and other for both internal and external factors. These studies include but not limited

to the following: (Thornton & Molyneux, 1992), (Lukorito, Muturi & Nyangau 2014),

(Onuonga, 2014) and (Shipho, 2011) however the result differ in terms of micro-economic

condition, financial system of certain country as well as operating environment of banks at a

certain period of time

In Tanzania, various studies have been conducted focusing on determinants of bank’s efficiency

which includes but not limited to Aikaeli (2008), Zawadi (2013), Gwahula (2013), Raphael,

(2013), Lotto (2019), whereas; Lotto (2019), it was pointed out that Tanzania’s banks should

avoid irresponsible lending that would increase level of unsecured credits in banking portfolio as

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 well as consider potential technologies which could improve profit efficiency level. Further to

that Raphael (2013) whose research based on commercial banks that operate within East African

Community (Tanzania, Kenya, Uganda, Rwanda and Burundi) and concluded that, number of

employees, operating expenses and interest income are significant contributors in efficiency of

banks in Tanzania.

This study analyzed the internal factors affecting performance of commercial banks by extending

to the most current data i.e. to the year 2019. Also the study focused on top ten commercial

banks in Tanzania. This is due to the fact that ten largest banks holding 72.2 percent of the total

assets, 72.98 percent of total loans and 74.5 percent of total deposits for Tanzania Banking sector

(Financial Sector Supervision Annual Report, 2019).

1.3 Objective of the Study

1.3.1 The Main Objective of the Study

The main objective of the study was to determine internal factors affecting performance of

commercial banks in Tanzania case of ten largest commercial banks from 2010 to 2019.

1.3.2 Specific Objectives of the Study

The specific objectives of the study were as follows:

i. To examine effect of quality of assets on the performance of commercial banks in

Tanzania

ii. To examine effect of capital adequacy on the performance of commercial banks in

Tanzania

iii. To examine whether liquidity level affect performance of commercial banks in

Tanzania

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 iv. To examine effect of non-interest expenses on the performance of commercial banks

in Tanzania

1.4 Research Hypothesis

Based on the objectives of this study, the following key research hypothesis have been

considered to determine internal factors affecting performance of commercial banks in Tanzania

case of ten largest commercial banks from 2010 to 2019.

i. Quality of assets has significant effect on the performance of commercial banks in

Tanzania

ii. Capital adequacy has significant effect on the performance of commercial banks in

Tanzania

iii. Liquidity has significant effect on the performance of commercial banks in Tanzania

iv. Non-interest expenses has significant effect on the performance of commercial banks

in Tanzania

1.5 Significant of the Study

The following values is added upon completion of this study:

The study adds more knowledge and act as a foundation for further studies on factors affecting

performance of commercial banks in Tanzania.

The study increase awareness to Tanzanian policy makers on the factors that affect performance

of commercial banks in Tanzania considering and considering further impact on assets quality,

liquidity, and capital adequacy.

The bank owners benefits extensively from the findings of this study. They understands further

the internal factors that affect them and come up with strategic measures on how to improve their

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 performance and become more competitive in the industry as well as the economy both locally

and globally.

Other financial institutions also benefit in that they can now benchmark themselves and do an

analysis on whether the factors analyzed in this study affect their performance as well.

Recommendations that is proposed at the end of the study also help them in having solutions to

similar situations that have been covered in the study.

The government have more information on how the effects the regulations they put in place

affect the banking sector and consequently the economy. The study findings can be used as a

platform of coming up with measures that improve the sector and consequently the economy.

The study is partial fulfillment for the award of master’s degree in Finance and Investment of

Institute of Finance and Management.

1.6 Scope of the Study

The research focus on examines internal factors that affect performance of commercial banks in

Tanzania case of ten largest commercial banks from 2010 to 2019. The study applied

explanatory and statistical approach design for Tanzania’s banking industry, therefore measured

all the selected commercial banks in the country. The study emphases on ten largest commercial

banks in Tanzania for a period of ten years from 2010 to 2019 whereas as of 31 st December 2019

there were 51 licensed banking institutions in Tanzania, whereas 38 out of 51 are commercial

banks. (Bank of Tanzania, 2019).

1.7 Limitation of the Study

The findings of this study have to be seen in light of some limitations such as on sampling basis,

other researcher should have also considered development banks, community banks and

microfinance banks to come up with full picture of the banking industry.

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 However, no major variations on findings are expected basing on the sample selected of ten

largest commercial banks since these have gained more than 70 percent of total assets, total loans

and total deposits for Tanzania Banking sector (Source: Financial Sector Supervision Annual

Report 2019).

CHAPTER TWO

LITERATURE REVIEW

2.1 Introduction

This chapter prescribes selected research and critical surveys on internal factors affecting

profitability performance of banking sector by different scholars. It describes the conceptual

framework, definition of key terms relating to the research, theoretical and empirical review.

Theoretical review will focus on the theories done by scholars which for this study are the

signaling theory, Risk return hypothesis, the efficiency structure and Market Power theory while

Empirical review entails related journal and articles has been reviewed to enhance

understanding of the internal factors that affect profitability performance of banking institutions

in Tanzania

The chapter ends with a summary of the empirical evidence and identifying the gap that will be

filled by this study.

There are various factors that influence the performance of banks internally and they can be

controlled. Every bank has its own internal factor that affects the financial performance

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 differently. Bank specific factors include capital adequacy, asset quality, liquidity, operational

cost efficiency and income diversification (Shipho 2011)

Capital adequacy shows the level of capital required by the banks to enable them withstand the

risks such as credit, market and operational risks they are exposed to in order to absorb the

potential loses and protect the bank's debtors (Ongore & Kusa, 2013).

Statistically bank specific factors significantly affect the financial performance of commercial

banks in Kenya. (Ongore and Kusa 2013).

The study will examine internal factors that affect performance of commercial banks in Tanzania

case of ten largest commercial banks from 2010 to 2019

2.3 Definition of Key Terms Relating to Research

2.3.1 Bank

This is defined as an entity that is engaged in the banking business. Whereas the banking

business “means the business of receiving funds from general public through the acceptance of

deposits payable upon demand or after a fixed period or after notice, or any similar operation

through frequent sale or placement of bonds, certificates, notes or other securities, and to use

such funds, in whole or in part for loans or investments for the account of and at the risk of the

person doing such business (Bank of Tanzania, 2006)

2.3.2 Financial Institutions

Is an entity engaged in the business of banking, but limited as to size, locations served, or

permitted activities, as prescribed by the Bank of Tanzania or required by the terms and

conditions of its license. This institution does not mobilize customer’s deposits like Banks does.

(Bank of Tanzania, 2006)

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 2.3.3 Commercial Bank

This defined as a bank “that offer a broad range of deposits accounts, including checking,

savings and time deposits, and extend loans to individual and businesses. The banking

institutions are highly regulated and supervised institutions in the emerged economy.

(Ugur,2006)

2.3.4 Microfinance Bank

This means a bank or financial institution which is licensed by the Bank (BOT) to undertake

banking business mainly with individual, groups, and micro and small enterprises in the rural or

urban areas (Bank of Tanzania, 2014)

2.3.5 Mobile Network Operators (MNO’s)

Is a telecommunication service provider organization that provides wireless voice and data

communication for its subscribed mobile users.

2.3.6 Mortgage Firms

These are business operations which involve issuance of mortgages. Mortgage means a loan

granted to the borrower for the purpose of acquiring, improving, or constructing a residential

property and is secured by the acquired, improved, or constructed residential property (Bank of

Tanzania, 2015)

2.3.7 Community Bank

Means a financial institution serving a defined geographical area whose primary activities shall

be restricted to acceptance of deposits and lending such other activities as the Bank may specify

(Bank of Tanzania, 2014)

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 2.3.8 International Financial Reporting Standards No 9 (IFRS 9)

This is a financial instrument sets out the requirement for recognizing and measuring financial

assets, financial liabilities, and some contracts to buy or sell financial items. The standard

replaces IAS 39 Financial instrument: Recognition and measurement. According to revised

standards, the International Accounting Standard Board (IASB) has introduced the IFRS forward

looking credit loss, whereas all banks are required to make provision for expected credit loss

immediately after granting credit accommodation to the customer, unlike the previously where

provision where made after defaulting signs. Therefore, IFRS 9 is expected to increase provision

made by banks hence affect profitability performance. The standard was effective from January

2018.

2.4 Theoretical Literature Review

This section reviews several theories that have described the factors that determine Bank’s

profitability. Some of the common theories includes Signaling Theory (Berger 1995), Risk

Return Hypothesis (Olweny & Shipo, 2011), Efficiency structure and Market Power theory.

2.4.1 The Signaling Theory

The signaling hypothesis suggests that a higher capital is a positive signal to the market value of

a bank (Ommeren, 2011). As Berger (1995) and Trujillo-Ponce (2013) observe, under the

signaling theory, the bank management signals private information that the future prospects are

good by increasing capital. Thus, a lower leverage indicates that banks perform better than their

competitors who cannot raise their equity without further deteriorating the profitability

(Ommeren, 2011).

Furthermore, Purnamawati (2014) narrate that signaling theory provide companies management

mandate to share audited financial statements and give direction on future of the company

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 financially. Signaling theory assume that majority of the profitable entities signal their

competitive power through communicating new and important information to the market,

therefore management of the bank signal good future expectation by increasing of capital which

indicate less debt ration therefore perform better than their competitor.

Signaling theory offers signal to external users of financial statements within a certain time

frame (Ozili,2015. The theory confirms that when a bank’s performance is excellent, directors

will signal the banks performance to its stakeholders and market by making various disclosures

which poor performing firms cannot make. By enhancing more disclosure most managers will

wish to receive high benefits and a good reputation which may increase the value of the firm and

profitability.

2.4.2 The Risk Return Hypothesis

The risk-return hypothesis suggests that increasing risks, by increasing leverage of the firm,

leads to higher expected returns. Therefore, if a bank expects increased returns(profitability) and

takes up more risks, by increasing leverage, the equity to asset ratio (represented by capital) will

be reduced. Thus, risk-return hypothesis predicts a negative relationship between capital and

profitability (Ommeren, 2011; Sharma & Gounder, 2012).

The concept of the risk-return tradeoff is used to explain the relationship between risk and return.

The hypothesis states that potential return increase when risk increases, and so this relationship is

linear. Basically, an investor is only accepting taking on more risk if compensated by a higher

rate of return. Markowitz explains this by stating that an investor’s utility function must be

quadratic, this is, if an investor prefers smaller standard deviation to larger standard deviation

(expected return remains the same) then, given that the investor a) maximize the expected value

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 of some utility function and b) her choice among portfolios depends only on her expected return

and standard deviation (Harry Markowitz, 1959).

2.4.3 Efficiency Structure Theory

Efficiency Structure (ES) hypothesis preserves that banks earn high profits because they are

more efficient than others. The efficiency theory was formulated by Demsetz (1973) as an

alternative to market power theory. Efficiency Structure theories explains the relationship

between the internal inefficiencies and profitability. Shipho (2011) observed that the Efficiency

Structure hypothesis maintains that banks earn high profits because they are more efficient than

the others. Concluding on the Efficiency structure theory, Shipho (2011) argued that theory

assumes that the bank profitability is influenced by internal inefficiencies.

The efficient structure hypothesis formalizes the concept that more efficient firms have lower

costs, which in turn lead to higher profits. The most efficient firms will be able to increase their

market share, resulting in higher concentration. The efficient-structure theory also includes two

hypotheses – the X-efficiency and scale-efficiency hypotheses. The X-efficiency hypothesis

argues that banks with better management and practices control costs and raise profit, moving

the bank closer to the best-practice, lower-bound cost curve. The scale-efficiency hypothesis

argues some banks achieve better scale of operation and, thus, lower costs. Lower costs lead to

higher profit and faster growth for the scale-efficient banks.

2.4.4 Market Power Theory

Market power theory in relation to banks performance was developed by Bain (1951) under the

notion that monopoly is associated with an increase in market power cites excessive profit rate

on sales. Market Power theory explains the relationship between the bank size and profitability.

(Olweny & Shipo, 2011) observe that the market power or performance of the bank is influenced

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 by market structure of the industry. The market power theory assumes that additional profits

results from a higher market concentration which allows commercial banks to collude and earn

supernormal profits which arise due to the firms portfolio of differentiated products that also

increases the market share and market power in determining prices for products (Mirzaei, 2012).

Using market power theory Jeon and Miller (2005) found positive correlation between bank and

concentration.

2.5 Empirical Literature Review

Almazari (2014) investigated the internal factors that affect profitability of banks. The main

objective was to compare the profitability of Saudi and Jordanian banks by using the internal

factors for estimation. A sample of 23 Saudi and Jordanian banks were considered with 161

observations for the period 2005 – 2011. Financial ratios were calculated and statistical tools

including Pearson’s correlation, descriptive analysis of variance and regression analysis were

utilized in testing the hypotheses and to measure the differences and similarities between the

sample banks according to their different characteristics. The factors influencing the profitability

were tested empirically. However, the results indicated that there is a significant positive

correlation between ROA of Saudi banks with TEA, TIA and LQR variables, as well as a

negative correlation with NCA, CDR, CIR and SZE variables. Meanwhile, there is a significant

positive correlation between ROA of Jordanian banks with LQR, NCA, TEA and CDR variables,

also there is a negative correlation of return on assets with CIR, TIA and SZE. The study

recommended that empirical studies should be undertaken in the same field to find out what

more internal factors could affect profitability of banks.

Nsambu (2014) studied the factors affecting performance of domestic commercial banks in

Uganda. The objective was to establish the impact of key internal factors that affect the

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 performance of domestic commercial banks in Uganda, so that the remedial action can be taken

for better performance. The study was carried out in Uganda. It included all the licensed

commercial banks (four) in Uganda as at 31st December 2011. The period for the study was

from 2000 – 2011. Linear multiple regression analysis was employed. The study found that,

management efficiency; asset quality; interest income; capital adequacy and inflation are factors

affecting the performance of domestic commercial banks in Uganda over the period 2000-2011.

Policy implications emerged for commercial banks’ management includes; efficient

management; credit risk management; capital adequacy levels; diversification and commercial

bank investment. In addition, monetary policy regulations and instruments should not enforce

high liquidity and capital adequacy levels. Regulations on non-interest income activities should

be put in place to harmonize the impact of diversification on all commercial banks’ performance

and to avoid exploitation of bank customers.

Gutu (2015) carried out a study on the microeconomic factors affecting bank’s financial

performance focusing on 11 entities for the period between 2003 and 2013 in the Romanian sea.

The objective was to determine the most important internal factors that influence banks’

performance. The performance was measured by return on assets. The independent variables

used were bank’s size, financial leverage, loans to assets ratio, and deposits to assets ratio,

number of employees, liquidity, net result and monetary policy rate. The results of the study

showed that bank’s size and loans to assets ratio do not have a significant impact on

performance. Financial leverage has a negative impact, meanwhile the number of employees,

liquidity ,deposits to assets ratio and net result have a positive effect.

Mhiri & Ameur, (2013) carried out a study on the factors explaining Tunisian bank performance.

They employed the GMM estimator technique described by Blundell and Bond (1998).The

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 population of the study was the main 10 commercial Tunisian banks during the 1998 to 2011

period. They examined whether, for banks operating in similar macroeconomic and financial

development environments, one can make judgments concerning the success of their competitive

strategies and other managerial procedure by using different profitability measures. The

investigation included bank-specific as well as industry-specific and macroeconomic factors

affecting bank performance. The empirical results revealed a high degree of persistence of bank

performance. By the other hand, their findings suggested that the bank capitalization, as well as

the best managerial efficiency, have a positive and significant effect on the bank performance.

Private owned banks seem to be more profitable than state owned ones. Privatizing state-owned

Tunisian banks was recommended in order to improve their performance. Industry-specific

factors, as the concentration and that of the system bank size have a negative and a significant

effect on performance. As for the impact of the macroeconomic indicators, we conclude overall

that the variables do not have a significant effect on bank performance. However Inflation seems

to affect negatively bank’s net interest margin.

Cekrezi (2015) did a study to explore the factors that mostly affect financial performance of

commercial banks which operate in Albania. The study population consisted of 16 commercial

banks with domestic and foreign capital, during the period 2010-2013 with a total of 48 data. The

investigation used cross-sectional time series data which are collected from the Balance Sheet

Annual Reports. Based on literature review, performance is defined in different ways but the

study seeked to establish the underlying factors responsible on determine the return on assets

(ROA) of the sample selected. The findings were that bank size and non interest expenses has a

negative but statistically insignificant effect on banks. Capital adequacy has a negative impact

and liquidity as well. Age is not a significant factor to take into consideration in analyzing bank

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 performance. A policy on efficient management should be put in place for bank the

determination of equity capital and amount of loans by finding ways to obtain the optimal

utilization of resources.

Obamuyi (2013) carried out a study to investigate the effects of bank capital, bank size, expense

management, interest income and the economic condition on banks’ profitability in Nigeria. The

fixed effects regression model was employed on a panel data obtained from the financial

statements of 20 banks from 2006 to 2012. The results indicated that improved bank capital and

interest income, as well as efficient expenses management and favorable economic condition,

contribute to higher banks ‘performance and growth in Nigeria. Thus government policies in the

banking system must encourage banks to regularly raise their capital and provide the enabling

environment that will accelerate economic growth in the country. Bank management must

efficiently manage their portfolios in order to protect the long run interest of profit-making.

Tai (2014) carried out a study to examine the efficiency and performance of 58 publicly listed

conventional and Islamic national banks in the Gulf Cooperation Council (GCC) countries

between 2003 and 2011. A translog cost function was used to evaluate the efficiency of the GCC

banking sector and multiple regression analysis was employed to identify factors affecting the

performance of the 58 national banks. Empirical findings revealed that Masraf Al Rayan of Qatar

(an Islamic bank) was the most efficient bank while Kuwait Finance House (also an Islamic

bank) was the least efficient bank during the study period. Conventional banks were more

profitable, liquid, and solvent than Islamic banks during the earlier years of the study period

while Islamic banks were more profitable, liquid, and solvent than conventional banks during the

later years of the study period. Regression results indicate that economic conditions, bank size,

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 financial development, operating costs, and type of bank (conventional or Islamic) are significant

variables affecting return on average assets.

Ongore & Kusa (2013) carried out a study on the determinants of financial performance of

commercial banks in Kenya. The researchers used linear multiple regression model and

generalized Least Square on panel data to estimate the parameters. The data was from 2001 to

2010 and the study was done on 37 commercial banks in Kenya. The findings showed that bank

specific factors significantly affect the performance of commercial banks in Kenya, except for

liquidity variable. But the overall effect of macroeconomic variables was inconclusive at 5%

significance level. The moderating role of ownership identity on the financial performance of

commercial banks was insignificant. Thus, it can be concluded that the financial performance of

commercial banks in Kenya is driven mainly by board and management decisions, while

macroeconomic factors have insignificant contribution.

Onuonga (2014) did an analysis of profitability of Kenya’s six commercial banks: Internal factor

analysis. The aim of the study was to analyze the impact of the internal determinants of

profitability of Kenya’s top six commercial banks over the period 2008-2013. The paper used

generalized least squares method to estimate the impact of banks asset, capital, loan, deposits and

assets quality on banks profitability. Return on Assets (ROA) was used as a measure of

profitability. The findings revealed that bank size, capital strength, ownership, operations

expenses, diversification do significantly influence the profitability of the top six commercial

banks. The results suggested that the Kenyan Government should set policies that encourage

banks to raise their asset capital base as this will enhance performance of the sector. Another

implication of the study was that commercial banks need to invest in technologies and

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 management skills which minimize costs of operations as this will impact positively their growth

and survival.

Lukorito, Muturi & Nyangau (2014) carried out a study determined the effect of internal factors

on profitability of commercial banks in Kenya particularly the banks liquidity. The study

employed a descriptive research design incorporating panel data. All the 43 Commercial banks in

Kenya formed the population and a census was done over a period of 5 years from 2009 to 2013

due to availability of data. The study used secondary data obtained from the annual published

financial statements which were analyzed using descriptive and inferential statistics. Internal

factor was Liquidity, while Profitability was measured using ROA ratios. The findings of the

study showed that all the variables, liquidity, have statistically significant and positive

relationship with banks’ profitability. The study recommended that banks should invest heavily

in assets if substantial gains have to be realized, maintain adequate liquidity levels though in the

form of short term marketable securities in order to realize profits and aggressively identify

viable investment opportunities and link such opportunities to customer deposits.

2.6 Narrations of the Variables

2.6.1 Dependent Variables

Profitability is the dependent variable for this study that will be estimated using different

method. The research concentrates on determining internal factors affecting performance of

banking sector using regression model.

Profitability refers to money that a firm can attain with the available resources. The goal of most

organization is profit maximization and loss minimization (Niresh & Velnampy, 2014).

Profitability depict efficiency of the management in converting firm’s resource to profit (Muya

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 & Gathogo, 2016) The profitability of a banking institution can thus be defined as net profit of

the bank (San & Heng, 2013)

In accounting theory, profitability shows surplus of profit over expenses for a specified duration

that represent earning of commercial banks from various activities they perform in a growing

economy (Tariq, et al.,2014)

The study will analyses profitability using Return on Assets (ROA) as one of the profitability

ratios.

2.6.2 Independent Variables

The internal factors that affect the profitability of banks in Tanzania. The CAMEL framework

often used by scholars to proxy the bank specific factors (Dang, 2011). CAMEL stands for

Capital Adequacy, Asset Quality, Management Efficiency, Earnings Ability and Liquidity.

However, this study will focus on the following factors:

2.6.2.1 Capital Adequacy

This is an internal factor for the measurement of the profitability and the amount retained by the

bank to meet the unexpected loss and danger involved. Capital adequacy is measured by the ratio

of capital and reserves of each commercial bank to total assets or as the ratio of equity to total

assets of a bank. Generally, banks with high capital ratio, if other factors are constant, will face

relatively lower financial difficulties during general financial crisis within the economy and this

will translate to high profits. Also, well capitalized banks are able to meet the capital

requirements set by central bank while the excess can be used to provide loans.

Capital adequacy shows the level of capital required by the banks to enable them withstand the

risks such as credit, market and operational risks they are exposed to in order to absorb the

potential loses and protect the bank's debtors (Ongore & Kusa, 2013). Capital adequacy ratio

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 demonstrates the internal strength of the bank to support losses during crisis periods. High of this

ratio shows the high profitability and lower ratio indicates the decrease of the profitability.

Berger capital requirements may give incentives for some banks to increase their risks of failure.

Inaccuracies in setting capital requirements distort relative prices and may create allocate

inefficiencies that divert financial resources from their most productive uses. Capital adequacy is

computed as a ratio of total equity to total asset.

2.6.2.2 Asset Quality

The bank's asset is another bank specific variable that affects the profitability of a bank. The

bank asset includes among others current asset, credit portfolio, fixed asset, and other

investments. Often a growing asset (size) related to the age of the bank (Athanasoglou et al.,

2005). More often than not the loan of a bank is the major asset that generates the major share of

the bank’s income. Loan is the major asset of commercial banks from which they generate

income. The quality of loan portfolio determines the profitability of banks. The loan portfolio

quality has a direct bearing on bank profitability.

The highest risk facing a bank is the losses derived from delinquent loans (Dang, 2011). Thus,

nonperforming loan ratios are the best proxies for asset quality. Different types of financial ratios

are used to study the performances of banks by different scholars. It is the major concern of all

banks to keep the amount of nonperforming loans to low level. This is so because high

nonperforming loan affects the profitability of the bank. Thus, low nonperforming loans to total

loans shows that the good health of the portfolio a bank. The lower the ratio the better the bank

performing (Sangmi&Nazir, 2010). Basically asset quality is the ratio of non-performing and

delinquent loans to total loans. (Ginevicius & Podviezko, 2011).

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 2.6.2.3 Liquidity

Liquidity is the amount of short-term responsibilities that could be met with the amount of liquid

assets. Liquidity has been found in some studies to have a positive impact on the financial

performance of banks. In other studies, it has a negative effect while in others it has no effect and

is insignificant. Different scholars have different ways of measuring liquidity of banks. There are

various measures that can be used to measure liquidity, but all show how the company/firm is

able to cover their current liabilities using their current assets.

This study will explore liquidity as a determinant of performance of banks considering various

directives from BOT and IASB (International Accounting Standard Board) that have been done

during the period for instance introduction of IFRS 9.

2.6.2.4 Non-interest Expenses

Non-interest expenses can be defined as operating expenses of a bank or financial institution that

is classified separately from interest expense and provision for credit losses. Examples of non-

interest expenses includes salaries and benefits; Fees and commissions; and other operating

expenses.

2.7 Summary of the Literature Review

Empirical review was more on the global literature than local studies. This is because very few

studies have been done in Tanzania and Africa in relation to the area of the study. The empirical

studies have showed various factors that affect the financial performance of banks. In most of the

studies financial performance has been measured using the return on assets (ROA). Factors

analyzed include capital adequacy, bank size, asset quality, liquidity, income diversification and

operational cost efficiency. Most of the studies that incorporated capital adequacy, income and

diversification found the studies to have a positive significant correlation to financial

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 performance. Results on bank size and liquidity were inconclusive. A study on the effect of

financial restricting found that its effect was very minimal and could only explain 26.7% of

financial performance leaving the other more than 70% unexplained, at least not in the findings

of the analysis of the study. This study covered the main factors outlined in the literature review

and focused on the impact of internal factors on the financial performance of commercial banks

operate in Tanzania: case of ten largest commercial banks.

2.2 Conceptual Framework of the Study

The section describes the relationship between dependent and independent variables that are

expected to be employed in this research. Dependent variable is profitability that is measured

through ROA while the independent variables are internal factors initiated from banks specific

such as Asset quality, Capital Adequacy (CAR), Liquidity and non-interest expense

Figure 2. 1Conceptual Framework

Independent Variable Dependent Variables

 Asset quality
 Capital Adequacy (CAR) Bank’s Profitability
 Liquidity (ROA)
 Non-interest expense

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 CHAPTER THREE

RESEARCH METHODOLOGY

3.1 Introduction

Research methodology applied for this study is described in this chapter. It explains the research

design, population and sample size, data collection technique, measurement of research variables

as well as data analysis.

3.2 Research Design

Research design refers to how data collection analysis is structured in order to meet the research

objectives through empirical evidence economically (Cooper &Schindler, 2003). The research

uses a descriptive research design that seeks to provide more information on the internal factors

that affect profitability of banks in Tanzania and how exactly they affect the financial

performance. The study looks into the internal factors that affect financial performance. This

obtained from the empirical evidence that was gathered. Once that is gathered, the results were

evaluated through econometrics model to deduce the extent to which each of the factors

identified affects the performance of the banks. The level of significance of each factor was also

identified. Preliminary estimation coefficients of variables were carried out to determine

explanatory variables that appeared in regression model.

3.3 Population Size

Cooper & Emory (1995) define population as the total collection of elements about which the

researcher wishes to make inferences. The population from this study comprised of ten largest

commercial banks in Tanzania for the period of 2010 to 2019. This is because ten largest banks

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 holding 72.2 percent of the total assets, 72.98 percent of total loans and 74.5 percent of total

deposits for Tanzania Banking sector (Source: Financial Sector Supervision Annual Report

2019).

The largest commercial banks comprise of CRDB Bank Plc, NMB Bank, NBC Bank, Stanbic

Bank, Standard Chartered Bank, Absa Bank Tanzania Limited, DTB -Diamond Trust Bank,

Exim Bank Plc, Azania Bank, Citibank Tanzania. (Source: Total Assets of Commercial Banks

Annual Reports for the year 2019)

3.4 Sampling Procedure and Techniques

A sample is a group of respondents drawn from a population in which the researcher is interested

to collect information and drawing conclusion (Goetz & LeCompte, 1984). A sample comprise

of ten largest commercial banks in Tanzania for the period from 2010 to 2019.

3.5 Data Collection

This study used secondary data for the various variables that was put into the model. Data

collected was from various sources, including the Bank of Tanzania, websites of banks operated

in Tanzania, National bureau of statistics (NBS) and Banking sector annual reports for the period

from 2010 to 2019 from Directorate of Banking Supervision, Bank of Tanzania). This data was

used extensively in analyzing the various factors that affect the financial performance.

3.6 Data Analysis

The secondary data obtained in this study was analyzed using inferential analysis. It covered the

period of nine years from 2010 to 2019. For purposes of analysis, Pearson correlation and

regression analysis was used in testing the hypothesis. The financial performance was the

dependent variable in the model. The internal factors affecting financial performance was the

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 independent variable. The focus of this study was to establish the link between internal factors

and financial performance. The study model was:

ROA t =α 0 +α 1 LQR it +α 2 AQ ¿ +α 3 CA ¿ +¿ α 4 NIE¿ + μ ¿

Where:

ROA- Return on asset at a certain point in time t.

α 0−¿ is the intercept.

α 1−α 4 are the coefficients parameters.

LQR ¿−¿ Liquidity ratio of bank at time t.

AQ ¿ - Asset quality bank i at time t

AC ¿ −¿Capital adequacy of bank at time t.

NIE¿- Non-Interest expense of bank at time t

μ¿ - is the error term where i is cross sectional and t is the multiplier.

Return on assets (ROA) was measured by the ratio of net income to average total assets.

Liquidity (LQR) is the measure of the banks’ ability to pay operating expenses and other short-

term, or current, liabilities. It’s the ratio of total loans to total customer deposits. A low liquidity

measure would indicate either that the bank is having financial problems, or that the bank is

poorly managed.

Non- Interest Expense (NIE) is measured as non-interest expenses divided by total income. This

will assist in measuring cost efficiency.

Capital adequacy (K) is measured through dividing total equity by Total assets.

Asset quality (AQ) is the ratio of nonperforming loans to total loans. It’s arrived at through

dividing nonperforming loans by total loans.

To check for normality, descriptive statistics will be used.

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 The existence of a strong correlation between independent variables was tested using the

correlation coefficient. Scores of 1.0 and 0.8 respectively show the existence of multicollinearity.

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 CHAPTER FOUR

DATA ANALYSIS AND INTERPRETATION OF FINDINGS

4.1 Introduction

This chapter presents the analysis and findings of the study as set out in the research objective

and research methodology. The study findings are presented on the internal factors affecting

performance of commercial banks in Tanzania case of ten largest commercial banks in Tanzania.

The data was collected from the bank's annual reports for the period of 2010-2019. Data were

analyzed using Eview software. The result findings include a test for multicollinearity,

correlation and regression analysis.

4.2 Correlation Analysis

Correlation is a bivariate analysis that measures the strength of linear association between two

variables and the direction of the relationship. According to Gogtay and Thatte (2017),

Pearson(r) correlation is the most widely used correlation statistic to measure the degree of the

relationship between linearly related variables and adopted in this study. To measure the strength

of the relationship, the value of the correlation coefficient varies between +1 (positive one) and -

1 (negative one). Correlation provides Pearson r correlation coefficients between the independent

variable (Liquidity, Capital adequacy, Asset quality, Non-interest expense) and dependent

variable (bank performance).

Table 4. 1Correlations

Bank Liquidity Capital Asset’s Non-interest

performance adequacy quality expenses
Bank 1.000
performance
Liquidity 0.661 1.000
Capital 0.4507 0.1708 1.0000
adequacy

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 Asset’s 0.4152 -0.4559 0.0199 1.0000
quality
Non-interest 0.3590 0.4518 -0.4021 -0.3139 1.0000
expenses
Source: Researcher, 2021

From the correlation table, the correlation indicated a positive relationship between Bank

performances and Liquidity. That is as Liquidity increases there is an increase in Bank

performances. The results are consistent with Yi-Kai Chen et al, (2017) who conducted a study

on the Bank Liquidity Risk and Performance and revealed that there is a significantly positive

relationship between financial performance and liquidity.

The correlation indicated a positive relationship between Bank performances and Capital

adequacy. That is as Capital adequacy increases there is an increase in Bank performances.

Furthermore, Ozili, (2015) conducted a study on Determinants of Bank Performance and Basel

Capital Regulation and revealed that the bank performance was influenced by capital adequacy

of the banking sector.

The correlation indicated a strong positive relationship between Bank performances and asset

quality. That is as Asset quality increase there is an increase in Bank performance. Mehari and

Aemiro (2013) assess the impact of the Ethiopian companies' characteristics on their

performance. The results showed a positive significant between asset and performance.

According to the results, the quality of assets represents the important determinants of insurers'

performance.

The correlation indicated a positive relationship between Bank performances and non-interest

expense. That is as Non-interest expense increases there is an increase in Bank performances.

Amal et al, (2012) identified the factors affecting the financial Performance of Companies Listed

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 on Amman Stock Exchange. The results showed that the non-interest expenses have a positive

statistical effect on the financial performance of Companies

4.3 Tests for Statistical Assumptions

Different tests were run to make the data ready for analysis and to get reliable output from the

research. These tests were intended to check whether the Regression Model assumptions are

fulfilled when the explanatory variables are regressed against the dependent variables.

Accordingly, the following sub-section presents tests.

4.3.1Test of Heteroscedasticity

This section presents the tests for heteroscedasticity. The test statistics give us the information

we need to determine whether the assumption of homoscedasticity is valid or not. Results

reported indicate that the null hypothesis cannot be rejected since the p-values of both tests are

considerably greater than 0.05. From the results, we conclude that there is no heteroscedasticity

problem. This implies that, there is no evidence for the presence of heteroscedasticity, since the

p-values are considerably in excess of 0.05.

Table 4. 2 Heteroscedasticity result

Ho: Constant variance

Obs*R-squared = 0.3091

Prob. Chi-Square = 0.3017

Source: Researcher, 2021

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 4.3.2 Test for Assumption of Autocorrelation

As noted in Brooks (2008) this is an assumption that the covariance between the error terms over

time (or cross-section ally, for that type of data) is zero. In other words, it is assumed that the

errors are uncorrelated with one another. If the errors are not uncorrelated with one another, it

would be stated that they are ‘auto correlated’ or that they are serially correlated.

The results of Durbin-Watson test value for the autocorrelation of residual which is 1.416. The

Durbin-Watson statistic varies from 0 to 4 where a value near 2 indicates non-autocorrelation

while a value closer to 0 shows autocorrelation. A value closer to 4 indicates negative

autocorrelation. In this study the value is closer to 2 and we conclude that there is no

autocorrelation.

4.3.3 Test of Multicollinearity

Multicollinearity refers to predictors that are correlated with other predictors. Multicollinearity

occurs when the model includes multiple factors that are correlated not just to the response

variable but also to each other. According to Pallant (2013), multicollinearity increases the

standard errors of the coefficients. Increased standard errors in turn mean that coefficients for

some independent variables may be found not to be significantly different from 0. This means

that by overinflating the standard errors, Multicollinearity makes some variables statistically

insignificant when they should be significant. Without Multicollinearity, those coefficients might

be significant. Pearson‟s correlation analysis will be used to test for the existence of

Multicollinearity.

Variance inflation factor (VIF) was be used to confirm Multicollinearity. If the VIF for any

variable is around 10 or greater than 10, there is collinearity associated with that variable and

must be removed from the regression model, (Aandstad & Simon, 2013). The results show the

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 value VIF of all variables was below 10 which implies that there was no Multicollinearity

problem.

Table 4. 3Multicollinearity Test

Variables VIF

Capital adequacy 2.045

Asset quality 5.631

Liquidity 2.529

Non-interest expense 3.568

Source: Researcher, 2021

4.4 Regression Analysis

Regression analysis is a form of predictive modelling technique which investigates the

relationship between a dependent and independent variable(s). Regression analysis was

conducted to assess the factors affecting bank performance. Under regression analysis,

determining how well the model fits, this provided R 2 and adjusted R2, which was used to

determine how well a regression model fits the data. Another was statistical significance; this

controls whether the general regression model is suitable for data. Also, estimated model

coefficients, this coefficient provides the information necessary for the researcher to predict

variables dependent on independent variables, as well as to determine whether independent

variables contribute statistically to the model. Furthermore, with this analysis, one is able to

understand how the typical values of the dependent variable change when one of the independent

variables is varied, while the other variables are held constant/fixed.

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 4.4.1 Model fitness

In determining how well the model fits, R2, adjusted R2, was conducted to determine how well a

regression model, fits the data. In this case, the regression results in table 4.3 R-Square in the

study were found to be 0.7497. This value indicates that the independent variables (Liquidity,

Capital adequacy, Asset quality, Non-interest expense) can explain 74.97% of the variance in the

dependent variable (bank performance). Then the study found that the adjusted R² of the model

was 0.6996. This means that the linear regression explains 69.96% of the variance in the data.

Table 4. 4Model fit

Prob > F = 0.000

R-squared = 0.7497

Adjusted R-squared = 0.6996

Source: Researcher, 2021

4.4.2 Statistical Significance

In determining the Statistical Significance, Prob>F shows whether the overall regression model

is a good fit for the data. The results in table 4.3 show that the independent variables statistically

significantly predict the dependent variable, Prob > F = 0.0000 (the model was a good fit of the

data). Therefore, the null hypothesis was rejected by saying that at least one of the independent

variables (Liquidity, Capital adequacy, Asset quality and Non-interest expense) has effects on

dependent variables (Bank Performance)

4.4.3 Estimated Model

In determining the relationship between variables, the Coefficients provides the necessary

information to the researcher to predict the dependent variable from independent variables, as

well as determine whether independent variables contribute statistically significantly to the

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 model. Furthermore, Coefficient values were used to present the regression equation. The beta

values indicate the direction of the relationship. A p-value of less than 0.05 was recommended as

it signifies a high degree of confidence.

In this case, liquidity, capital and asset quality produced statistically significant results p< 0.05.

Liquidity (p= 0.040), Capital adequacy (p=0.000), Asset quality (p=0.000).This implies that the

hypothesis was accepted by concluding that, that Liquidity, Capital adequacy and Asset quality,

have a statistically significant contribution to the model (Bank Performance). Furthermore non-

interest expense produced statistically insignificant results p> 0.05, Non-interest expense (p=

0.736). This implies that non-interest expense, has a statistical insignificant contribute to the

model (Bank Performance)

The general form of the equation to predict dependent variable from independent variables which

were; Liquidity, Capital adequacy, Asset quality, Non-interest expense was;

Bank performance= -.0084687 + .007049LIQ + .03798CAP + .0281015AQ + -.0000204NIE +є

Furthermore, the results in coefficients indicated how much the dependent variable varies with

independent variables when all other independent variables are held constant. The results of the

regression show that if all the predictor variables were rated zero, Bank Performance would be

-.0084687. A unit increase in Liquidity, Bank Performance would be .007049 while a unit

increase in Capital adequacy, Bank Performance would be .03798. A unit increase in Asset

quality, Bank Performance would be .0281015. A unit increase in Non-interest expense, Bank

Performance would be -.0000204. The Stochastic Error Term was assumed to be zero.

Table 4. 5Regression Results

Bank performance Coef. Std. Err. T p>|t|

Liquidity .007049 .0032157 2.19 0.040

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 Capital adequacy .03798 .0077279 4.91 0.000

Assets quality .0281015 .0062025 4.53 0.000

Non-interest expenses -.0000204 .0000597 -0.34 0.736

_cons -.0084687 .0043062 -1.97 0.063

Source: Researcher, 2021

4.5 Discussion of Findings

The preceding sections present the overall results of the study. Thus, this section discusses in

detail the analyses of the results for each explanatory variable. In addition, the discussions

analyses the statistical findings of the study in relation to the previous empirical evidences.

Hence, the following discussions present the relationship between variables.

4.5.1 Effect of Liquidity on the performance of commercial banks

The study examine whether liquidity level affect performance of commercial banks in Tanzania.

The regression results showed Liquidity has a significant relationship with the bank performance

with a p-value of 0.040. These results are consistent with Gutu (2015) who carried out a study on

the microeconomic factors affecting bank’s financial performance focusing on 11 entities for the

period between 2003 and 2013 in the Romanian sea. The results of the study showed that

liquidity have a significant impact on performance. Financial leverage has a negative impact,

meanwhile the number of employees, deposits to assets ratio and net result have a positive effect.

Furthermore, Mhiri & Ameur, (2013) revealed that there is a significant relationship between

financial performance and liquidity.

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 4.5.2 Effect of capital adequacy on the performance of commercial banks

The study examined effect of capital adequacy on the performance of commercial banks in

Tanzania. The regression results shown capital adequacy has a significant relationship to the

bank performance with a p-value of 0.000. These results are consistent with Nsambu (2014) who

studied the factors affecting performance of domestic commercial banks in Uganda. The period

for the study was from 2000 – 2011. Linear multiple regression analysis was employed. The

study found that, capital adequacy and inflation are factors affecting the performance of domestic

commercial banks in Uganda over the period 2000-2011. Furthermore, Ongore & Kusa, (2013)

revealed that there is a statistically significant relationship between the degrees of capital

adequacy in the commercial bank's performance.

4.5.3 Effect of Asset quality on the performance of commercial banks

The study examined effect of quality of assets on the performance of commercial banks in

Tanzania. The regression results showed asset quality has a significant relationship to the bank

performance with a p-value of 0.000. Therefore, the hypothesis was accepted. These results are

consistent with Nsambu (2014) who studied the factors affecting performance of domestic

commercial banks in Uganda. The results were that financial performance was positively related

to assets quality.

4.5.4 Effect of Non-interest expense on the performance of commercial banks

The study examined effect of non-interest expenses on the performance of commercial banks in

Tanzania. The regression results showed non-interest expense has no significant relationship

with the bank performance with a p-value of 0.736. Ongore & Kusa (2013) carried out a study on

the determinants of financial performance of commercial banks in Kenya. The researchers used

linear multiple regression model and generalized Least Square on panel data to estimate the

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 parameters. The data was from 2001 to 2010 and the study was done on 37 commercial banks in

Kenya. The findings showed that bank non-interest expense affect the performance of

commercial banks in Kenya Muya & Gathogo, (2016) established that non-interest expenses has

a positive and insignificant effect on firm performance.

CHAPTER FIVE

CONCLUSIONS AND RECOMMENDATIONS

5.1 Introduction

This chapter is the concluding chapter of the study; it presents the conclusion of the study.

Additionally, it presents recommendations and suggestions for further studies for future

researchers.

5.2 Study Summary

The objective of the study was to determine internal factors affecting performance of commercial

banks in Tanzania case of ten largest commercial banks in Tanzania. Specifically, the study

examined effect of quality of assets on the performance of commercial banks, examine effect of

capital adequacy on the performance of commercial banks, examine whether liquidity level

affect performance of commercial banks and examine effect of non-interest expenses on the

performance of commercial banks in Tanzania.

The study adopted a descriptive research design. Comprised of ten largest commercial banks in

Tanzania for the period of 2010 to 2019. The study used secondary data for the variables

collected from banks annual reports. The secondary data obtained in this study was analyzed

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 using inferential analysis using Eview software whereby correlation and regression were

conducted to show the relationship between variables.

The empirical results show that assets quality has a significant effect on the performance of

commercial banks. Furthermore, the results show that capital adequacy has a significant effect on

the performance of commercial banks. Moreover, the results show that liquidity has a significant

effect on the performance of commercial banks and the results show that non-interest expenses

has no significant influence on the

5.3 Conclusions

This study sought to determine internal factors affecting performance of commercial banks in

Tanzania; case of ten largest commercial banks in Tanzania during the period 2010 to 2019. The

financial performance is measured by the return on assets. The empirical results showed that the

factors such as capital adequacy, asset quality and liquidity are major determinants of bank

performance and hence significantly influence performance while non-interest expense does not

significantly influence performance. The results imply that banks have to invest optimally in

both human and capital resources for it to generate revenues which translate to performance.

The study concludes that assets quality has a significant influence on performance. The study

concludes that liquidity has a significant influence on performance. The study concludes that

capital adequacy has a significant influence on performance and the study concludes that non-

interest expense has no significant influence on performance. Overall, this empirical study

provides evidence that bank-specific factors including capital adequacy, asset quality and

liquidity have the most significant impacts on the financial performance of commercial banks in

Tanzania.

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 5.4 Recommendations

Based on the study findings and conclusions, the following recommendations are made on ways

of improving the financial performance of commercial banks specifically, the commercial banks

for them to catch up with the rest of the institutions in Tanzania. This calls for regulatory

adjustments to address challenges that affect bank performance.

Firstly, policymakers on banks should be put in place for bank the determination of capital by

finding ways to obtain the optimal utilization of resources. Maintaining a sufficient capital base

can help the banks to embrace competition and enhance performance.

Furthermore, the banking sector stakeholders should consider assets as a variable that determine

the bank performances by considering both current assets, credit portfolios and other investments

Thus, it is possible to recommend that banks should consider asset quality because banks with

high asset quality and low non-performing loan are more profitable than the others.

Moreover, policymakers and bank management should create a strategy for banks to manage

liquidity because liquidity non-interest expenses is very important in bank performance.

Therefore for banks to enhance performance need to keep high liquid assets; rather it means that

liquidity has a high effect on the performance of commercial banks in the study period in

Tanzania. Thus, it is possible to recommend that those bank managers who invest their liquid

assets can generate income and boost their performance.

Also, performance is an important factor that reflects the company's financial health. However,

one should be aware that people's expectations and reactions towards income disclosure might

have pressured managers to manipulate it to deceive readers. Close inspection of financial

numbers will reduce the risks than looking at the bottom line.

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 In general, it can be recommended that liquidity, capital and asset quality should be taken into

consideration because are the most significant determinants of the financial performance of

commercial banks in Tanzania.

5.5 Area for Further Study

This study determines internal factors affecting performance of commercial banks in Tanzania,

case of ten largest commercial banks. The study was collected from 10 commercial banks.

Further study should include sample size that include banks of all size

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