經濟與管理論叢(Journal of Economics and Management), 2011, Vol. 7, No.

1, 43-72

Profitability of the Korean Banking Sector:

Panel Evidence on Bank-Specific
and Macroeconomic Determinants

Fadzlan Sufian*
Khazanah Research and Investment Strategy, Khazanah Nasional Berhad, Malaysia
and
Department of Economics, Faculty of Economics and Management, Universiti Putra
Malaysia, Malaysia

The paper analyzes the profitability of banks in Korea, while controlling for a wide
array of bank specific and macroeconomic determinants. We find that Korean banks
with lower liquidity levels tend to exhibit higher profitability. Furthermore, higher
diversification regarding banks’ income sources towards derivative instruments and
other fee-based activities shows a positive effect. The impacts of credit risk and
overhead costs are always negative whether we control for the macroeconomic and
financial conditions or not. Business cycle effects, particularly inflation, display a
substantial pro-cyclical impact on bank profitability. The industry concentration of
the national banking system positively and significantly affects bank performance.
The impact of the Asian financial crisis is negative, while Korean banks have been
relatively more profitable during the pre-crisis compared to the post-crisis period.

Keywords: banks, profitability, financial crisis, Korea

JEL classification: G21

Received July 27, 2009, revised April 8, 2010, accepted June 29, 2010.
*
Correspondence to: Khazanah Research and Investment Strategy, Khazanah Nasional Berhad, Level
35, Tower 2, Petronas Twin Towers Kuala Lumpur City Centre, 50088 Kuala Lumpur, Malaysia. e-mail:
fadzlan.sufian@khazanah.com.my; fsufian@gmail.com. Tel.: 603-2034-0197, Fax: 603-2034-0035. We
would like to thank the anonymous referee for the comments and suggestions. Any remaining errors are
our own. The usual caveats apply.
44 經濟與管理論叢(Journal of Economics and Management)

1 Introduction

In recent years, major structural changes have occurred in the Korean banking sector.
These major changes in the Korean banking sector materialized after 1997, when
Korea suffered severe economic damage during the Asian financial crisis. Since then,
the banking sector in Korea has substantially metamorphosed under the
comprehensive financial reform programme agreed upon by the Korean government
and the International Monetary Fund (IMF). For example, the five commercial
banks which the Financial and Supervisory Commission (FSC) evaluated in June
1998 as unviable were ordered to be liquidated and their assets and liabilities
transferred to stronger banks under a purchase and assumption (P&A) arrangement.
Furthermore, Commercial Bank and Hanil Bank, which were conditionally approved
for restructuring by the FSC, were merged. Korea First Bank and Seoul Bank, which
proved to be insolvent in 1997, were recapitalized by the Government and later sold
to foreign banks.
Corporate governance in the Korean banking sector has also improved
dramatically and various financial deregulation measures have been introduced since
the Asian financial crisis. The ownership and governance structure of commercial
banks has been changed extensively by a series of amendments to the Banking Act.
In addition, new standards have been implemented to better protect shareholders’
rights. The limit of a 4 percent corporate ownership ceiling for foreign investors has
been lifted and most of the regulations concerning foreign banks were abolished in
the early 1990s.1
It is reasonable to assume that these developments posed great challenges to
financial institutions in Korea as the environment in which they operated changed
rapidly, a fact that consequently had an impact on the determinants of Korean banks’
profitability. As Golin (2001) points out, adequate earnings are required in order for
banks to maintain solvency, to survive, grow, and prosper in a competitive
environment.

1
One of the notable changes in the Korean financial market in recent years is the increasing
ownership by foreign investors. The share of total market capitalization of foreigners’ shareholdings has
steadily increased and totaled more than 40 percent in January 2004. In addition to the above examples,
Kookmin Bank is a 74 percent foreign-held bank.
 Profitability of the Korean Banking Sector 45

As the banking sector is the backbone of the Korean economy and plays an
important financial intermediary role, its health is very critical to the health of the
general economy at large. Given the relationship between the well being of the
banking sector and the growth of the economy (Rajan and Zingales, 1998; Levine,
1998; Levine and Zervos, 1998; Cetorelli and Gambera, 2001; Beck and Levine,
2004), knowledge of the underlying factors that influence the financial sector’s
profitability is therefore essential not only for the managers of the banks, but also for
numerous stakeholders such as the central banks, bankers’ associations,
governments, and other financial authorities. Knowledge of these factors would also
be useful to help the regulatory authorities and bank managers formulate going-
forward policies for the improved profitability of the Korean banking sector.
By using an unbalanced bank level panel data set, this study seeks to examine
the determinants of Korean banks’ profitability during the period 1992-2003, which
is characterized as a time of significant reform in the country’s financial sector.
While there have been extensive studies examining the profitability of the financial
sector in developed countries, empirical works on factors that influence the
performance of financial institutions in developing economies are relatively scarce.
This remainder of this paper is structured as follows. Section 2 reviews the
related studies in the literature, and is followed by Section 3 that outlines the
econometric framework. Section 4 reports the empirical findings. Finally, Section 5
concludes and offers avenues for future research.

2 Related Studies

The empirical literature on bank profitability has mainly focused on the U.S.
banking system (Berger, 1995; Angbazo, 1997; DeYoung and Rice, 2004; Stiroh
and Rumble, 2006; Hirtle and Stiroh, 2007) and the banking systems in the western
and developed countries such as New Zealand (Ho and Tripe, 2002), Australia
(Williams, 2003), Greece (Pasiouras and Kosmidou, 2007; Kosmidou et al., 2007;
Athanasoglou et al., 2008; Kosmidou and Zopounidis, 2008).
By contrast, fewer studies have looked at bank performance in developing
economies. Guru et al. (2002) investigate the determinants of bank profitability in
Malaysia, using a sample of 17 commercial banks during the 1986 to 1995 period.
46 經濟與管理論叢(Journal of Economics and Management)

The profitability determinants are divided into two main categories, namely, the
internal determinants (liquidity, capital adequacy, and expenses management) and
the external determinants (ownership, firm size, and economic conditions). Their
findings reveal that efficient expenses management is one of the most significant
factors explaining high bank profitability. Among the macro indicators, a high
interest ratio is associated with low bank profitability and inflation is found to have a
positive effect on bank performance.
Chantapong (2005) investigates the performance of domestic and foreign banks
in Thailand during the period 1995-2000. All banks are found to have reduced their
credit exposure during the crisis years and have gradually improved their
profitability during the post-crisis years. The results indicate that foreign bank
profitability is higher than the average profitability of the domestic banks. This is in
spite of the gap between foreign and domestic bank profitability having been closed
in the post-crisis period, implying that the financial restructuring program has
yielded some positive results.
Ben Naceur and Goaied (2008) examine the impact of bank characteristics,
financial structure, and macroeconomic conditions on Tunisian banks’ net-interest
margins and profitability during the period from 1980 to 2000. They suggest that
banks which hold a relatively high amount of capital and higher overhead expenses
tend to exhibit higher net-interest margin and profitability levels, while size is
negatively related to bank profitability. During the period under study, they find that
stock market development has a positive impact on bank profitability. The empirical
findings suggest that private banks are relatively more profitable than their state-
owned counterparts. The results indicate that macroeconomic conditions have no
significant impact on Tunisian banks’ profitability.
Ben Naceur and Omran (2008) analyze the influence of bank regulations,
concentration, and financial and institutional development on the Middle East and
North Africa (MENA) countries’ commercial banks’ margins and profitability
during the period 1989-2005. They find that bank-specific characteristics, in
particular bank capitalization and credit risk, have a positive and significant impact
on banks’ net interest margins, cost efficiency, and profitability. On the other hand,
macroeconomic and financial development indicators have no significant impact on
bank performance.
 Profitability of the Korean Banking Sector 47

More recently, Sufian and Habibullah (2009) have investigated the

determinants of the profitability of the Chinese banking sector during the post-
reform period of 2000-2005. They find that liquidity, credit risk, and capitalization
have positive impacts on the state-owned commercial banks’ profitability, while the
impact of overhead cost is negative. They suggest that the joint stock commercial
banks with higher credit risk tend to be more profitable, while higher costs result in
lower joint stock commercial banks’ profitability levels. They find that size and cost
result in the lower profitability of city commercial banks, while the more diversified
and relatively better capitalized city commercial banks exhibit higher profitability
levels. The impact of economic growth is positive, while the growth of money
supply is negatively related to the state-owned commercial banks’ and city
commercial banks’ profitability levels.

3 Data and Methodology

We collected our bank-specific variables from the financial statements of a sample

of commercial banks operating in Korea over the period 1992-2003 that are
available in the Bankscope database of Bureau van Dijk’s company. The
macroeconomic variables are retrieved from the IMF Financial Statistics (IFS)
database. Due to the consolidation and exit of banks during the past decade, the total
number of commercial banks in the sample varied from 11 banks in 1992 to 29
banks in 2000. This gives us a total of 251 bank year observations.

3.1 Performance Measure

In the literature, bank profitability, which is typically measured by the return on

assets (ROA) and/or the return on equity (ROE), is usually expressed as a function
of internal and external determinants. Internal determinants are factors that are
mainly influenced by a bank’s management decisions and policy objectives. Such
profitability determinants are the level of liquidity, provisioning policy, capital
adequacy, expenses management, and bank size. On the other hand, the external
determinants, both industry- and macroeconomic-related, are variables that reflect
the economic and legal environments where the financial institution operates.
48 經濟與管理論叢(Journal of Economics and Management)

Following Sufian and Habibullah (2009), Ben Naceur and Goaied (2008), and
Kosmidou (2008) among others, the dependent variable used in this study is ROA.
ROA shows the profit earned per dollar of assets and most importantly reflects
management’s ability to utilize the bank’s financial and real investment resources to
generate profits (Hassan and Bashir, 2003). For any bank, ROA depends on the
bank’s policy decisions as well as uncontrollable factors related to the economy and
government regulations. Rivard and Thomas (1997) suggest that bank profitability is
best measured by ROA given that ROA is not distorted by high equity multipliers
and ROA represents a better measure of the ability of the firm to generate returns on
its portfolio of assets. ROE, on the other hand, reflects how effectively a bank
management is in utilizing its shareholders’ funds. Since ROA tends to be lower for
financial intermediaries, most banks utilize financial leverage heavily to increase
ROE to competitive levels (Hassan and Bashir, 2003).

3.2 Internal Determinants

The bank-specific variables included in the regression models are LNTA (log of
total assets), LLP/TL (loans loss provisions divided by total loans), NII/TA (non-
interest income divided by total assets), NIE/TA (total overhead expenses divided by
total assets), LNDEPO (log of total deposits), and EQASS (book value of
stockholders’ equity as a fraction of total assets).
The LNTA variable is included in the regression as a proxy of size to capture
the possible cost advantages associated with size (economies of scale). This variable
controls for cost differences and product and risk diversification according to the
size of the bank. The first factor could lead to a positive relationship between size
and bank profitability if there are significant economies of scale (Akhavein et al.,
1997; Bourke, 1989; Molyneux and Thornton, 1992; Bikker and Hu, 2002; Goddard
et al., 2004), while the second could lead to a negative one, if increased
diversification leads to lower credit risk and thus lower returns. Other researchers,
however, conclude that marginal cost savings can be achieved by increasing the size
of the banking firm, especially as markets develop (Berger et al., 1987; Boyd and
Runkle, 1993; Miller and Noulas, 1997; Athanasoglou et al., 2008). In essence,
LNTA may lead to positive effects on bank profitability if there are significant
 Profitability of the Korean Banking Sector 49

economies of scale. On the other hand, if increased diversification leads to higher

risks, the variable may exhibit negative effects.
The ratio of loan loss provisions to total loans (LLP/TL) is incorporated as an
independent variable in the regression analysis as a proxy of credit risk. The
coefficient of LLP/TL is expected to be negative because bad loans reduce bank
profitability. In this direction, Miller and Noulas (1997) suggest that the greater the
exposure of the financial institutions to high-risk loans, the higher would be the
accumulation of unpaid loans and profitability would be lower. Miller and Noulas
(1997) suggest that declines in loan loss provisions are in many instances the
primary catalyst for increases in profit margins. Furthermore, Thakor (1987) also
suggests that the level of loan loss provisions is an indication of the bank’s asset
quality and signals changes in future performance.
To recognize that financial institutions in recent years have increasingly been
generating income from “off-balance sheet” business, particularly income from
trading in the stock markets and derivative financial instruments and fee income
generally, the ratio of non-interest income over total assets (NII/TA) is entered in the
regression analysis. Non-interest income consists of commission, service charges,
and fees, guarantee fees, net profits from sales of investment securities, and foreign
exchange profits. The ratio is also included in the regression model as a proxy
measure of bank diversification into non-traditional activities. The variable is
expected to exhibit a positive relationship with bank profitability.
The ratio of overhead expenses to total assets, NIE/TA, is used to provide
information on the variations in bank operating costs. The variable represents the
total amount of wages and salaries, as well as the costs of running branch office
facilities. For the most part, the literature argues that reduced expenses improve the
efficiency and hence raise the profitability of a financial institution, implying a
negative relationship between the operating expenses ratio and profitability (Bourke,
1989). However, Molyneux and Thornton (1992) observe a positive relationship,
suggesting that high profits earned by firms may be appropriated in the form of
higher payroll expenditures paid to more productive human capital.
The variable LNDEPO is included in the regression model as a proxy variable
for network embeddedness. It would be reasonable to assume that banks with large
branch networks are able to attract more deposits, which is a cheaper source of funds.
50 經濟與管理論叢(Journal of Economics and Management)

Earlier studies by Chu and Lim (1998) among others point out that large banks may
attract more deposits and loan transactions and in the process command larger
interest rate spreads, while the smaller banking groups with smaller depositor bases
might have to resort to purchasing funds in the inter-bank market, which is more
costly (Lim and Randhawa, 2005). On the other hand, Lim and Randhawa (2005)
suggest that the small banks, with their smaller depositor bases and thus fewer
deposits to transform into loans, have attained higher efficiency levels compared to
their larger counterparts.
EQASS is included in the regressions to examine the relationship between
profitability and bank capitalization. Even though leverage (capitalization) has been
demonstrated to be important in explaining the performance of financial institutions,
its impact on bank profitability is ambiguous. As lower capital ratios suggest a
relatively risky position, one might expect a negative coefficient on this variable
(Berger, 1995). However, it could be the case that higher levels of equity would
decrease the cost of capital, leading to a positive impact on bank profitability
(Molyneux, 1993). Moreover, an increase in capital may raise expected earnings by
reducing the expected costs of financial distress, including bankruptcy (Berger,
1995).

3.3 External Determinants

Bank profitability is sensitive to macroeconomic conditions despite the trend in the

industry towards greater geographic diversification and the larger use of financial
engineering techniques to manage risk associated with business cycle forecasting.
Generally speaking, higher economic growth encourages banks to lend more and
permits them to charge higher margins, as well as improving the quality of their
assets. Neely and Wheelock (1997) use per capita income and suggest that this
variable exerts a strong positive effect on bank earnings. Dermiguc-Kunt and
Huizinga (2001) and Bikker and Hu (2002) identify possible cyclical movements in
bank profitability, i.e., the extent to which bank profits are correlated with the
business cycle. Their findings suggest that such correlation exists, although the
variables used are not direct measures of the business cycle.
 Profitability of the Korean Banking Sector 51

To measure the relationship between economic and market conditions and bank
profitability, LNGDP (the natural log of GDP), INFL (the rate of inflation), CR3
(the ratio of the three largest banks’ assets), MKTCAP (the ratio of the stock market
capitalization over GDP), DUMTRAN1 (a dummy variable that takes a value of 1
for the first tranquil (pre-crisis) period, and 0 otherwise), DUMCRIS (a dummy
variable that takes a value of 1 for the crisis period, and 0 otherwise), and
DUMTRAN2 (a dummy variable that takes a value of 1 for the second tranquil
(post-crisis) period, and 0 otherwise) are used.
Gross domestic product (GDP) is among the macroeconomic indicators most
commonly used to measure total economic activity within an economy. The GDP is
expected to influence numerous factors related to the supply and demand for loans
and deposits. Favorable economic conditions will also positively influence the
demand for and supply of banking services. Another important macroeconomic
condition which may affect both the costs and revenues of banks is the inflation rate
(INFL). Staikouras and Wood (2003) point out that inflation may have direct effects,
i.e., increases in the price of labor, and indirect effects, i.e., changes in interest rates
and asset prices on the profitability of banks. Perry (1992) suggests that the effects
of inflation on bank performance depend on whether the inflation is anticipated or
unanticipated. In the anticipated case, the interest rates are adjusted accordingly,
thereby causing revenues to increase faster than costs and to subsequently positively
impact bank profitability. On the other hand, in the unanticipated case, banks may be
slow in adjusting their interest rates, resulting in bank costs increasing faster than
bank revenues, and consequently having a negative effect on bank profitability.
Earlier studies by Bourke (1989), Molyneux and Thornton (1992), Dermiguc-Kunt
and Huizinga (1999), among others, have found a positive relationship between
inflation and bank performance.
The CR3 variable, measured as the concentration ratio of the three largest
banks in terms of assets, is entered in the regression models as a proxy variable for
the banking sector structure. According to the industrial organization literature, a
positive impact is expected under both views, i.e., the collusion versus the efficiency
views (Goddard et al., 2001).
Following Dermiguc-Kunt and Huizinga (1999) among others, MKTCAP is
introduced to the regression model to reflect the complementarity or substitutability
52 經濟與管理論叢(Journal of Economics and Management)

between bank and stock market financing. Dermiguc-Kunt and Huizinga (1999) find
that stock market capitalization to bank assets is negatively related to bank margins
and suggests that the relatively well-developed stock markets can substitute for bank
finance. We therefore expect the variable to be negatively related to bank
performance.
To capture the impact of the Asian financial crisis on the profitability of the
Korean banking sector, DUMTRAN1, DUMCRIS, and DUMTRAN2 are included
in regression models 3, 4, and 5, respectively. We expect the Korean banking sector
to exhibit higher profitability levels during both the tranquil periods, i.e.,
DUMTRAN1 and DUMTRAN2, while DUMCRIS is expected to exhibit a negative
relationship with the Korean banks’ profitability.
Table 1 lists the variables used to proxy profitability and its determinants. We
also include the notation and the expected effect of the determinants according to the
literature.
Table 2 presents the summary statistics of the dependent and the explanatory
variables.

3.4 Econometric Specification

To test the relationship between bank performance and the bank specific and
macroeconomic determinants described earlier, we estimate a linear regression
model in the following form:

yit = δ t + α ′jt X ijt + α it′ X ejt + ε jt , (1)

where j refers to an individual bank; t refers to year; yit refers to the return on
assets (ROA) and is the observation of bank j in a particular year t ; X i
represents the internal factors (determinants) of a bank; X e represents the external
factors (determinants) of a bank; and ε jt is a normally distributed random variable
disturbance term. We apply the least squares method of the fixed effects (FE) model,
where the standard errors are calculated by using White’s (1980) transformation to
control for cross-sectional heteroskedasticity. The opportunity to use a fixed effects
rather than a random effects model has been tested using the Hausman test.
 Profitability of the Korean Banking Sector 53

Table 1: Description of the Variables Used in the Regression Models

Variable Description Hypothesized

Relationship with
Profitability
Dependent
ROA The return on average total assets of bank j in year t. NA
ROE The return on average total shareholders’ equity of bank j in NA
year t.
Independent
Internal Factors
LNTA The natural logarithm of the accounting value of the total +/–
assets of bank j in year t.
LOANS/TA A measure of liquidity, calculated as total loans/ total assets. +
The ratio indicates what percentage of the assets of the bank
is tied up in loans in year t.
LLP/TL Loan loss provisions/ total loans. An indicator of credit risk, –
which shows how much a bank is provisioning in year t
relative to its total loans.
NII/TA A measure of diversification and business mix, calculated as +
non-interest income/ total assets of bank j in year t.
NIE/TA Calculated as non-interest expense/ total assets and provides –
information on the efficiency of the management regarding
expenses relative to the assets in year t. Higher ratios imply
a less efficient management.
LNDEPO LNDEP is a proxy measure of network embeddedness, +/–
calculated as the log of total deposits of bank j in year t.
EQASS A measure of bank j’s capital strength in year t, calculated +/–
as equity/ total assets. A high capital asset ratio is assumed
to be an indicator of low leverage and therefore lower risk.
External Factors
LNGDP Natural logarithm of gross domestic product. +/–
INFL The annual inflation rate. +/–
CR3 The three largest banks’ asset concentration ratio +/–
MKTCAP The ratio of stock market capitalization. The variable serves –
as a proxy of financial development.
DUMTRAN1 Dummy variable that takes a value of 1 for the first tranquil +
(pre crisis) period, and 0 otherwise.
DUMCRIS Dummy variable that takes a value of 1 for the crisis period, –
and 0 otherwise.
DUMTRAN2 Dummy variable that takes a value of 1 for the second +
tranquil (post crisis) period, and 0 otherwise.
54 經濟與管理論叢(Journal of Economics and Management)

Table 2: Summary Statistics of Dependent and Explanatory Variables

ROA ROE LNTA LOANS/ LLP/ NII/ NIE/ LNDEPO EQASS LNGDP INFL CR3 MKTCAP

TA TL TA TA

Mean –0.01 –0.34 15.57 0.60 0.01 0.02 0.03 15.14 0.06 13.17 4.04 0.36 0.39

Min –0.12 –17.00 9.81 0.19 –0.11 –0.10 0.01 11.01 –0.06 12.83 1.40 0.24 0.18

Max 0.08 4.86 19.05 4.79 0.15 0.12 0.17 18.72 1.12 13.40 6.60 0.47 0.58

Std. Dev. 0.03 1.82 1.98 0.32 0.03 0.02 0.02 1.91 0.08 0.16 1.43 0.09 0.12
Note: The table presents the summary statistics of the variables used in the regression analysis.

By extending equation (1) to reflect the variables, as described in Table 1, the

baseline model is formulated as follows:

ROA jt = δ 0 + α 1 LNTA jt + α 2 LOANS / TA jt + α 3 LLP / TL jt

+ α 4 NII / TA jt + α 5 NII / TA jt + α 6 LNDEPO jt
+ α 7 EQASS jt + β 1 LNGDPt + β 2 INFLt + β 3CR3t
+ β 4 MKTCAPt + β 5 DUMTRAN1 + β 6 DUMCRIS
+ β 7 DUMTRAN 2 + ε jt . (2)

Table 3 provides information on the degree of correlation between the

explanatory variables used in the multivariate regression analysis. The matrix shows
that, in general, the correlation between the bank-specific variables is not strong,
suggesting that multicollinearity problems are not severe or non-existent. Kennedy
(2008) points out that multicollinearity is a problem when the correlation is above
0.80, which is not the case here. However, it is worth noting that the correlations
among the macroeconomic and market condition variables are relatively high. To
address this concern, we have estimated all the regression models by using a step-
wise regression. The empirical findings do not qualitatively change our results.
Therefore, we choose not to report the regression results in the paper, but they are
available upon request.
 Table 3: Correlation Matrix for the Explanatory Variables
The notation used in the table below is defined as follows: LLP/TL is a measure of bank risk calculated as the ratio of total loan loss provisions divided by total loans; NII/TA is a measure of bank diversification towards non interest income,
calculated as total non-interest income divided by total assets; NIE/TA is a proxy measure for management quality, calculated as personnel expenses divided by total assets; LOANS/TA is used as a proxy measure of loans intensity,

calculated as total loans divided by total assets; LNTA is a proxy measure of size, calculated as a natural logarithm of total bank assets; LNDEPO is a proxy measure of network embeddedness, calculated as the log of total deposits; EQASS
is a measure of capitalization, calculated as book value of shareholders equity as a fraction of total assets; LNGDP is natural log of gross domestic products; DUMTRAN1 is a dummy variable that takes a value of 1 for the first tranquil (pre

Profitability of the Korean Banking Sector

crisis) period, 0 otherwise; DUMCRIS is a dummy variable that takes a value of 1 for the crisis period, 0 otherwise; DUMTRAN2 is a dummy variable that takes a value of 1 for the second tranquil (post crisis) period, 0 otherwise.

Independent LNTA LOANS/TA LLP/TL NII/TA NIE/TA LNDEPO EQASS LNGDP INFL CR3 MKTCAP DUMTRAN1 DUMCRIS DUMTRAN2
Variables

LNTA 1.000
LOANS/TA –0.333** 1.000
LLP/TL –0.156* 0.138* 1.000
NII/TA –0.001 0.104 –0.071 1.000
NIE/TA 0.137* 0.049 0.169** 0.531** 1.000
LNDEPO 0.981** –0.253** –0.142* –0.032 0.055 1.000

EQASS –0.361** 0.749** –0.052 0.113 0.070 –0.328** 1.000

LNGDP 0.195** 0.353** 0.344** –0.118 –0.074 –0.133* –0.006 1.000
INFL 0.143* –0.158* –0.415** 0.172** 0.109 0.098 0.008 –0.498** 1.000

CR3 –0.210** 0.297** 0.330** –0.069 –0.084 –0.145* 0.002 0.752** –0.667** 1.000
MKTCAP –0.124* 0.197** 0.452** –0.347** –0.121 –0.079 0.042 0.448** –0.820** 0.490** 1.000
DUMTRAN1 0.186** –0.241** –0.291** –0.085 0.015 0.142* 0.041 –0.764** 0.508** –0.672** –0.281** 1.000

DUMCRIS 0.040 –0.098 0.245** 0.464** 0.162* 0.011 –0.055 –0.133* 0.426** –0.239** –0.715** –0.328** 1.000
DUMTRAN2 –0.204** 0.300** 0.462** –0.289** –0.142* –0.140* 0.005 0.810** –0.806** 0.809** 0.826** –0.663** –0.491** 1.000
Note: The table presents the results from Spearman ρ correlation coefficients.
**
and * indicates significance at 1% and 5% levels.

55
56 經濟與管理論叢(Journal of Economics and Management)

4 Empirical Findings

It is in the public interest to know what banks can do to improve their profitability so
that scarce resources are allocated to their best uses and not wasted during the
production of services and goods (Isik and Hassan, 2003). For this purpose, we
investigate whether any aspects of the banks are related to their degree of
profitability. In the preceding analysis, we will discuss the performance of the
Korean banking sector based on the results derived from a series of parametric and
non-parametric tests, before we embark on a discussion of the results derived from a
multivariate regression setting.

4.1 The Performance of the Korean Banking Sector: A Univariate

Setting

To examine the difference in the relative performance of the Korean banking sector
during the pre and post-crisis periods, we perform a series of parametric (t-test) and
non-parametric (Mann-Whitney [Wilcoxon] and Kruskall-Wallis) tests. The results
are presented in Table 4. It is observed that on average the Korean banking sector
has been relatively more profitable during the pre-crisis period under both
profitability measures, i.e., ROA and ROE (significant at the 5% level or better
under both the parametric t-test and non-parametric Mann-Whitney [Wilcoxon] and
Kruskall-Wallis tests). The empirical findings also suggest that the Korean banking
sector has been relatively larger ( 16.12692 ≥ 15.16819 ) and has incurred higher
overhead expenses ( 0.02795 ≥ 0.02447 ) during the pre-crisis period (statistically
significant at the 1% level in the non-parametric Mann-Whitney [Wilcoxon] and
Kruskall-Wallis tests).
It is observed from Table 4 that Korean banks’ credit risk has been lower
during the pre-crisis period ( 0.00262 ≤ 0.02695 ) and is statistically significant at the
1% level under both the parametric t-test and non-parametric Mann-Whitney
[Wilcoxon] and Kruskall-Wallis tests. We also find that Korean banks have derived
a higher proportion of income from non-interest sources during the pre-crisis period
( 0.01578 ≥ 0.01246 ), but it is not statistically significant at any conventional levels
 Profitability of the Korean Banking Sector 57

Table 4: Summary of Parametric and Non-Parametric Tests

Test Groups
Parametric Test Non-Parametric Test
t -test Mann-Whitney Kruskall-Wallis
Individual
[Wilcoxon Rank-Sum] Equality of Populations
Tests
test test
Test Statistics t ( Prb > t ) z ( Prb > z )
Mean t Mean z χ 2 ( Prb > χ 2 )
Rank
ROA
Pre-Crisis 0.00404 3.495*** 113.68 –2.328** 5.422**
Post-Crisis –0.00770 94.00
ROE
Pre-Crisis 0.06675 2.714*** 110.61 –1.739* 3.023*
Post-Crisis –0.27247 95.89
LNTA
Pre-Crisis 16.12692 3.414*** 115.20 –2.615*** 6.836***
Post-Crisis 15.16819 93.06
LOANS/TA
Pre-Crisis 0.48506 –4.388*** 56.59 –8.570*** 73.443***
Post-Crisis 0.69276 129.16
LLP/TL
Pre-Crisis 0.00262 –6.279*** 57.44 –8.495*** 72.161***
Post-Crisis 0.02695 128.64
NII/TA
Pre-Crisis 0.01578 1.207 107.96 –1.234 1.523
Post-Crisis 0.01246 97.52
NIE/TA
Pre-Crisis 0.02795 1.598 125.78 –4.640*** 21.534***
Post-Crisis 0.02447 86.54
LNDEPO
Pre-Crisis 15.54269 2.462** 111.45 –1.900* 3.608*
Post-Crisis 14.86871 95.37
EQASS
Pre-Crisis 0.06326 0.358 120.33 –3.594*** 12.918***
Post-Crisis 0.05901 89.90
Note: The testing methodology follows Aly et al. (1990), Elyasiani and Mehdian (1992), and Isik and
Hassan (2002), among others. The parametric (t-test) and non-parametric (Mann-Whitney and Kruskall-
Wallis) tests test the null hypothesis of an equal mean between the two models.
***, **, *
denotes significance at the 1%, 5%, and 10% levels, respectively.

under both the parametric t-test and non-parametric Mann-Whitney [Wilcoxon] and
Kruskall-Wallis tests. It is also apparent that the Korean banking sector has better
58 經濟與管理論叢(Journal of Economics and Management)

network embeddedness ( 15.54269 > 14.86871 ) during the pre-crisis period

(statistically significant at the 5% level under the parametric t-test). The results from
the parametric t-test are further confirmed by the non-parametric Mann-Whitney
[Wilcoxon] and Kruskall-Wallis tests albeit at a lower significance level. Finally, it
is interesting to note that the Korean banking sector seems to be relatively better
capitalized during the pre-crisis period and is statistically significant at the 1% level
under the non-parametric Mann-Whitney [Wilcoxon] and Kruskall-Wallis tests.

4.2 Determinants of Bank Profitability: A Multivariate Analysis

The regression results focusing on the relationship between bank profitability and
the explanatory variables are presented in Table 5. To conserve space, the full
regression results, which include both bank- and time-specific fixed effects, are not
reported in the paper. Several general comments regarding the test results are
warranted. The model performs reasonably well with most variables remaining
stable across the various regressions tested. The explanatory power of the models is
also reasonably high, while the F-statistics for all models are significant at the 1%
level.
The relationship between size (LNTA) and Korean banks’ profitability is
positive, a fact that supports the results of Spathis et al. (2002) and Kosmidou
(2008). Hauner (2005) offers two potential explanations for which size could have a
positive impact on bank performance. First, if it relates to market power, large banks
should pay less for their inputs. Second, there may be increasing returns to scale
through the allocation of fixed costs (e.g., research or risk management) over a
higher volume of services or from efficiency gains from a specialized workforce.
However, the coefficient is not statistically significant at any conventional levels in
all of the regression models estimated.
Referring to the impact of bank liquidity, LOANS/TA is positively related to
the profitability of Korean banks, indicating a negative relationship between bank
profitability and the level of liquid assets held by the bank. As higher figures for the
ratio denote lower liquidity, the results imply that more (less) liquid banks tend to
exhibit lower (higher) profitability levels. As pointed out by Sufian (2009), the
positive relationship found between bank profitability and LOANS/TA may be
 Profitability of the Korean Banking Sector 59

supporting the efficient markets hypothesis, since market power in the loan markets
could be the result of efficient operations. Due to their ability to manage operations
more productively, relatively efficient banks might have lower production costs,
which enable them to offer more reasonable loan terms and ultimately gain larger
market shares over their inefficient peers.

Table 5: Panel Fixed and Random Effects Regression Results - ROA

ROAjt = δ 0 + α1 LNTA jt + α 2 LOANS / TA jt + α 3 LLP / TL jt
+ α 4 NII / TA jt + α 5 NIE / TA jt + α 6 LNDEPO jt
+ α 7 EQASS jt + β1 LNGDP + β 2 INFL + β 3CR3
+ β 4 MKTCAP + β 5 DUMTRAN1 + β 6 DUMCRIS
+ β 7 DUMTRAN 2 + ε jt

The dependent variable is ROA calculated as net profit divided by total assets; LNTA is a proxy measure
of size, calculated as a natural logarithm of total bank assets; LOANS/TA is used as a proxy measure of
loans intensity, calculated as total loans divided by total assets; LLP/TL is a measure of bank credit risk
calculated as the ratio of total loan loss provisions divided by total loans; NII/TA is a measure of bank
diversification towards non-interest income, calculated as total non-interest income divided by total assets;
NIE/TA is a proxy measure for management quality, calculated as personnel expenses divided by total
assets; LNDEPO is a proxy measure of network embeddedness, calculated as the log of total deposits;
EQASS is a measure of capitalization, calculated as the book value of shareholders’ equity as a fraction of
total assets; LNGDP is the natural log of gross domestic product; INFL is the rate of inflation; CR3 is the
three bank concentration ratio; MKTCAP is the ratio of stock market capitalization divided by GDP;
DUMTRAN1 is a dummy variable that takes a value of 1 for the first tranquil (pre crisis) period, and 0
otherwise; DUMCRIS is a dummy variable that takes a value of 1 for the crisis period, and 0 otherwise;
and DUMTRAN2 is a dummy variable that takes a value of 1 for the second tranquil (post crisis) period,
and 0 otherwise.

(1) (2) (3) (4) (5)

CONSTANT –0.070559 0.021953 –0.250111 –0.076477 –0.128424
(–1.449393) (0.088732) (–1.140400) (–0.386152) (–0.370957)
Bank
Characteristics
LNTA 0.002619 0.004155 0.006991 0.007206 0.004141
(0.203503) (0.322971) (0.533809) (0.563736) (0.323730)
LOANS_TA 0.029880** 0.024043** 0.024202** 0.023780** 0.024402**
(2.540711) (2.195571) (2.211245) (2.160525) (2.217046)
LLP/TL –0.469738*** –0.428787*** –0.414561*** –0.417854*** –0.425236***
(–2.891933) (–3.237606) (–3.059252) (–3.134731) (–3.168178)
NII/TA 0.728529*** 0.649505*** 0.630097*** 0.628930*** 0.649352***
(7.535184) (9.177574) (8.261724) (8.329660) (9.104791)
60 經濟與管理論叢(Journal of Economics and Management)

(1) (2) (3) (4) (5)

NIE/TA –0.843040*** –0.748699*** –0.705193*** –0.683008*** –0.764581***
(–4.788621) (–5.427843) (–5.107667) (–4.907431) (–5.617721)
LNDEPO 0.001740 0.005647 0.002364 0.002936 0.004983
(0.125761) (0.364840) (0.148470) (0.189836) (0.318695)
EQASS 0.018313 0.031989 0.031462 0.034806 0.029186
(0.254844) (0.423491) (0.408546) (0.446557) (0.386090)
Economic and
Market Conditions
LNGDP –0.019298 0.002208 –0.010497 –0.007524
(–0.923546) (0.115034) (–0.614542) (–0.261556)
INFL 0.008630*** 0.007149*** 0.007310*** 0.008411***
(4.989742) (5.603595) (4.883670) (5.107783)
CR3 0.053100** 0.056716*** 0.040125** 0.067063***
(2.057333) (3.115341) (2.256394) (3.251060)
MKTCAP 0.064593*** 0.050429** 0.029571 0.081069**
(2.852045) (2.548016) (1.142165) (2.492021)
DUMTRAN1 0.010463***
(3.622630)
DUMCRIS –0.011191***
(–2.893924)
DUMTRAN2 –0.009279
(–0.897570)
2
R 0.660158 0.707700 0.717774 0.716870 0.709031
Adjusted R2 0.601124 0.650358 0.660786 0.659700 0.650277
Durbin–Watson
1.439565 1.618103 1.557754 1.558969 1.607438
statistic
F–statistic 11.18275*** 12.34190*** 12.59520*** 12.53917*** 12.06790***
No. of
251 251 251 251 251
Observations
Values in parentheses are t-statistics.
*** **
, , and * denote significance at the 1, 5, and 10% levels, respectively.

As expected, the impact of credit risk (LLP/TL) has a negative relationship

with bank profitability and is statistically significant at the 1% level in all regression
models, suggesting that banks with higher credit risk exhibit lower profitability
levels. The results imply that Korean banks should focus more on credit risk
 Profitability of the Korean Banking Sector 61

management, which has been proven to be problematic in the recent past. Serious
banking problems have arisen from the failure of financial institutions to recognize
impaired assets and create reserves for writing off these assets. An immense help
towards smoothing out these anomalies would be provided by improving the
transparency of the banking sector, which in turn will assist banks to evaluate credit
risk more effectively and avoid problems associated with hazardous exposure.
The coefficient of NII/TA is positive and is statistically significant at the 1%
level whether we control for macroeconomic and market conditions or not. The
results imply that banks which derived a higher proportion of their income from
non-interest sources such as derivatives and stock market trading and other fee based
services tend to report a higher level of profitability levels. It is observed from Table
5 that the intensity of NII/TA towards Korean banks’ profitability is relatively high.
We find that Korean banks’ profitability would increase in the range of 63 to 73 per
cent for every 1 per cent increase in non-interest income. The empirical findings are
consistent with an earlier study by Canals (1993) who suggests that revenues
generated from new business units have significantly contributed to improving bank
performance. On the other hand, Stiroh (2004) suggests that greater reliance on non-
interest income, particularly trading revenue, is associated with lower risk-adjusted
profits and higher risk, while Stiroh and Rumble (2006) find that the diversification
benefits of U.S. financial holding companies are offset by the increased exposure to
non-interest activities, which are much more volatile, but not necessarily more
profitable, than interest-generating activities.
As for the impact of overhead costs, NIE/TA exerts a negative and significant
impact on bank profitability. The results imply that an increase (decrease) in these
expenses reduces (increases) the profits of banks operating in Korea. Pasiouras and
Kosmidou (2007) and Kosmidou (2008), among others, have also found poor
expenses management to be among the main contributors to poor profitability.
Clearly, efficient cost management is a prerequisite for the improved profitability of
the Korean banking sector, i.e., the high elasticity of profitability of this variable
indicates that banks have much to gain if they improve their managerial practices.
Furthermore, the Korean banking sector has not reached the maturity level required
to link quality effects from increased spending to higher bank profitability.
62 經濟與管理論叢(Journal of Economics and Management)

The impact of network embeddedness (LNDEPO) on bank profitability is

positive, supporting the earlier findings of Lim and Randhawa (2005) and Sufian
(2007), among others, which indicate that the large banks are relatively more
managerially efficient. It could be argued that the large banks with extensive branch
networks across the nation may have an advantage over smaller bank counterparts as
they may attract more deposits and loan transactions, and in the process command
larger interest rate spreads and subsequently higher levels of profitability.
The level of capitalization (EQASS) is positively related to the profitability of
Korean banks and is statistically significant at the 5% level or better in all regression
models. This empirical finding is consistent with Berger (1995), Dermiguc-Kunt and
Huizinga (1999), Staikouras and Wood (2003), Goddard et al. (2004), Pasiouras and
Kosmidou (2007), and Kosmidou (2008), providing support to the argument that
well-capitalized banks face lower costs of going bankrupt, thus reducing their cost
of funding. Furthermore, a strong capital structure is essential for banks in
developing economies, since it provides additional strength to withstand financial
crises and increased safety for depositors facing unstable macroeconomic conditions.
The results regarding the impact of GDP growth on ROA are mixed. It is
observed from Table 5 that the coefficient of GDP is negative, but it becomes
positive when we control for both the crisis and the tranquil periods. However, the
coefficient of the variable is not statistically significant in any of the regression
models estimated. The impact of inflation (INFL) is positively related to the Korean
banks’ profitability, implying that during the period under study the levels of
inflation were anticipated by the Korean banks. This gave them the opportunity to
adjust the interest rates accordingly and consequently to earn higher profits. This
result is consistent with the findings by Pasiouras and Kosmidou (2007) among
others.
During the period under study, we find that the impact of concentration (CR3)
is positive and is statistically significant at the 5% level or better in all regression
models. If anything could be delved, the empirical findings clearly support the
Structure-Conduct-Performance (SCP) hypothesis. To recap, the SCP hypothesis
states that banks in highly concentrated markets tend to collude and therefore earn
monopoly profits (Short, 1979; Gilbert, 1984; Molyneux et al., 1996).
 Profitability of the Korean Banking Sector 63

The impact of stock market capitalization (MKTCAP) on bank profitability is

positive and is significant at the 5% level or better, implying that during the period
under study the Korean stock market is a relatively developed market, and thus
offers substitution possibilities to potential borrowers. However, it is interesting to
note that the coefficient of the variable loses its explanatory power when we control
for the Asian financial crisis period (DUMCRIS), suggesting that the stock market
does not exert any influence on the profitability of the Korean banking sector during
the period of economic turbulence.
As expected, the empirical findings seem to suggest that Korean banks have
been relatively more profitable during the first tranquil period (DUMTRAN1)
implying that the Korean banking sector has been relatively more profitable during
the pre-Asian financial crisis period compared to the post-crisis and crisis periods. It
is also observed from Table 5 that the coefficient of DUMCRIS is negative and is
statistically significant at the 1% level, thus supporting the notion that the Asian
financial crisis has a significant negative impact on the profitability of the Korean
banking sector.

4.3 Robustness Checks: Alternative Measure of Bank Profitability

In order to check for the robustness of the results, we have performed a number of
sensitivity analyses. First, we replace the ratio of the return on assets (ROA) with the
ratio of the return on equity (ROE) as the dependent variable. The results are
presented in Table 6. It is worth noting that all the regression models perform
reasonably well with most of the baseline variables’ coefficients staying the same:
they keep the same sign, the same order of magnitude, they remain significant as
they were in the baseline regressions (albeit sometimes at different levels) and, with
few exceptions, they do not become significant if they were not in the baseline
regressions.
It is interesting to note that when we replace ROE as the dependent variable,
the coefficient of CR3 loses its explanatory power in most of the regression models
estimated and is only statistically significant at the 10% level in regression model 5.
In a similar vein, the empirical findings seem to suggest that the coefficient of
DUMCRIS as a proxy variable for the Asian financial crisis remains negative in the
64 經濟與管理論叢(Journal of Economics and Management)

regression model, but no longer statistically significantly explains the variations in

the Korean banks’ profitability.
Table 6: Panel Fixed and Random Effects Regression Results – ROE
ROE jt = δ 0 + α1 LNTA jt + α 2 LOANS / TA jt + α 3 LLP / TL jt
+ α 4 NII / TA jt + α 5 NIE / TA jt + α 6 LNDEPO jt
+ α 7 EQASS jt + β1 LNGDP + β 2 INFL + β 3CR3
+ β 4 MKTCAP + β 5 DUMTRAN1 + β 6 DUMCRIS
+ β 7 DUMTRAN 2 + ε jt

The dependent variable ROE is calculated as net profit divided by total shareholders’ equity; LNTA is a
proxy measure of size, calculated as a natural logarithm of total bank assets; LOANS/TA is used as a
proxy measure of loan intensity, calculated as total loans divided by total assets; LLP/TL is a measure of
bank credit risk calculated as the ratio of total loan loss provisions divided by total loans; NII/TA is a
measure of bank diversification towards non-interest income, calculated as total non-interest income
divided by total assets; NIE/TA is a proxy measure for management quality, calculated as personnel
expenses divided by total assets; LNDEPO is a proxy measure of network embeddedness, calculated as
the log of total deposits; EQASS is a measure of capitalization, calculated as the book value of
shareholders’ equity as a fraction of total assets; LNGDP is the natural log of gross domestic product;
INFL is the rate of inflation; CR3 is the three bank concentration ratio; MKTCAP is the ratio of stock
market capitalization divided by GDP; DUMTRAN1 is a dummy variable that takes a value of 1 for the
first tranquil (pre-crisis) period, and 0 otherwise; DUMCRIS is a dummy variable that takes a value of 1
for the crisis period, and 0 otherwise; DUMTRAN2 is a dummy variable that takes a value of 1 for the
second tranquil (post-crisis) period, and 0 otherwise.

(1) (2) (3) (4) (5)

CONSTANT 1.343613 0.114728 –14.02609 –4.854258 –8.984372

(0.651463) (0.010471) (–1.401453) (–0.507500) (–0.442980)

Bank

Characteristics
LNTA –0.090190 0.040194 0.187615 0.194195 0.039348

(–0.170328) (0.061386) (0.278228) (0.277654) (0.059683)

LOANS_TA 0.852899** 0.593311* 0.601533* 0.580004* 0.615023*

(1.979422) (1.674857) (1.899558) (1.818440) (1.785918)

LLP/TL –11.09474*** –10.96305*** –10.22359** –10.41112** –10.74813**

(–2.764171) (–2.645905) (–2.487381) (–2.552723) (–2.568973)

NII/TA 25.58707*** 22.81365*** 21.80491** 21.77502** 22.80440***

(2.967671) (2.636403) (2.488447) (2.411209) (2.612622)

NIE/TA –46.85006*** –41.86026*** –39.59898*** –38.54404*** –42.82126***

(–4.229252) (–4.232723) (–3.914223) (–3.469264) (–4.070992)
 Profitability of the Korean Banking Sector 65

(1) (2) (3) (4) (5)

LNDEPO 0.024163 0.035795 –0.134851 –0.101062 –0.004372

(0.052865) (0.057771) (–0.220910) (–0.163678) (–0.007049)

EQASS 0.863157 1.576571 1.549146 1.718772 1.406947

(0.308512) (0.569097) (0.561274) (0.614701) (0.510442)

Economic and

Market
Conditions

LNGDP –0.285526 0.832250 0.158760 0.426917

(–0.259694) (0.842886) (0.162453) (0.228632)

INFL 0.292381*** 0.215397*** 0.225757*** 0.279114**

(2.783704) (3.124804) (3.626002) (2.367351)

CR3 1.276970 1.464960 0.622003 2.121909*

(0.738428) (1.009721) (0.476577) (1.612584)

MKTCAP 2.932080** 2.195883*** 1.164070 3.929001***

(2.349064) (2.654284) (1.049647) (2.776224)

DUMTRAN1 0.543836***

(2.627242)

DUMCRIS –0.564971
(–1.438797)

DUMTRAN2 –0.561435

(–0.805503)
2
R 0.307530 0.318303 0.323618 0.322867 0.319255
2
Adjusted R 0.187242 0.184573 0.187041 0.186138 0.181796

Durbin-Watson 1.925437 1.928966 1.940680 1.932229 1.937097

statistic

F-statistic 2.556607*** 2.380192*** 2.369486*** 2.361365*** 2.322558***

No. of 251 251 251 251 251

Observations
Values in parentheses are t-statistics.
*** **
, , and * denote significance at the 1%, 5%, and 10% levels.
66 經濟與管理論叢(Journal of Economics and Management)

4.4 Additional Robustness Checks

To further check for the robustness of the results, we conduct several additional tests.
Firstly, we restrict our sample to banks with more than three years of observations.
All in all, the results remain qualitatively similar in terms of directions and
significance levels. Secondly, we address the effects of outliers in the sample by
removing the data and exclude the top and bottom 1% of the sample. The results
remain robust in terms of directions and significance levels. Thirdly, we replace
ROA with PBT/TA (Profit Before Tax/Total Assets) and repeat Eq. (1). In general,
the results confirm the baseline regression results. Finally, we perform the test for
redundancy to ensure that all the variables incorporated in the regression models are
relevant. All in all the results of this test fail to be rejected at the 5% level that the
explanatory variables are redundant in any of the regression models estimated. To
conserve space, we do not report the full regression results in the paper, but they are
available upon request.

5 Concluding Remarks and Directions for Future

Research

The Asian financial crisis has had a profound negative impact on the Korean
banking sector. The sharp decline in the domestic currency had damaging effects on
the leading banks’ balance sheets. Moreover, banks’ revenues shrank as the banks
could not pass on higher rates to distressed corporate borrowers, subsequently
resulting in negative interest rate spreads and reductions in banks’ net income that
damaged their capital adequacy.
By using unbalanced bank level panel data, this study seeks to examine the
determinants of Korean banks’ profitability during the period 1992-2003. The
empirical findings suggest that Korean banks with lower liquidity levels tend to
exhibit higher profitability levels. Furthermore, higher diversification regarding
banks’ income sources towards derivative instruments and other fee-based activities
has a positive effect. The impact of credit risk and costs are always negative.
Business cycle effects exert a substantial pro-cyclical impact on bank profits. The
 Profitability of the Korean Banking Sector 67

industry concentration of the national banking system positively and significantly

affects banks’ profitability. The impact of the Asian financial crisis is negative,
while Korean banks have been relatively more profitable during the pre-crisis period
compared to the post-crisis period.
The findings of this study have considerable policy relevance. It could be
argued that the more profitable financial institutions will be able to offer more new
products and services. To this end, the role of technology advancement is
particularly important given that a financial institution with relatively more
advanced technologies may have an added advantage over its peers. The continued
success of the Korean banking sector depends on its efficiency, profitability, and
competitiveness. Furthermore, in view of the increasing competition attributed to the
more liberalized banking sector, bank management as well as the policymakers will
be more inclined to find ways of obtaining the optimal utilization of capacities as
well as making the best use of their resources, so that these resources are not wasted
during the production of banking products and services.
Moreover, the ability to maximize risk-adjusted returns on investment and
sustaining stable and competitive returns is an important element in ensuring the
competitiveness of the Korean banking sector. Thus, from the regulatory perspective,
the performance of the financial sector will be based on their efficiency and
profitability. The policy direction will be directed towards enhancing the resilience
and efficiency of the financial institutions with the aim of intensifying the robustness
and stability of the financial sector.
Future research could include more variables such as taxation and regulation
indicators, exchange rates as well as indicators of the quality of the offered services.
Another possible extension could be the examination of differences in the
determinants of profitability between small and large or high and low profitability
banks. In terms of methodology, a statistical cost accounting and frontier techniques
could also be used.
68 經濟與管理論叢(Journal of Economics and Management)

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