Determinants of commercial banks’ profitability in Tanzania

This study aims to investigate the determinants of commercial banks’ profitability in Tanzania, the nature of profit persistence and causality between profitability and equity formation. Using a quarterly panel of twenty-one commercial banks for 1998q1 to 2010q1 period (734 observations), the researcher employed the Arellano-Bond Generalized Method of Moments estimation technique to reduce the severity of endogeneity. The findings suggest that credit risk and financial deepening have a negative relationship with profitability, while capital, expense management inefficiency, inflation, Treasury bill rate, openness of the economy, macroeconomic stability and crowding have a positive relationship with bank profitability. The Granger causality test suggests that higher capitalization is associated with lower future profitability, while profitability was associated with lower future levels of equity formation. The results further confirmed the dynamic character of the model, while the Structure-Conduct Performance hypothesis was not supported. These findings recommend that existing commercial banks improve their portfolio management and income source diversification, their efficiency and competitiveness in order to deliver quality services at reasonable cost and minimum interest rate spread. In addition they should improve their systems for forecasting, screening and monitoring credit and other types of bank risk, there should be keen supervisory surveillance by the central bank as well as speeding up the establishment of a credit reference bureau to promote sharing of information on borrower characteristics. Finally, there should be an improvement in budget stance and stable macroeconomic conditions through the use of prudent fiscal, monetary and exchange rate policies that enhance the intermediation efficiency and reduce the critical problem of crowding.