2011 Determinants of Bank Profitability Before and During The Financial Crisis Swizerland PDF

Int. Fin. Markets, Inst.
and Money 21 (2011) 307327
Contents lists available at ScienceDirect
Journal of International Financial

Markets, Institutions & Money
j o ur na l ho me pa ge : w w w . e l s e v i e r . c o m / l o c a t e / i n t f i n
Determinants of bank protability before and during the

crisis: Evidence from Switzerland
Andreas Dietrich, Gabrielle Wanzenried
Lucerne University of Applied Sciences and Arts, Institute of Financial Services IFZ, Grafenauweg 10, 6304 Zug, Switzerland
a r t i c l e
i n f o
Article history:
Received 19 January 2010
Accepted 26 November 2010
Available online 7 December 2010
JEL classication:
E44
G21
G32
L2
C23
Keywords:
Banking protability
Macroeconomic impact on banking
protability
Financial crisis
Market structure
Ownership
a b s t r a c t
Using the GMM estimator technique described by Arellano and
Bover (1995), this paper analyzes the protability of 372 commercial banks in Switzerland over the period from 1999 to 2009. To
evaluate the impact of the recent nancial crisis, we separately
consider the pre-crisis period, 19992006, and the crisis years of
20072009. Our protability determinants include bank-specic
characteristics as well as industry-specic and macroeconomic factors, some of which have not been considered in previous studies.
The inclusion of these additional factors as well as the separate consideration of the crisis years allow us to gain new insights into what
determines the protability of commercial banks.
2010 Elsevier B.V. All rights reserved.
1. Introduction
Using data from the Swiss banking market, this paper examines bank protability as a measure
of how well a bank is run. We examine whether, for banks operating in similar environments, one
can make judgments concerning the success of their competitive strategies and other managementdetermined factors by using protability measures. Likewise, for banks that are essentially similar,
Corresponding author. Tel.: +41 417246537; fax: +41 417246550.

E-mail addresses: andreas.dietrich@hslu.ch (A. Dietrich), gabrielle.wanzenried@hslu.ch (G. Wanzenried).
1042-4431/$ see front matter 2010 Elsevier B.V. All rights reserved.
doi:10.1016/j.intn.2010.11.002
308
A. Dietrich, G. Wanzenried / Int. Fin. Markets, Inst. and Money 21 (2011) 307327
this paper examines whether environmental factors have an impact on bank protability. Given the
importance of protability for the stability of the banking industry, and the impact of the banking
industry on the capital markets and the economy as a whole, these questions are of vital importance. This is especially true in light of the recent global nancial crisis, for which we include a
separate analysis for the data recorded for the Swiss banking industry during the crisis years of
20072009.
Research on the determinants of bank protability has typically focused on both the returns on
bank assets and equity, and the net interest margins as dependent variables. More recent studies have
expanded the number of factors considered. Thus, scholars (Staikouras and Wood, 2004; Athanasoglou
et al., 2008; Brissimis et al., 2008; Garca-Herrero et al., 2009) have examined the effect of bank-specic
(i.e. capital ratio, operational efciency, bank size), industry-specic (i.e. ownership and concentration) and macroeconomic (i.e. ination and cyclical output) determinants on bank performance. Until
now, few papers have analyzed the impacts of the recent nancial crisis on the determinants of bank
protability. Likewise, no econometric study has yet considered the determinants of protability for
the Swiss commercial banking system, which is both diverse and strong, although not immune to
uctuations in the global market. However, to appreciate the value of the Swiss commercial banking
system for research purposes, some background information is required.
Below the level of its national government, Switzerland is organized into 26 regional governments
known as cantons. From canton to canton, certain aspects of the banking environment, such as market
growth, bank competition, and tax regimes can differ. However, across all cantons, some factors do
remain constant. Therefore, the analysis of banking protability in the Swiss banking market offers
insight on how the variation of a particular factor can affect bank protability. In addition, unlike
banking sectors in other countries, the Swiss banking industry includes several different types of
bank. These institutions differ from each in important characteristics, such as ownership (state-owned
versus privately owned), business model, and economic environment. These aspects are expected to
affect bank performance and are captured in our study. Finally, analyzing bank performance within
such a diverse context and during periods of dramatically different levels of economic prosperity is a
promising way to better understand the underlying mechanisms of bank performance in developed
countries.
The present paper builds on the work by Athanasoglou et al. (2008) and Garca-Herrero et al. (2009).
We empirically assess the main factors that determine the protability of banks in Switzerland. To that
end, we use data from 372 commercial banks and for the longest relevant period (from 1998 to 2009).
To account for prot persistence and potential endogeneity problems, we apply a GMM technique to
our panel of Swiss banks.
Our results show that protability is, for the most part, explained by ve factors: operational efciency, the growth of total loans, funding costs, the business model, and the effective tax rate. We
nd, not surprisingly, that operationally efcient banks are more protable than banks that are less
operationally efcient. Likewise, we nd that above-average growth in loan volume affects bank profitability positively, while higher funding costs result in a lower protability. The interest income share
also has a signicant impact on protability. Banks that are heavily dependent on interest income are
less protable than banks whose income is more diversied. Furthermore, the separate consideration
of the time periods before and during the crisis provides new insights with respect to the underlying
mechanisms that determine bank protability. Our results provide empirical evidence that, for the
Swiss market during the nancial crisis, state-owned banks are more protable than privately owned
banks. We believe that, during this time of turmoil, state-owned banks were thought of as safer and
better banks in comparison to privately owned institutions. The loan loss provisions relative to total
loans ratio, which is a measure of credit quality, did not have a statistically signicant effect on bank
protability before the crisis. However, the loan loss provisions have signicantly increased during
the crisis, and this is reected in its negative impact on protability during the crisis years. The yearly
growth of deposits has had a signicant and negative impact on bank protability, and this effect is
seen mainly in the crisis years. Banks in Switzerland were not able to convert the increasing amount
of deposit liabilities into signicantly higher income earnings during the recent time of turmoil.
The paper is structured as follows. Section 2 surveys the relevant literature on banking protability.
Section 3 outlines our model and the dependent and independent variables used in our analyses.
309
Section 4 describes the data sample and methodology used. Section 5 presents the results of our
empirical analysis, and Section 6 concludes.
2. Theoretical background
This section reviews the relevant literature on the determinants of banking protability.
2.1. Literature on determinants of bank protability
Following early work by Short (1979) and Bourke (1989), a number of more recent studies have
attempted to identify some of the major determinants of bank protability. The respective empirical
studies have focused their analyses either on cross-country evidence or on the banking system of
individual countries. The studies by Molyneux and Thornton (1992), Demirguc-Kunt and Huizinga
(1999), Abreu and Mendes (2002), Staikouras and Wood (2004), Goddard et al. (2004), Athanasoglou
et al. (2006), Micco et al. (2007) and Pasiouras and Kosmidou (2007) investigate a panel data set. Studies
by Berger et al. (1987), Berger (1995), Neely and Wheelock (1997), Mamatzakis and Remoundos (2003),
Naceur and Goaied (2008), Athanasoglou et al. (2008) and Garca-Herrero et al. (2009) focus their
analyses on single countries. The empirical results of these above-mentioned studies do vary, which
is to be expected, given the differences in their datasets, time periods, investigated environments,
and countries. However, we found some mutual elements that we used to categorize further the
determinants of banking protability.
Bank protability is usually measured by the return on average assets and is expressed as a function of internal and external determinants. The internal determinants include bank-specic variables.
The external variables reect environmental variables that are expected to affect the protability of
nancial institutions.
In most studies, variables such as bank size, risk, capital ratio and operational efciency are used
as internal determinants of banking protability. Pasiouras and Kosmidou (2007) nd a positive and
signicant relationship between the size and the protability of a bank. This is because larger banks
are likely to have a higher degree of product and loan diversication than smaller banks, and because
they should benet from economies of scale. Other authors, such as Berger et al. (1987), provide evidence that costs are reduced only slightly by increasing the size of a bank and that very large banks
often encounter scale inefciencies. Micco et al. (2007) nd no correlation between the relative bank
size and the ROAA for banks, i.e. the coefcient is always positive but never statistically signicant.
Another determinant of bank protability is risk. Abreu and Mendes (2002), who examined banks
in Portugal, Spain, France and Germany, nd that the loans-to-assets ratio, as a proxy for risk, has
a positive impact on the protability of a bank. Bourke (1989) and Molyneux and Thornton (1992),
among others, nd a negative and signicant relationship between the level of risk and protability. This result might reect the fact that nancial institutions that are exposed to high-risk loans
also have a higher accumulation of unpaid loans. These loan losses lower the returns of the affected
banks.
Empirical evidence by Bourke (1989), Demirguc-Kunt and Huizinga (1999), Abreu and Mendes
(2002), Goddard et al. (2004), Naceur and Goaied (2001, 2008), Pasiouras and Kosmidou (2007) and
Garca-Herrero et al. (2009) indicate that the best performing banks are those who maintain a high level
of equity relative to their assets. The authors explain this relation with the observation that banks with
higher capital ratios tend to face lower costs of funding due to lower prospective bankruptcy costs.
Furthermore, there is also empirical evidence that the level of operational efciency, measured by
the cost-income ratio (Goddard et al., 2009) or overhead costs over total assets (Athanasoglou et al.,
2008) positively affects bank protability (Athanasoglou et al., 2008; Goddard et al., 2009). A further
bank-specic variable is the ownership of a bank. Micco et al. (2007) found that whether a bank is
privately owned or state-owned does affect its performance. According to their results, state-owned
banks operating in developing countries tend to have a lower protability, lower margins, and higher
overhead costs than comparable privately owned banks. In industrialized countries, however, this
relationship has been found to be much weaker. Iannotta et al. (2007) point out that governmentowned banks exhibit a lower protability than privately owned banks. Demirguc-Kunt and Huizinga
310
(1999) suggest that the international ownership of banks has a signicant impact on bank protability.
Foreign banks are shown to be less protable in developed countries. In contrast, Bourke (1989) as
well as Molyneux and Thornton (1992) report that the ownership status is irrelevant for explaining
bank protability. They nd little evidence to support the theory that privately owned banks are more
protable than state-owned banks. Furthermore, Beck et al. (2005) controlled for the age of the bank,
since longer established banks might enjoy performance advantages over relative newcomers. Their
results for the Nigerian market indicate that older banks did not perform as well as newer banks,
which were better able to pursue new prot opportunities.
Previous studies also include external determinants of bank protability such as central bank interest rate, ination, the GDP development, taxation, or variables representing market characteristics (e.g.
market concentration). Most studies have shown a positive relationship between ination, central
bank interest rates, GDP growth, and bank protability (e.g. Bourke, 1989; Molyneux and Thornton,
1992; Demirguc-Kunt and Huizinga, 1999; Athanasoglou et al., 2008; Albertazzi and Gambacorta,
2009). Furthermore, there is some evidence that the legal and institutional characteristics of a country
matter. The study of Demirguc-Kunt and Huizinga (1999) reports that taxation reduces bank profitability. Another study by Albertazzi and Gambacorta (2009) concludes that the impact of taxation on
banking protability is small because banks can shift a large fraction of their tax burden onto depositors, borrowers, or purchasers of fee-generating services. Overall, although scal issues are likely to
exert a signicant inuence on the behavior of a bank, the taxation of the nancial sector has received
little attention.
To
measure
the
effects
of
market
structure
on
bank
protability,
the
structureconductperformance (market-power) hypothesis states that increased market power
yields monopoly prots. According to the results of Bourke (1989) and Molyneux and Thornton (1992),
the bank concentration ratio shows a positive and statistically signicant relationship with the profitability of a bank and is, therefore, consistent with the traditional structureconductperformance
paradigm. In contrast, the results of Demirguc-Kunt and Huizinga (1999) and Staikouras and Wood
(2004) indicate a negative but statistically insignicant relationship between bank concentration and
bank prots. Likewise, the estimations by Berger (1995) and Mamatzakis and Remoundos (2003)
contradict the structureconductperformance hypothesis.
The literature on the impact of the recent nancial turmoil on the determinants of bank protability
is relatively sparse. Xiao (2009) runs qualitative and quantitative analyses to examine the performance
of French banks during 20062008. She concludes that French banks were not immune but proved
relatively resilient to the global nancial crisis reecting their business and supervision features. A
paper by Millon Cornett et al. (2010), looking at internal corporate governance mechanisms and the
performance of publicly traded U.S. banks before and during the nancial crisis, nds that banks of
all size groups suffered bank performance decreases. However, they nd that the largest banks faced
the largest losses. Beltratti and Stulz (2009) nd that large banks with more Tier 1 capital and more
deposit nancing at the end of 2006 exhibited signicantly higher returns during the crisis.
To our knowledge, no previous study has investigated the protability of Swiss commercial banks.
Studies on Swiss banking are only very loosely related to our paper and have instead focused on the
relationship between the size of a bank and its efciency (e.g. Hermann and Maurer, 1991; Rime and
Stiroh, 2003), or cost efciency (Bikker, 1999 for banks in nine European countries).
To conclude, the existing literature provides a comprehensive examination of the effects of bankspecic, industry-specic, and macroeconomic determinants on bank protability. However, the
impact of the crisis on the determinants of bank protability has not yet been widely analyzed. Furthermore, our study lls an important gap in the literature because no study has yet analyzed the
protability determinants of Swiss commercial banks. These two novelties should make an important
addition to the extensive literature on the determinants of bank protability.
3. Determinants of bank protability and variable selection

In this section, we describe both the dependent and independent variables that we selected for our
analysis of bank protability. See Table 1 for a summary of the variables described below.
311
3.1. Dependent variables

We use the return on average assets (ROAA) as our main measure of bank protability. The ROAA
is dened as the ratio of net prots to average total assets expressed as a percentage. As alternative
protability measures, we use the return on average equity (ROAE), which is the ratio of net prots
to average equity expressed as a percentage, as well as the net interest margin (NIM). The latter is
dened as the net interest income divided by total assets.
The ROAA reects the ability of a banks management to generate prots from the banks assets. It
shows the prots earned per CHF of assets and indicates how effectively the banks assets are managed
to generate revenues. To capture changes in assets during the scal year, our study relies on the average
assets value. As Golin (2001) points out, the ROAA has emerged as the key ratio for the evaluation of
bank protability and has become the most common measure of bank protability in the literature.
Our second measure of protability is the return on average equity (ROAE), which is the return to
shareholders on their equity. Although the nancial literature commonly uses the ROAE to measure
protability, we nd that it is not the best indicator of protability. For example, banks with a lower
leverage ratio (higher equity) usually report a higher ROAA but a lower ROAE. However, the ROAE disregards the higher risk that is associated with a high leverage and the effect of regulation on leverage.
Thus, in our analyses, we consider the ROAA as the better measure of protability and use it as the
main dependent variable, although we also report the results for the ROAE.
Finally, the net interest margin serves as our third performance measure. As a measure of the return
on assets, the net interest margin has been used in many studies of bank performance. While the ROA
measures the prot earned per dollar of assets and reects how well bank management uses the banks
real investment resources, the NIM focuses on the prot earned on interest activities.
3.2. Independent variables: determinants of bank protability
This section describes the independent variables that we used to analyze bank protability. They
include bank-specic (internal) and market-specic (external) factors.
3.2.1. Bank-specic determinants
As bank-specic determinants of bank protability, we use the following variables:Equity over
total assets: As a proxy for a banks capital, we use the ratio of equity to assets. Anticipating the net
impact of changes in this ratio is complex. For example, banks with higher capital-to-asset ratios
are considered relatively safer and less risky compared to institutions with lower capital ratios. In
line with the conventional risk-return hypothesis, we expect banks with lower capital ratios to have
higher returns in comparison to better-capitalized nancial institutions. In contrast, highly capitalized
banks are safer and remain protable even during economically difcult times. Furthermore, a lower
risk increases a banks creditworthiness and reduces its funding cost. In addition, banks with higher
equity-to-assets ratios normally have a reduced need for external funding, which has again a positive
effect on their protability. From this point of view, a higher capital ratio should have a positive effect
on protability. Given that we have anticipated effects pointing in opposite directions, the impact of a
banks capitalization on its protability cannot be anticipated theoretically.Cost-income ratio: The costto-income ratio is dened as the operating costs (such as the administrative costs, staff salaries, and
property costs, excluding losses due to bad and non-performing loans) over total generated revenues.
This ratio measures the effect of operating efciency on bank protability. We therefore expect higher
cost-income ratios to have a negative effect on bank protability.
Loan loss provisions over total loans: The ratio of loan loss provisions over total loans is a measure of
a banks credit quality. The loan loss provisions are reported on a banks income statement. A higher
ratio indicates a lower credit quality and, therefore, a lower protability. Thus, we expect a negative
effect from the loan loss provisions relative to total loans on bank protability.
Yearly growth of deposits: We measure a banks growth by the annual growth of its deposits. One
might expect that a faster growing bank would be able to expand its business and thus generate greater
prots. However, the contribution to prots that derives from an increase in deposits depends upon
a number of factors. First, it depends on the banks ability to convert deposit liabilities into income-
312
earning assets, which, to a certain extent, also reects a banks operating efciency. It also depends
on the credit quality of those assets. Growth is often achieved by investing in assets of lower credit
quality, which has a negative effect on bank protability. In addition, high growth rates might also
attract additional competitors. This again reduces the prots for all market participants. Therefore,
the sign of this variable cannot be anticipated theoretically.
Difference between bank and market growth of total loans: We include a variable measuring the
growth of a banks loan volume relative to the average market growth rate of loans. From a theoretical
viewpoint, the impact of changes of this variable on bank performance is very difcult to anticipate.
For example, one might expect that a bank with a higher growth rate of its loan volume (relative
to the markets growth rates) would be more protable due to the additional business generated.
However, if the bank realized its growth through lower margins, one might expect a negative impact
on protability. Furthermore, a high growth of the loan volume might also lead to a decrease in credit
quality and thus to a lower protability. Given that we have effects pointing in opposite directions,
the overall effect on bank protability cannot be anticipated theoretically.
Bank size: We measure bank size by total assets. To identify potential size effects, we build dummy
variables for small, medium, and large banks. One of the most important questions in the literature
is which bank size maximizes bank protability. For example, Smirlock (1985) argue that a growing
bank size is positively related to bank protability. This is because larger banks are likely to have a
higher degree of product and loan diversication than smaller banks, which reduces risk, and because
economies of scale can arise from a larger size. Because reduced risk and economies of scale lead to
increased operational efciency, we expect a larger size to have a positive effect on bank protability,
at least up to a certain point.
However, banks that have become extremely large might show a negative relationship between size
and protability. This is due to agency costs, the overhead of bureaucratic processes, and other costs
related to managing extremely large rms (e.g. Stiroh and Rumble, 2006; Pasiouras and Kosmidou,
2007). Accordingly, the overall effect is indeterminate from a theoretical point of view. As a robustness
test, we use total assets as an alternative size variable in our analyses.
Interest income share: Swiss commercial banks in our sample generate a large fraction of their
total income through traditional commercial banking activities (interest operations) and to a lesser
extent through fee and commission income and trading operations. Because margins in fee and
commission income and trading operations are usually higher than margins in interest operations,
we expect reduced protability of banks with a higher share of interest income relative to their total
income. This variable represents an item that is off the balance sheet and is a good proxy for the banks
business model.
Funding costs: Funding costs are dened as interest expenses over average total deposits and are
mainly determined by a banks credit rating, competition, market interest rates, and by the composition of the sources of funds and its relative importance.
Overall, we expect better prots from banks that are able to raise funds more cheaply.
Bank age: We classify banks into three age groups. The rst group includes banks founded after
1990, the second group includes those institutions founded between 1950 and 1990, and the third
group refers to banks established before 1950. We expect older banks to be more protable due to
their longer period of service, during which the banks could build up a good reputation.
Bank ownership: In our model, a bank is either privately owned or state-owned. We classify a bank
as state-owned if the public sector owns more than 50% of the bank. From a theoretical viewpoint,
the effect of differences in bank ownership on performance is indeterminate, and there is even disagreement among the empirical studies. Some studies (e.g. Bourke, 1989; Molyneux and Thornton,
1992) nd no signicant relationship between the ownership status and the performance of a bank.
However, Micco et al. (2007) and Iannotta et al. (2007), nd strong empirical evidence that ownership
does affect bank protability. Furthermore, we investigate whether being listed at a stock exchange
has an impact on bank protability. As a potentially positive impact, listed banks face greater pressure for being protable from their shareholders, the analysts, and the nancial markets overall. As a
potentially negative impact, listed banks, in contrast to unlisted banks, face many reporting and other
requirements, which create signicant additional costs. Therefore, the overall effect is indeterminate
and remains to be answered empirically.
313
Table 1
Denition of variables.
Variables
Dependent variables: bank protability
ROAA
ROAE
NIM
Description
Net prots over average total assets (%)
Net prots over average total equity (%)
Net interest margin (in %), dened as net
interest income divided by total assets
Independent variables
Expected effect
Bank-specic characteristics (internal factors)

Equity over total assets
+/
Equity over total assets (%). This is a measure of

capital adequacy, respectively the bank risk.
The higher this ratio, the lower the risk of the
bank
Cost-income ratio
Total expenses over total generated revenues
as a measure of operational efciency (%)
Loan loss provisions over total loans
Loan loss provisions over total loans (%). This is
a measure of credit quality
Yearly growth of deposits
Annual growth of deposits (%)
Difference between bank and market
Difference between the annual growth of a
growth of total loans
banks lending volume relative to the average
growth rate of the market lending volume (%)
Bank size
Dummy variables for different bank size
categories. Bank size is measured by the
accounting value of the banks total assets
Interest income share
Total interest income over total income (%)
Funding costs
Interest expenses over average total deposits
(%)
Bank age
Dummy variable for different bank age groups
Dummy variable: Public bank if public sector
Bank ownership
owns more than 50% of the shares
Dummy variable: Listed bank if institution is
listed at the stock exchange
Nationality
Dummy variable: Foreign bank if at least 50%
of the banks stocks are in foreign hands
Macroeconomic and industry-specic characteristics (external factors)
Effective tax rate
Total taxes over pretax prot (%)
Real GDP growth
The yearly real GDP growth (%)
Term structure of interest rates
The difference between the interest rate of a
5-year and a 2-year treasury bill in CHF issued
by the Swiss government (%)
Herndahl index
The market shares in the mortgage business of
all in Switzerland acting commercial banks by
region (market structure variable)
+/
+
+/
+
+/
+/
+
+
+/
Nationality: We consider whether the nationality of the bank owner, i.e. whether a bank is Swissowned or foreign-owned, has an effect on protability. An institution is dened as a foreign bank if at
least 50% of the banks stocks are in foreign hands. We expect foreign banks to be less familiar with
the Swiss environment and, therefore, to be less protable than Swiss-owned banks.
3.2.2. Macroeconomic and industry-specic characteristics (external factors)
In addition to the bank-specic variables described above, our analysis includes a set of macroeconomic and industry-specic characteristics that we expect to have an impact on bank protability.
Effective tax rate: The effective tax rate, dened as taxes paid divided by before-tax prots, reects
the explicit taxes paid by the banks (mostly corporate income taxes). This variable is not uniform across
the Swiss market, where tax rates vary widely among the Swiss cantons. This variation provides an
opportunity to see whether the differences in effective tax rates affect the protability of the banks.
In cantons with higher effective tax rates, we would expect banks to shift a large fraction of their
tax burden onto their depositors, borrowers, and purchasers of fee-generating services. This would
314
protect those banks from the full impact of the higher tax burden, but it would not eliminate the
impact entirely. Thus, consistent with the results of Demirguc-Kunt and Huizinga (1999), we expect
a higher effective tax rate to have a negative impact on bank protability.
Real GDP growth: GDP growth, which varies over time but not among the Swiss cantons, is expected
to have a positive effect on bank protability according to the literature on the association between
economic growth and nancial sector protability (e.g. Demirguc-Kunt and Huizinga, 1999; Bikker and
Hu, 2002; Athanasoglou et al., 2008). Accordingly, because the demand for lending increases during
cyclical upswings, we expect a positive relationship between bank protability and GDP development.
Term structure of interest rate: We use the difference between the interest rate of a 5-year and a 2year treasury bill in CHF issued by the Swiss government and as published by the Swiss National Bank
as proxy for the term structure of interest rates. Again, this variable varies over time but not across
cantons. Commercial banks usually use short-term deposits to nance long-term loans. This maturity
transformation is an important function of commercial banks and is inuencing its protability. Thus,
we expect a steeper yield curve to affect the protability positively.
Herndahl index: We measure the market structure in the banking industry by means of the
HerndahlHirschman-Index, which is dened as the sum of the squares of the market shares of
all the banks within the industry, where the market shares are expressed as fractions. As the lending
business of commercial banks in our sample is locally oriented, market structure and competition
also vary by region. Therefore, we compute the Herndahl index by region, measuring the market
shares in the mortgage business of all commercial banks acting in Switzerland (see Piazza, 2008).
According to the structureconductperformance hypothesis, banks in highly concentrated markets
earn monopoly rents, because they tend to collude (e.g. Gilbert, 1984). Because collusion may result
in higher rates being charged on loans and lower interest rates being paid on deposits, we expect that
a higher bank concentration has a positive impact on protability. On the other hand, a higher bank
concentration might be the result of a tougher competition in the banking industry, which would suggest a negative relationship between performance and market concentration (Boone and Weigand,
2000). As a result, the overall effect of market concentration on banking performance is indeterminate
and remains to be answered empirically.
For a summary of the denitions of our dependent and explanatory variables, see Table 1.
4. Data and methodology
This section identies the sources of our data, presents the data itself, and describes the regression
model we use to investigate the effects of internal and external factors on bank protability.
4.1. Data
Our main data source for the bank-specic characteristics is the Fitch-IBCA Bankscope (BSC)
database, which provides annual nancial information for banks in 179 countries around the world.
Coverage by the Bankscope database is comprehensive, with the included banks accounting for roughly
90% of the assets of all banks. Information about bank age, bank ownership, and the nationality of the
bank owners were taken from the Swiss National Bank and from the web pages of the respective institutions. In addition to the bank-specic data, we use a set of macroeconomic and industry-specic
variables to explain bank protability. The real GDP growth and the interest rates for 5-year and a
2-year treasury bills issued by the Swiss Government were taken from the Swiss National Bank. The
data for the Herndahl index, measuring the market shares in the mortgage business of all commercial
banks acting in Switzerland, stems from Piazza (2008).
To use the data of the Bankscope database (BSC) for our statistical analysis, we had to edit the
data carefully in the following ways. Given that our focus lies on commercial banks in Switzerland,
we start by excluding the Swiss National Bank, investment banks, securities houses and non-banking
credit institutions. We also exclude the big banks Credit Suisse and UBS AG from our sample (see
also below for a detailed description of the included institutions). In a further step, we eliminate
duplicate information. If BSC reports both unconsolidated and consolidated statements, we dropped
the unconsolidated statement.
315
Table 2
Number of banks and observations by bank category.
No. of banks
No. of observations
Cantonal banks
Regional and savings banks
Raiffeisen banks
Other banks
All
24
156
86
417
169
691
93
375
372
1639
This table reports the number of banks and the number of observations by bank category, as dened by the Swiss National Bank
(SNB, 2010).
Similarly, we needed to make a choice concerning data from the banks with balance sheet data
reported at the aggregated level. BSC builds aggregated statements by combining the statements of
banks that have merged or are about to merge. Aggregated statements may then report the data of
groups of afliated banks that neither have nancial links nor form a legal entity. As a result, a given
bank might be reported several times in database, namely as an independent unit by its consolidated
as well as by its unconsolidated statements. As Micco et al. (2007) outline, there are two ways to deal
with banks that have aggregated statements. The rst is always to work with the aggregated statement
and drop the observations for the individual banks. The second is to drop the aggregated statement
and work with the individual banks up to the time of the merger and then, starting from the year of
the merger, with the new bank. We use the rst strategy and work with the aggregated statements.
Our sample is an unbalanced panel dataset of 372 commercial banks in Switzerland, consisting of
1639 observations over the years from 1999 to 2009. To investigate the impact of the recent nancial
crisis, we split the sample into two time periods: the period from 1999 to 2006, the pre-crisis period;
and the years 2007, 2008 and 2009, the post-crisis period. In our sample, we include the cantonal
banks, regional and savings banks, and Raiffeisen banks according to the ofcial statistics maintained
by the Swiss National Bank. Furthermore, foreign-owned banks that are active in the traditional commercial banking activities, and other banks active in traditional lending business (mainly category 5.11
commercial banks, as dened by the Swiss National Bank) are considered in our analyses (see Table 2).
Note that we explicitly exclude the two big banks Credit Suisse and UBS from our sample, and this
for the following reasons: First, they provide all banking services (private banking, institutional asset
management, investment banking and commercial banking); second, a large share of their lending
activities is abroad; and third because commercial banking is not a predominant part of their revenues
on the accounted group level. Due to these reasons, it is hard to compare these two big banks with the
other commercial banks in Switzerland, especially also with respect to protability considerations.
Overall, the banks in our sample have a clear focus on commercial banking activities, with a median of
roughly 85% of their income generated in the traditional eld of interest income. For a more detailed
description of our sample, please check Appendix A.
Table 3 reports the descriptive statistics for the variables used in our analyses. Let us briey highlight a few interesting facts. On average, the banks in our sample have a ROAA of 0.63% over the entire
period from 1999 to 2009. The difference between mean and median indicates that there exist large
protability differences among the banks in our sample. The same holds true for our second protability measure, the ROAE, which amounts to 7.31% on average. The banks in our sample exhibit an average
net interest margin of 1.73%. On average, the capitalization of banks is 8.55%, which, however, differs
among banks, like the other variables as well. The best-capitalized bank in our sample, for instance,
has a capital ratio of 87%, whereas, for the least-capitalized institutions, total equity only covers 0.5%
of total assets. The loan loss provision relative to total loans, which is an indicator of the quality of
the credit portfolio, amounts to 0.35% on average, which seems quite low, but there exist again large
differences among the banks in our sample with respect to this variable. As pointed out above, a substantial part of the total income of the commercial banks in our sample stems from interest operations.
This interestincome share amounts to almost 74% on average. The median of this variable is even 86%.
The effective tax rate as one of the macroeconomic factors amounts to 29.9% on average. This variable
reects the tax burden across the different Swiss cantons, which may differ signicantly. Finally, note
that the Herndahl index as our measure of bank concentration is 2450, which is quite high compared
to bank concentration ratios in other countries (see, e.g. Beck et al., 2006). The correlation matrix for
the independent variables can be found in Table 4.
316
Table 3
Descriptive statistics.
Dependent variables: bank protability
Mean
Median
Std. dev.
ROAA
ROAE
NIM
0.63
7.31
1.73
0.31
6.57
1.67
1.18
5.86
0.56
Independent variables
Mean
Bank-specic characteristics (internal factors)

8.55
Costincome ratio
64.97
0.35
8.16
Difference between bank and market
2.68
growth of total loans
Dummy: large bank: total
0.37
assets > 512 m. USD
Dummy: medium bank: total assets
0.38
between 212 m and 512 m. USD
(reference category)
Dummy: small bank: total
0.25
assets < 212 m. USD
74.36
Funding costs
2.30
Bank age
Dummy: bank was founded before
0.70
1950 (reference category)
0.20
Dummy: bank was founded between
1950 and 1989
Dummy: bank was founded after
0.10
1990
Bank ownership
0.90
Dummy: bank is privately owned
0.09
Dummy: bank is (co-)owned by a
state or city
Dummy: bank is not listed at a stock
0.94
exchange (reference category)
Dummy: bank is listed at a stock
0.06
exchange
Nationality
Dummy: bank is a Swiss bank
0.82
Dummy: bank is a foreign bank
0.18
Macroeconomic and industry-specic factors (external factors)
Effective tax rate
29.94
Real GDP growth
2.12
0.51
Herndahl Index
2449.2
Median
6.42
62.44
0.05
5.00
1.08
0
Std. dev.
9.68
16.51
1.74
16.65
17.51
0
86.04
2.03
27.36
1.34
1
0
26.32
2.53
0.45
2545
18.75
1.24
0.29
797.11
The table reports the descriptive statistics of the variables used in the regression analyses. For the notation of the variables see
Table 1.
4.2. Methodology
To empirically investigate the effects of internal and external factors on bank protability, we follow
Athanasoglou et al. (2008) and Garca-Herrero et al. (2009) and use a linear model given by (1):
PERFit = c + PERFi,t1 +
J

j=1
j Xit +
L

l=1
j Xit + it
(1)
Table 4
Cross-correlation matrix of independent variables.
CI ratio
Loan
loss
prov o.
TA
0.22
0.15
0.07
0.09
0.05
0.05
0.06
0.02
0.21
0.05
0.07
0.02
0.02
0.01
0.09
0.08
0.09
0.02
0.01
0.27
0.26
0.22
0.20
0.06
0.02
0.21
0.04
0.03
0.31
0.14
0.07
0.09
0.13
0.12
0.05
0.15
0.02
0.20
0.13
0.12
0.08
0.18
0.41
1
0.04
0.31
0.25
0.09
0.08
0.07
0.04
0.09
0.31
0.06
0.16
0.01
0.11
0.03
0.08
0.06
0.29
0.12
0.05
0.09
0.13
0.11
0.02
0.05
0.02
0.04
0.05
0.31
0.12
0.05
0.06
0.08
0.05
0.28
0.35
0.16
0.18
0.11
0.06
0.24
0.08
0.32
0.06
0.28
0.28
0.14
0.09
0.22
0.01
0.07
0.01
0.02
0.32
0.13
0.23
0.17
0.01
0.10
0.32
0.16
0.11
0.02
0.16
0.05
0.06
0.24
0.05
0.02
0.02
0.08
0.02
0.01
0.02
0.02
0.02
0.07
0.11
0.14
0.04
0.09
0.11
0.03
0.01
0.05
0.24
0.02
0.04
0.01
0.01
0.06
0.01
0.44
0.03
0.03
0.01
0.01
0.02
0.02
0.03
0.01
0.05
0.04
0.08
0.21
0.02
0.05
0.09
0.04
0.03
Yr
Growth Dum
growth tot.loans large
deposits
bank
Dum
small
bank
int.inc.
sh
Fund
costs
Dum
bank
age
middle
Dum
bank
age
young
Dum
state
bank
Dum
list.
bank
Dum
for.
bank
Eff. tax
rate
Real
gdp
growth
Term
structure
HHI
Loan loss
prov o. TA
Yr growth of
deposits
Diff. growth
total loans
Dum large
bank
Dum small
bank
Interest
income
share
Funding costs
Dum bank
age middle
Dum bank
age young
Dum state
bank
Dum listed
bank
Dum foreign
bank
Effective tax
rate
Real gdp
growth
Term
structure
of int.
HHI
Eq. o.
TA
1
317
318
PERFi,t is protability of bank i at time t, with i = 1,. . .,N, t = 1,. . .,T, c is a constant term, Xit s are the
bank-specic and market-specic explanatory variables as outlined above, and i.t is the disturbance,
with vi the unobserved bank-specic effect and uit the idiosyncratic error. This is a one-way error component regression model, where vi (IIN(0, 0, v2 )) and independent of uit (IIN(0, u2 )). Bank prots
show a tendency to persist over time, reecting impediments to market competition, informational
opacity and/or sensitivity to regional/macroeconomic shocks to the extent that these are serially correlated (Berger et al., 2000). As a consequence, we specify a dynamic model by including a lagged
dependent variable among the regressors, i.e. PERFi,t1 is the one-period lagged protability and the
speed of adjustment to equilibrium. A value of between 0 and 1 implies persistence of prots, but
they will eventually return to their normal level. A value close to 0 indicates an industry that is fairly
competitive, while a value close to 1 implies a less competitive structure.1
Given the dynamic nature of our model, least squares estimation methods produce biased and
inconsistent estimates (see Baltagi, 2001). Therefore, we use techniques for dynamic panel estimation
that are able to deal with the biases and inconsistencies of our estimates. Another challenge with
estimation of bank protability refers to the endogeneity problem. As Garca-Herrero et al. (2009)
outline, more protable banks, for example, may also be able to increase their equity more easily by
retaining prots. Similarly, they could also pay more for advertising campaigns and increase their size,
which in turn might affect protability. However, the causality could also go in the opposite direction,
because more protable banks can hire more personnel, and thus reduce their operational efciency.
Another important problem is unobservable heterogeneity across banks, which denitively also exists
in the Swiss banking industry, differences in corporate governance, which we cannot measure well.
Following Garca-Herrero et al. (2009), we address these problems by employing the generalized
method of moments (GMM) following Arellano and Bover (1995), also known as system GMM estimator. This methodology accounts for endogeneity. The system GMM estimator uses lagged values of
the dependent variable in levels and in differences as instruments, as well as lagged values of other
regressors which could potentially suffer from endogeneity.
We instrument for all regressors except for those which are clearly exogenous. The variables treated
as endogenous are shown in italics in the result tables below. The system GMM estimator also controls
for unobserved heterogeneity and for the persistence of the dependent variable. All in all, this estimator
yields consistent estimations of the parameters.
In a rst step, we estimate our model over the entire time period from 1999 to 2009. In order to
investigate the impact of the recent nancial crisis on the determinants of banking protability, we
additionally split up the sample into two time periods, namely the pre-crisis period ranging from 1999
to 2006, and the crisis and post-crisis period including the years 2007, 2008 and 2009.
Finally, the simultaneous inclusion of certain variables may raise concerns of multicollinearity. As
noted later on, we computed several tests in order to make sure that our results are not affected by
multicollinearity issues.
5. Empirical results
Table 5 summarizes the empirical results for our main protability measure ROAA. The rst two
columns report the results when including all eleven years in our sample. In order to investigate the
impact of the recent nancial crisis on the banks protability determinants, we further split up the
sample: Columns three and four refer to the period before the crisis (up to 2006). Columns ve and
six report the estimates for the years of the nancial crisis, namely 20072009. In order to identify the
stability of the coefcients and their signicance, we rst include only the bank-specic determinants
into our model (columns one, three and ve). In a second step, we report the estimates of the full
model with the bank- and market-specic factors (columns two, four and six).
Our estimation results point out to stable coefcients. Also, the Wald-test indicates ne goodness of
t and the Hansen test shows no evidence of over-identifying restrictions. The equations indicate that
a negative rst-order autocorrelation is present. However, this does not imply that the estimates are
See also Athanasoglou et al. (2008) for further details.
Table 5
Regression results for returns on average assets (ROAA) as dependent variable.
Dependent variable: ROAA
Before the nancial crisis: 19992006
During the nancial crisis 20072009
Bank-specic
factors
Bank- and
market-specic factors
Bank-specic
factors
Bank- and
Bank-specic
factors
Bank- and
0.087*** (0.023)
0.011 (0.007)
0.028*** (0.001)
0.005 (0.010)
0.005*** (0.001)
0.008*** (0.001)
0.090*** (0.023)
0.014** (0.007)
0.027*** (0.001)
0.000 (0.010)
0.006*** (0.001)
0.008*** (0.001)
0.044 (0.029)
0.005 (0.011)
0.025*** (0.002)
0.016 (0.013)
0.003 (0.002)
0.010*** (0.001)
0.051* (0.030)
0.005 (0.011)
0.025*** (0.002)
0.021 (0.013)
0.004* (0.002)
0.011*** (0.002)
0.156***(0.049)
0.023** (0.010)
0.027*** (0.001)
0.143** (0.060)
0.010*** (0.002)
0.009*** (0.001)
0.131*** (0.050)
0.028*** (0.010)
0.028*** (0.002)
0.138** (0.061)
0.011*** (0.002)
0.007*** (0.002)
0.155 (0.132)
0.118 (0.133)
0.436** (0.185)
0.419** (0.187)
0.929*** (0.268)
0.871*** (0.272)
0.758*** (0.136)
0.817*** (0.139)
1.377*** (0.189)
1.420*** (0.191)
0.227 (0.253)
0.067 (0.262)
0.005*** (0.001)
0.053*** (0.015)
0.687*** (0.148)
0.004*** (0.001)
0.031* (0.017)
0.614*** (0.152)
0.017*** (0.004)
0.154*** (0.022)
0.997*** (0.217)
0.019*** (0.004)
0.151*** (0.024)
1.006*** (0.223)
0.011*** (0.002)
0.058 (0.121)
0.991*** (0.284)
0.012*** (0.002)
0.070 (0.112)
0.834*** (0.297)
0.301* (0.165)
1.336*** (0.293)
0.300* (0.166)
1.105*** (0.308)
0.056 (0.225)
1.001 (0.925)
0.003 (0.227)
0.443 (0.551)
1.237*** (0.307)
1.803*** (0.399)
1.105*** (0.318)
1.750*** (0.433)
1.930*** (0.337)
1.852*** (0.346)
1.653*** (0.464)
1.341*** (0.476)
1.468*** (0.569)
1.388** (0.586)
0.318** (0.135)
0.007*** (0.001)
4.185*** (0.210)
1639
372
2 (22) = 1898.26
(1.000)
(0.002)
(0.144)
0.285** (0.137)
0.007*** (0.001)
0.037*** (0.013)
0.193*** (0.067)
0.000** (0.000)
3.643*** (0.293)
1639
372
2 (25) = 1886.68
(1.000)
(0.13)
(0.13)
0.326* (0.191)
0.008*** (0.002)
3.452*** (0.311)
981
318
2 (22) = 966.46
(1.000)
(0.002)
(0.58)
0.198 (0.197)
0.009*** (0.002)
0.006 (0.016)
0.038 (0.089)
0.000*** (0.000)
2.346*** (0.418)
981
318
2 (25) = 963.19
(1.000)
(0.002)
(0.503)
0.133 (0.270)
0.009*** (0.002)
3.459*** (0.454)
658
263
2 (22) = 1232.55
(1.000)
(0.03)
(0.961)
0.053 (0.275)
0.008*** (0.002)
0.032 (0.044)
0.282** (0.135)
0.000 (0.000)
3.923*** (0.594)
658
263
2 (25) = 1238.11
(1.000)
(0.039)
(0.884)
319
The table reports results from GMM estimations of the effects of bank- and market-specic characteristics on bank protability. The dependent variable is the return on average assets
ROAA. For the notation of the variables see Table 1. The full sample includes 1639 observations from 372 banks. The period covers the years 1999 to 2009. Variables in italics are
instrumented through the GMM procedure following Arellano and Bover (1995). Robust standard errors are in brackets. Coefcients that are signicantly different from zero at the 1%,
5%, and 10% level are marked with ***, **, and * respectively. The Hansen test is the test for over-identifying restrictions in GMM dynamic model estimation. AB test AR(1) and AR(2) refer
to the ArellanoBond test that average autocovariance in residuals of order 1 respectively of order 2 is 0 (H0: no autocorrelation); p-values in brackets.
L.ROAA
Cost-income ratio
Diff. between bank and market growth
of total loans
Dummy: large bank: total assets>512
m. USD
Dummy: small bank: total assets<212
m. USD
Funding costs
1950 and 1989
Dummy: bank was founded after 1989
Dummy: bank is (co-)owned by state
or city
Dummy: bank is listed at stock
exchange
Effective tax rate
Real gdp growth
Herndahl Index
Constant
Number of observations
Number of banks
Wald-test
Hansen test (p-value)
AB test AR(1) (p-value)
All years
320
inconsistent. Inconsistency would be implied if second-order autocorrelation was present (Arellano

and Bond, 1991). But this case is rejected by the test for AR(2) errors.
Our lagged dependent variable, which measures the degree of persistence of our protability measure ROAA, is statistically signicant across all models, indicating a high degree of persistence of bank
protability and justifying the use of a dynamic model.
Overall, we observe some signicant differences between the estimation results of the different
time periods, both with respect to the signicance and the size of the coefcients. The capital ratio,
which is dened as equity over total assets, does not have a signicant impact on bank protability
before the crisis. However, it has a negative and signicant effect on bank protability as measured
by ROAA during the nancial crisis 20072009. One of the main reasons for this relation is that safer
banks in Switzerland were attracting additional saving deposits (mainly from UBS) during the crisis.
However, they were not able to convert the substantially increasing amount of deposits into signicantly higher income earnings as the demand for lending decreased in this period. Even though total
earnings for these banks often slightly increased during this time of turmoil, protability decreased as
banks did not nd attractive investment opportunities or were lowering net interest margins in order
to lend their additional deposits.)
The coefcient of the cost-to-income ratio, our operational efciency measure, is negative and
highly signicant for all different time period. The more efcient a bank is the higher is its protability.
This result meets our expectation and stands in line with the results of Athanasoglou et al. (2008).
The loan loss provisions relative to total loans ratio, which is a measure of credit quality, do not
have a statistically signicant effect on bank protability before the crisis. This is not surprising, given
that banks in Switzerland had very low loan loss provisions before the nancial crisis. However, the
loan loss provisions have signicantly increased during the crisis, and this is reected in its negative
impact on protability during the crisis years, with the coefcients being signicant at the 5% level.
The yearly growth of deposits has a signicant and negative impact on bank protability, and
this effect is mainly driven by the crisis years. Banks in Switzerland were not able to convert the
increasing amount of deposit liabilities into signicantly higher income earnings above all in recent
time of turmoil. However, and most interestingly, banks with relatively higher lending growth rates
(in comparison to the market) were more protable than slowly growing banks in all considered time
periods. The effect of a faster growing loan volume seems to over-compensate the risk that a too fast
growth in loans may lead to a decrease in credit quality.
As to bank size, which we track by dummy variables, we nd some empirical evidence that larger
and smaller commercial banks were more protable than medium-sized banks (reference category)
before the crisis. This gives some indication that larger banks were able to benet from higher product
and loan diversication possibilities, and/or economies of scales (see Smirlock, 1985; Bikker and Hu,
2002). However, large banks in Switzerland were less protable than small and medium-sized bank
during the past 3 years of the nancial crisis.2 The main reasons for this negative relationship between
size and protability are that larger banks in Switzerland had relatively higher loan loss provisions
during the crisis and that larger banks were found to have signicantly lower net interest margins in
times of turmoil than smaller banks (see below). This might also be a consequence of some reputational
problems that mainly larger banks in Switzerland faced during the recent crisis.
On average, 75% of total income for the commercial banks in our sample consists of traditional
banking income (interest income) and to a lesser extent of fee and commission income as well as
trading operations. Our ndings show that banks with a higher share of interest income relative to
the total income are signicantly less protable, and this holds before as well as during the crisis, with
the effect being signicant at the 1% level. The reason for this coherence is that prot margins of fee,
commission and also trading operations are usually higher than prot margins in interest operations,
and that many banks could benet from a positive development of the stock market and a higher stock
exchange turnover.
2
As a robustness test, we alternatively measure bank size by total assets instead of the dummy variables for the different size
categories. The effect of total assets on the ROAA is negative and statistically signicant at the 10% level, which conrms our
results from the dummy approach. Note that the advantage of including the dummy variables for size is that we have obtained
more information about the impact of size on the return on bank protability.
321
Funding costs have a signicantly negative impact on the return on assets before the crisis, i.e.
banks that raise cheaper funds are more protable. However, this does not hold anymore during the
crisis, where funding costs dropped anyway to a historically low level. Furthermore, bank age has a
signicant impact on banking protability in the whole sample period. In contrast to our hypothesis as
formulated above, older banks are not more protable than recently founded banks or banks founded
between 1950 and 1989. Newer banks seem to be even more protable than older banks. This means
that newer banks are able to pursue successfully new prot opportunities and that a longer tradition
of service and, in this context, a better reputation does not positively affect the protability of a bank.
Also, younger banks may be more efcient in terms of their IT infrastructure, which is reected in the
protability measure as well.
Our results regarding the impact of ownership on protability before the crisis support the ndings
of Bourke (1989), Molyneux and Thornton (1992) and Athanasoglou et al. (2008) that the ownership status (private or state-owned banks) is irrelevant for explaining protability. Our results from
Switzerland stand thus in contrast to the ndings of Micco et al. (2007) and Iannotta et al. (2007), who
point out that government-owned banks exhibit a lower protability than privately owned banks.
However, things look different for the crisis years, which is quite interesting. Our results provide
empirical evidence for the Swiss market that state-owned banks are more protable than privately
owned banks during the nancial crisis. In this time of turmoil, state-owned banks were considered
as safer and better banks in comparison to privately owned institutions. International ownership of a
bank seems to have a signicant impact on bank protability when considering the whole model. In
fact, foreign-owned banks in Switzerland seem to be less protable than their Swiss competitors. This
result conrms the ndings of Demirguc-Kunt and Huizinga (1999), who nd evidence that foreignowned banks are less protable in developed countries than domestic banks. Furthermore, there is
some empirical evidence that banks listed on the stock exchange are slightly less protable than banks
that are not. This holds for all specications.
Considering the external factors related to the macroeconomic environment and the nancial structure in Switzerland, our study nds that taxation negatively affects bank protability in Switzerland,
with the coefcients being signicant at the 1% level in all specications. Our results conrm the ndings of Demirguc-Kunt and Huizinga (1999) that higher tax rates lead to a lower post-tax prot. This
result is of specic importance in Switzerland, where tax rates vary widely across the Swiss cantons,
all of which have their own tax regime. However, the impact of taxation on banking protability is
rather small. Overall, it seems that banks are able to shift a large fraction of their tax burden onto their
depositors, borrowers, and purchasers of fee-generating services.
The business cycle signicantly affects bank prots when considering all years. Bank prots seem
to be pro-cyclical as the demand for lending increases during cyclical upswings and thus lead to more
and more protable business (Athanasoglou et al., 2008; Albertazzi and Gambacorta, 2009). The term
structure of interest rates, measured by the difference between the 5-year and 2-year treasury bills
in CHF issued by the Swiss government, positively affects the protability of Swiss banks overall and
in particular during the nancial crisis. Commercial banks in Switzerland use short-term deposits to
nance long-term loans. A steeper yield curve, as during the nancial crisis years, thus affects the
protability positively.
Furthermore, the impact of the market structure, approximated by the Herndahl index seems to
have a signicant and positive effect on bank protability before the crisis, but not thereafter. Accordingly, we do nd some support for the structure-conduct-performance hypothesis. These ndings are
in line with the results of Bourke (1989) and Molyneux and Thornton (1992), even though the effect
seems to be rather small.
Table 6 reports the regression results for our second protability measure return on average equity
ROAE. Again, we estimate the model for the entire time period considered, and then separately for the
two subsamples pre-crisis and crisis years.
Overall, the results of these regressions conrm to a large extent the above-discussed key results.
There are, however, also some differences. In contrast to the results for our main protability measure
ROAA, differences exist related to our ownership variables. The ownership status (private or stateowned banks) has no impact on bank protability when measured by the ROAE. This does not only
hold for the period before the crisis, but also thereafter. Banks listed at the stock exchange are more
322
Table 6
Regression results for returns on average equity (ROAE) as dependent variable.
Dependent variable: ROAE
All years
Bank- and
Bank-specic
factors
Bank- and
Bank-specic
factors
Bank- and
0.181*** (0.024)
0.023 (0.056)
0.144*** (0.009)
0.078 (0.081)
0.024** (0.011)
0.025*** (0.007)
0.180*** (0.024)
0.036 (0.057)
0.140*** (0.009)
0.090 (0.082)
0.017 (0.012)
0.031*** (0.008)
0.123*** (0.033)
0.055 (0.097)
0.208*** (0.016)
0.176 (0.116)
0.006 (0.019)
0.044*** (0.012)
0.128*** (0.033)
0.054 (0.098)
0.203*** (0.016)
0.197* (0.119)
0.004 (0.019)
0.046*** (0.014)
0.086* (0.045)
0.050 (0.058)
0.084*** (0.008)
0.535* (0.325)
0.004 (0.011)
0.020*** (0.007)
0.092** (0.045)
0.065 (0.059)
0.088*** (0.008)
0.474 (0.333)
0.001 (0.012)
0.008 (0.009)
2.412** (1.093)
2.647** (1.101)
8.654*** (1.717)
8.587*** (1.736)
4.462*** (1.323)
4.580*** (1.355)
3.289*** (1.131)
3.521*** (1.153)
9.298*** (1.765)
9.345*** (1.778)
0.962 (1.344)
0.726 (1.413)
0.014*** (0.010)
0.400*** (0.123)
0.475 (1.199)
0.012*** (0.011)
0.293** (0.133)
0.290 (1.231)
0.219*** (0.033)
1.247*** (0.194)
3.407* (1.900)
0.223*** (0.034)
1.186*** (0.210)
3.326* (1.943)
0.052*** (0.009)
0.245 (0.181)
0.441 (1.593)
0.060*** (0.010)
0.198 (0.183)
0.844 (1.681)
2.388* (1.376)
2.365 (2.211)
2.412* (1.381)
3.204 (2.307)
3.002 (2.022)
1.885 (4.442)
3.035 (2.043)
3.362 (4.585)
1.896 (1.773)
1.188 (2.158)
2.171 (1.839)
1.149 (2.304)
2.724 (2.600)
3.186 (2.672)
1.633 (4.102)
2.563 (4.196)
6.919** (3.091)
7.523** (3.156)
0.240 (1.141)
0.022** (0.010)
25.116*** (1.734)
1639
372
2 (22) = 911.46
(1.000)
(0.015)
(0.405)
0.231 (1.157)
0.021** (0.010)
0.264**
0.715 (0.542)
0.001 (0.001)
22.024*** (2.366)
1639
372
2 (25) = 914.37
(1.000)
(0.01)
(0.35)
0.221 (1.757)
0.011 (0.016)
20.559*** (2.749)
981
318
2 (22) = 660.12
(1.000)
(0.085)
(0.41)
0.457 (1.798)
0.012 (0.016)
0.104 (0.142)
0.417 (0.782)
0.001 (0.001)
17.455*** (3.521)
981
318
2 (25) = 653.21
(1.000)
(0.08)
(0.342)
3.303** (1.572)
0.070*** (0.009)
30.667*** (2.607)
658
263
2 (22) = 812.15
(1.000)
(0.04)
(0.739)
3.846** (1.633)
0.067*** (0.009)
0.370 (0.250)
0.368 (0.716)
0.000 (0.000)
32.572*** (3.330)
658
263
2 (25) = 801.76
(1.000)
(0.042)
(0.527)
The table reports results from GMM estimations of the effects of bank- and market-specic characteristics on bank protability. The dependent variable is the return on average equity
ROAE. For the notation of the variables see Table 1. The full sample includes 1639 observations from 372 banks. The period covers the years 19992009. Variables in italics are instrumented
through the GMM procedure following Arellano and Bover (1995). Robust standard errors are in brackets. Coefcients that are signicantly different from zero at the 1%, 5%, and 10%
level are marked with ***, **, and * respectively. The Hansen test is the test for over-identifying restrictions in GMM dynamic model estimation. AB test AR(1) and AR(2) refer to the
ArellanoBond test that average autocovariance in residuals of order 1 respectively of order 2 is 0 (H0: no autocorrelation); p-values in brackets.
L.ROAE
Cost-income ratio
of total loans
assets > 512 m. USD
assets < 212 m. USD
Funding costs
1950 and 1989
or city
exchange
Effective tax rate
Real gdp growth
Herndahl Index
Constant
Number of banks
Wald-test
Bank-specic
factors
Table 7
Regression results net interest margin (NIM) as dependent variable.
Dependent variable: NIM
Bank-specic
factors
Bank- and
Bank-specic
factors
Bank- and
Bank-specic
factors
Bank- and
0.668*** (0.018)
0.018*** (0.003)
0.004*** (0.000)
0.017*** (0.004)
0.001 (0.001)
0.001* (0.000)
0.704*** (0.018)
0.019*** (0.003)
0.003*** (0.000)
0.012*** (0.004)
0.002*** (0.001)
0.003*** (0.000)
0.621*** (0.023)
0.027*** (0.004)
0.006*** (0.001)
0.020*** (0.005)
0.001 (0.001)
0.003*** (0.001)
0.653*** (0.024)
0.029*** (0.004)
0.004*** (0.001)
0.014*** (0.005)
0.001 (0.001)
0.006*** (0.001)
0.668*** (0.041)
0.003 (0.005)
0.002*** (0.001)
0.009 (0.028)
0.006*** (0.001)
0.003*** (0.001)
0.652*** (0.041)
0.004 (0.005)
0.002** (0.001)
0.001 (0.028)
0.006*** (0.001)
0.004*** (0.001)
0.162*** (0.052)
0.090* (0.053)
0.084 (0.067)
0.034 (0.068)
0.242** (0.122)
0.235* (0.123)
0.117* (0.060)
0.108* (0.061)
0.144* (0.079)
0.176** (0.080)
0.378*** (0.122)
0.354*** (0.122)
0.001** (0.000)
0.042*** (0.006)
0.197*** (0.060)
0.000 (0.001)
0.045*** (0.006)
0.251*** (0.062)
0.009*** (0.001)
0.031*** (0.008)
0.018 (0.081)
0.007*** (0.001)
0.028*** (0.009)
0.109 (0.083)
0.002*** (0.001)
0.031* (0.017)
0.223 (0.144)
0.002* (0.001)
0.030* (0.017)
0.143 (0.152)
0.021 (0.066)
0.729*** (0.109)
0.020 (0.066)
0.659*** (0.115)
0.084 (0.086)
0.606*** (0.156)
0.025 (0.087)
0.389** (0.170)
0.288** (0.142)
0.013 (0.207)
0.288** (0.142)
0.017 (0.214)
0.883*** (0.123)
0.700*** (0.125)
0.969*** (0.151)
0.667*** (0.157)
0.252 (0.295)
0.196 (0.297)
0.060 (0.052)
0.000 (0.001)
0.101* (0.053)
0.001 (0.001)
0.047*** (0.005)
0.080*** (0.028)
0.000 (0.000)
0.007 (0.120)
1639
372
2 (25) = 3420.79
(1.000)
(0.002)
(0.49)
0.103 (0.066)
0.001 (0.001)
0.098 (0.069)
0.001 (0.001)
0.040*** (0.006)
0.118*** (0.034)
0.000*** (0.000)
0.074 (0.159)
981
318
2 (25) = 2274.52
(1.000)
(0.001)
(0.801)
0.203 (0.132)
0.001 (0.001)
0.129 (0.132)
0.000 (0.001)
0.032 (0.021)
0.056 (0.065)
0.000 (0.000)
0.608** (0.276)
658
263
2 (25) = 1441
(1.000)
(0.001)
(0.389)
0.565*** (0.079)
1639
372
2 (22) = 3251.90
(1.000)
(0.001)
(0.987)
0.699*** (0.110)
981
318
2 (22) = 2183.61
(1.000)
(0.003)
(0.94)
0.923*** (0.221)
658
263
2 (22) = 1392.62
(1.000)
(0.003)
(0.657)
323
The table reports results from GMM estimations of the effects of bank- and market-specic characteristics on bank protability. The dependent variable is the net interest margin NIM.
For the notation of the variables see Table 1. The full sample includes 1639 observations from 372 banks. The period covers the years 1999 to 2009. Variables in italics are instrumented
through the GMM procedure following Arellano and Bover (1995). Robust standard errors are in brackets. Coefcients that are signicantly different from zero at the 1%, 5%, and 10%
level are marked with ***, **, and * respectively. The Hansen test is the test for over-identifying restrictions in GMM dynamic model estimation. AB test AR(1) and AR(2) refer to the
ArellanoBond test that average autocovariance in residuals of order 1 respectively of order 2 is 0 (H0: no autocorrelation); p-values in brackets.
L.NIM
Cost-income ratio
of total loans
assets > 512 m. USD
assets < 212 m. USD
Funding costs
1950 and 1989
or city
exchange
Effective tax rate
Real gdp growth
Herndahl Index
Constant
Number of banks
Wald-test
All years
324
protable during the crisis than unlisted banks. This result might be driven by the fact that the return
on equity reects shareholder maximization attempts, which is a common practice of some of the
listed banks. In particular, some listed banks in Switzerland may have effectively lowered their equity
capital in order to increase the ROAE. Also, there is empirical evidence that foreign-owned banks are
not less protable over the whole period when the ROAE is our dependent variable. Furthermore,
there is no signicant impact of the market structure, approximated by the Herndahl index, on bank
protability before the crisis.
Table 7 reports the regression results for another protability measure, the net interest margin.
Again, we estimate the model for the entire time period considered, and then separately for the two
subsamples pre-crisis and crisis years. Analyzing the determinants of the net interest margin helps us
to better understand some results of the ROAA specications. For instance, it is interesting to see that
larger banks have a signicantly lower net interest margins during the nancial crisis than mediumor small-sized banks. This might also explain why large banks were less protable in the referring
years. Furthermore, banks with a high relative loan growth exhibit higher net interest margins. This
is also a possible explanation for the positive relationship between the relative loan growth and bank
protability when measured by both the ROAA and the ROAE. Furthermore, banks with a higher share
of interest income of total income have lower net interest margins. This might be another reason why
banks with a higher interest income share are less protable than banks that have a better income
diversication.
6. Conclusions
This paper has examined how bank-specic characteristics, industry-specic and macroeconomic
factors affect the protability of 372 commercial banks in Switzerland over the period from 1999 to
2009. To account for the impacts of the recent nancial crisis, we separately considered the years
before and during the crisis, namely the period up to 2006, and the crisis years 2007, 2008 and 2009.
To date, no econometric study has examined the determinants of protability for the Swiss banking
market, which is surprising given that Switzerland is one of the most important banking centers in the
world. Similarly, there exist very few papers that investigate the impact of the recent nancial crisis
on bank performance.
We use a dynamic model specication that allows for prot persistence. Our results clearly show
that there exist large differences in protability among the banks in our sample and that a signicant
amount of this variation can be explained by the factors included in our analyses. In particular, bank
protability is mainly explained by operational efciency, the growth of total loans, funding costs and
the business model. Efcient banks are more protable than banks that are less efcient. An aboveaverage loan volume growth affects bank protability positively; higher funding costs result in a lower
protability. The interest income share also has a signicant impact on protability. Banks that are
heavily dependent on interest income are less protable than banks whose income is more diversied.
We also nd some evidence that ownership is an important determinant of protability. Furthermore,
the separate consideration of the time periods before and during the crises provides new insights with
respect to the underlying mechanisms that determine bank protability. The results outlined in this
paper provide some evidence that the nancial crisis did indeed have a signicant impact on the Swiss
banking industry and on bank protability in particular.
Overall, our results provide some interesting new insights into the mechanisms that determine
the protability of commercial banks in Switzerland. Our ndings are relevant for several reasons.
First, our estimation results conrm ndings from former studies on bank protability. Second, we
consider a larger set of bank- and market-specic determinants of bank protability, which extends
our knowledge of bank protability with respect to several important dimensions. These extensions
let us generate some new and interesting ndings. Third, we consider the years from 1999 to 2009.
Not only do we provide evidence for a recent period, but these years were also characterized by some
important changes in the banking industry. In addition, by dividing the sample into pre-crisis and
post-crisis segments, we gain additional insights into the impacts of the nancial crisis on nancial
institutions. Finally, by using the system GMM estimator developed by Arellano and Bover (1995),
we apply an up-to-date econometric technique that addresses the issue of endogeneity of regressors,
325
which, in this type of study, can lead to inconsistent estimates. Also, our dynamic model specication
allows for the fact that bank prots show a tendency to persist over time and tend to be serially
correlated, reecting impediments to market competition, informational opacity, and sensitivity to
regional and/or macroeconomic shocks.
Even though our sample includes a large fraction of all commercial banks active in Switzerland and
considers the main bank protability determinants as well as factors related to the institutional and
macroeconomic environment, it has certain limitations. Including additional aspects in our analyses,
such as the impact of mergers, would help us to understand even better the determinants of bank
protability. In addition, it could be fruitful to integrate specic information on management and
board members, e.g. education, skill level, experience, independence, all of which are increasingly
important factors in understanding bank protability. Some of these issues will be addressed in future
work.
Acknowledgements
We would like to thank participants of the 2009 Annual Meeting of the European Financial Management Association in Milano, the 12th conference of the Swiss Society for Financial Market Research
(SGF) in Geneva in 2009 and the Brown Bag seminar at the Institute of Financial Services Zug, Urs
Birchler and Kevin Walsh for helpful suggestions, and the Lucerne University of Applied Sciences and
Arts for their nancial support.
Appendix A. The Swiss banking market
The Swiss banking system is based on the concept of universal banking, i.e. all banks may offer all
banking services. As of 2009, there are 278 authorized banks and securities dealers in Switzerland,
ranging from the two big banks down to small banks serving the needs of a single community or a few
special clients. Swiss banks vary of the degree to which they use the option to engage in all nancial
activities. Some banks really do offer universal services, while other institutions specialize either in
traditional banking or in asset management. In the ofcial statistics maintained by the Swiss National
Bank, Swiss banks are classied into seven major groups: the (two) big banks, the cantonal banks,
the regional and savings banks, the Raiffeisen banks, the foreign-owned banks, the private bankers,
and other banks. To better understand our sample and subsequent empirical work, we provide a brief
description of each type below.
The two big banks, UBS AG and the Credit Suisse Group, are the largest and second largest Swiss
banks. Both banks have extensive branch networks throughout the country and most international
centers. We do not include the two big banks in our sample because they pursue all lines of nancial activities (private banking, institutional asset management, investment banking and commercial
banking), because a large share of their lending activities is abroad and because commercial banking
is not a predominant part of their revenues on group level.
Cantonal banks are state-owned, either entirely or partially, and the majority of a cantonal banks
capital is owned by the sponsoring canton, which also guarantees the banks liabilities. According to
cantonal law, the objective of a cantonal bank is to promote the cantons economy, although cantonal
banks must comply with commercial principles in their business activities. Collectively, the cantonal
banks account for around 30% of banking business in Switzerland and have a combined balance sheet
total that is greater than 300 billion Swiss francs. Formerly, there were at least one or two cantonal
banks per canton. Today, there are only 24 cantonal banks (in Switzerlands 26 cantons and halfcantons). Cantonal banks vary both in size and in their business activities. They are engaged in all
banking businesses, with an emphasis on lending/deposit business, and they operate primarily in the
market of their home canton. Because these banks are active mainly in the traditional commercial
banking business, we include all 24 cantonal banks in our sample.
Regional and savings banks are typically small banks focusing on traditional banking, and their
business is often limited to very small geographical areas. We have included almost all Swiss regional
and savings banks in our sample.
326
Raiffeisen Switzerland, the third largest bank group in Switzerland, is comprised of 390 member
banks, most of which are located in rural areas, and each of which is run as a cooperative. Collectively, the 390 Raiffeisen banks control a network of 1154 branch ofces, the largest such network in
Switzerland, and count 1.4 million Swiss citizens as members, hence co-owners, of the cooperative.
As a group of banks with the largest branch network in Switzerland, 390 Raiffeisen banks with totally
1154 branches together form Raiffeisen Switzerland. Raiffeisen Switzerland coordinates the groups
activities, creates the conditions for the business activities of the local Raiffeisen banks and advises and
supports them in many issues. The bank group is organized as a cooperative and has positioned and
established itself as the third largest bank group in Switzerland. As one of Switzerlands leading retail
banks, Raiffeisen is mainly focusing on mortgage lending. Raiffeisen meanwhile counts 1.4 million
Swiss citizens as members of the cooperative and hence co-owners of their Raiffeisen bank. However,
the Raiffeisen banks are still legally independent small banks located and active mainly in rural areas.
Due to their legally independent status, our sample includes each of the Raiffeisen member banks
individually.
Foreign banks are institutions operating under Swiss banking law, but whose capital is primarily
foreign controlled. Foreign control means that foreigners with qualied interests hold over half of
the companys votes. The national origin of these foreign-owned banks is predominantly European
(over 50%) and Japanese (around 20%). These banks differ widely in size and activities. Some qualify
as universal banks while others focus on asset management. Our sample includes only those foreignowned banks that are active in the traditional banking activities. Our sample excludes foreign-owned
banks that are active only in asset management for private clients.
Private bankers are among the oldest banks in Switzerland. They are unincorporated rms, primarily active in asset management for private clients. Private bankers are subject to unlimited subsidiary
liability with their personal assets. Because these private banks, which do not publicly offer to accept
savings deposits, are not active in the traditional banking eld, and because they do not have to publish
data, we do not include them in our analysis.
The group, other banks, includes banks with various business objectives, such as institutes specializing in the stock exchange, securities, and asset management. For our sample, only banks active
in traditional lending (mainly category 5.11 commercial banks, as dened by the Swiss National Bank)
are considered in our analyses.
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Journal of International Financial

Determinants of bank protability before and during the

Corresponding author. Tel.: +41 417246537; fax: +41 417246550.

3. Determinants of bank protability and variable selection

3.1. Dependent variables

Bank-specic characteristics (internal factors)

Equity over total assets (%). This is a measure of

Regional and savings banks

Bank-specic characteristics (internal factors)

See also Athanasoglou et al. (2008) for further details.

Before the nancial crisis: 19992006

During the nancial crisis 20072009

inconsistent. Inconsistency would be implied if second-order autocorrelation was present (Arellano

During the nancial crisis 20072009

Before the nancial crisis: 19992006

Before the nancial crisis: 19992006

During the nancial crisis 20072009

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