ISSN : 1990-5157

Journal of
Banking & Financial Services
Volume 12 Number 1 June 2020

Department of Banking and Insurance

Faculty of Business Studies
University of Dhaka
 Editorial Board
Prof. M. Muzahidul Islam Prof. Md. Rafiqul Islam, PhD
Prof. Shibli Rubayat-Ul-Islam Prof. Md. Abu Taleb
Prof. A. R. Khan, PhD Prof. Md. Main Uddin, PhD
Prof. Hasina Sheykh, PhD Md. Shahidul Islam, PhD
Prof. Jamal Uddin Ahmed, PhD Prof. Atiur Rahman, PhD
Khandokar Ibrahim Khaled Toufic Ahmed Chowdhury, PhD

Chief Editor
Prof. Md. Main Uddin, PhD

Associate Editor
Md. Shahidul Islam, PhD

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University of Dhaka
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ISSN : 1990-5157
 Contents
Editorial: Banking and Insurance Update 1-2

The Determinants of Lending Rates of Commercial Banks in 3-18

Bangladesh: Lerner Index Analysis
Md. Shahidul Islam
Bank-Specific and Macroeconomic Drivers of Islamic Bank 19-41
Profitability: Dynamic Panel Evidence from Bangladesh
Md. Asif Nawaz
Raad Mozib Lalon
Competition and Profitability of Commercial Banks in 43-58
Bangladesh
Muhammad Saifuddin Khan
Jannatun Nayema
Determinants of Interest Rate Spread in the Banking Sector of 59-81
Bangladesh
Md Sajib Hossain
Shabnaz Amin
Factors Affecting Customer Satisfaction in Islamic Banking: 83-101
Evidence from Islamic Banks in Bangladesh
Md. Amdadul Hoque
Md. Shahidul Islam
Predicting the Bankruptcy Risk: Evidence from Banking 103-128
Industry of Bangladesh
Md. Nazmul Hasan
Kanij Fatama
Determinants of Intellectual Capital Disclosure: Evidence from 129-149
Banking Sector of Bangladesh
Mohammad Salahuddin Chowdhury
Zannatun Nayeem Chowdhury
Do Capital Inflows Contribute to Economic Growth of the 151-174
Least Developed Countries? Lesson from Bangladesh
Abdullah Al Mahmud
Shibli Rubayat Ul Islam
Financial Literacy Among University Students in Bangladesh 175-193
Naheed Rabbani
Impact of Innovation Culture on Organizational Citizenship 195-213
Behavior: A Study on Fin-tech Industry of Bangladesh
Shahrin Ashraf
The Moderating Role of University Environment in Boosting 215-231
Students’ Entrepreneurial Action Behavior
Kazi Md Jamshed
Muhammad Intisar Alam
 1

Editorial: Banking and Insurance Update

Banking Update
Bangladesh with no exception is capitulated under a significant threat of
economic disparity navigating a colossal crisis during and after the significant
outbreak of Covid-19 pandemic. The most significant issue in the banking sector
is high non-performing loans (NPLs) which stood around 8.88% of total
outstanding loans even after a circular of Bangladesh Bank to abstain from further
classification of any loan till December 2020. Hence, the biggest challenge of
2021 is to set the banking system in right shape and direction as the crucial
indicators of the banking sector are unable to show positive improvement during
2020. The gross NPL ratio of State-owned Commercial Banks (SCBs) dropped to
22.46% in Q1FY21 from 22.73% in Q4FY20. Similarly, the gross NPL ratio for
Private Commercial Banks (PCBs) stood at 5.56% in Q1FY21, declined by 0.30
percentage points from the preceding quarter. Moreover, the system-wide net
NPL ratio of the banking industry posted negative growth, the first-ever in the
running decade, to -0.22% in Q1FY21 in contrast to 0.39% in Q4FY20. This
decline is facilitated by PCBs reflecting higher interest suspense account balance
and actual provision. Moreover, provisioning maintained against classified loans
improved at the end of Q1FY21.
Most of the banks posted lower operating profits in 2020 as the
implementation of single-digit lending rate plunged their profitability and the
Covid-19 outbreak in the country lessened the disbursement and recovery of
loans. The 9% ceiling on lending rate came into force on April 1, 2020 following
an instruction from the government. The implementation of the rate was the major
reason for the drastic fall in operating profits in the year as many banks had to
pay higher interest against the deposits in the first half of the fiscal year, lowering
their profit margin. Before the rate cut, almost all the banks were charging more
than 11% against major lending products while many of them were charging even
more than 15%. The majority of the banks might fail to sustain their profit after
taxes as the entities have been asked to keep additional 1% provision against their
unclassified loans for 2020. Banks have been instructed to keep additional
provision to minimize risks as they were asked not to degrade loans for the
borrowers’ non-payment in 2020. The pandemic-induced economic shocks have
also resulted in a sharp decline in credit demand as businesses are shaky in
making fresh investment decision or to expand their business.
However, the capital to risk-weighted asset ratio (CRAR) grew to 11.94% in
Q1FY21 from that of 11.63% in Q4FY20, attributing mainly from SCBs and
FCBs. The CRAR of SCBs went up to 8.25% in Q1FY21, from 6.93% in
Q4FY20. Moreover, the CRAR of FCBs also registered an increased growth,
rising to 25.59% from 24.35% in Q4FY20. However, the CRAR of PCBs
remained almost unchanged at 13.3% in Q1FY21. Bangladesh Bank also set the
revised cash reserve ratio (CRR) to 4% which was 5% earlier to increase money
supply in economy. It also reduced the repo rate to 4.75% from 5.75% with a
view to boosting liquidity amid the pandemic. As a result, the liquidity position
remained adequate and improved further at the end of Q1FY21, partly due to
easing CRR policy, higher remittance inflows, and intervention in the foreign
exchange market. Likewise, excess liquidity, the excess of CRR and statutory
2

liquidity ratio as a percentage of total demand and time liabilities, increased to

12.6% in Q1FY21 compared to that of 10.7% in Q4FY20.
The bank deposits increased from 10.5% at the end of Q4FY20 to 12.4%
(from BDT 13,054.73 billion to BDT 13,454.36 billion) at the end of Q1FY21,
reflecting mainly higher remittance inflows (49.05% y-o-y). Moreover, the
growth of advances also witnessed an increase from 9% at the end of Q4FY20 to
9.6% (from BDT 10,647.13 billion to BDT 10,655.7 billion) at the end of
Q1FY21. According to Bangladesh Bank Annual Report 2020-21, total number
of branches reached 10,643 as on October 2020, wherein urban-rural proportion is
almost 50-50.

Insurance Update
Bangladesh insurance sector comprises 46 general insurance companies and 33
life insurance companies including two state-owned insurance corporations-one
in the life sector and other in the general sector. As of 2019, insurance penetration
measured by insurance premium as a percentage of GDP in Bangladesh was just
0.49% which was lowest in Emerging Asia and has mostly been on a downward
trend since 2015. Of total population of the country, only 11.45% have insurance
policies, revealing the low penetration. Bangladesh is one of the most
underinsured countries of the world. Its insurance premium per capita was just
$10.2 which is the lowest in Emerging Asian Countries, implying that people
have no insurance at all compared to the Emerging Asian counterparts. This under
penetration may be characterized by the shortage of skilled human capital, lack of
appropriate insurance product, backdated and inconsistent insurance business
model, deficiency of policy support from the government and above all absence
of good corporate governance in insurance sector.
Bangladesh insurance sector is dominated by life insurance since this sector
constitutes 73.5% of the Bangladesh insurance market whereas non-life insurance
constitutes 26.5%. According to Annual Report 2017-2018 of Bangladesh
Insurance Association, the total life insurance policies in force reached
10,951,920 at the end of 2017. On the other hand, the total number of insurance
policies which contributed to generate gross premium from different sub-classes
of general insurance business were 2,418,630 in 2017. Further, the gross premium
of life insurance companies in 2019 was Tk 96.1 billion. In contrast, non-life
insurance companies grew by 8.6% or Tk 36.8 billion, including the state-owned
Sadharan Bima Corporation.
Although Bangladesh experienced lowest insurance penetration, still it can be
considered as a land of opportunity that holds huge unmet demand for insurance
products. Bangladesh as a disaster-prone country requires disaster insurance
products namely catastrophe bonds and Insured Linked Securities to cover the
risk arising from climate shocks. Moreover, it should focus on micro insurance as
it is one of the major routes to attain financial inclusion through insurance. In this
regard, financial literacy specifically digital financial literacy, changing
technology and customer management will be the driving force for the progress
of insurance sector.
Volume 12, Number 1, June 2020

The Determinants of Lending Rates of Commercial

Banks in Bangladesh: Lerner Index Analysis

Md. Shahidul Islam 1

Abstract: Considering different bank and industry specific variables, the

present study investigates the determining factors of the pricing power of
the commercial banks operating in Bangladesh. The panel study comprised
data of 42 commercial banks both from conventional and Islamic Banks
spanned from the years of 2011 to 2017. Notably found the Lerner Index
having significant determining power on the loan pricing of the
commercial banks. The step-wise fixed effect (FE) regression outcomes
revealed that along with Lerner Index, the size of the respective banks,
marginal cost of operation and industry structure also significantly
determine the loan pricing behavior of the commercial banks. Findings of
the present study can be greatly used by the bank management and the
policy makers to understand the loan pricing issues and to formulate
sustainable strategies in coming days.
Keywords: Lerner Index; Lending rate; Marginal cost; Hirschman
Herfindahl Index (HHI)

1. Introduction
Among others, commercial banks are the most important depository financial
institutions (DFIs). In 2010, the share of total wealth of commercial banks in
the entire financial markets and institutions was 27% in the United States of
America. As the financial intermediary, commercial banks accept surplus of
the economic agents as deposit and provide loans and advances to the deficit
units in the economy. According to Flannery (1981), the rate commercial
banks provide on the deposit is borrowing rate (rB) and the rate that
commercial banks charge on loans and advances is called lending rate (rL).
The difference between lending rate (rL) and borrowing rate (rB) is termed as
spread (Allen, 1988). As the financial intermediary, commercial banks always
try to optimize their lending rate. But, there are certain factors affecting the
lending rate of commercial banks. In case of determination of the appropriate
lending rate, commercial banks must have to consider some bank specific
factors such as the cost of borrowing, size of business and so on along with
some industry specific factors like competition in the industry.

1
Associate Professor, Department of Banking and Insurance, University of Dhaka,
Dhaka-1000, Email: [email protected]
4 Journal of Banking & Financial Services

Alternatively speaking, lending rate is the price charged by the commercial

banks on the loans and advances they offer to the borrowers. So, there exist
the price sensitive issues like if there is any relationship between the lending
rate and the quantity or volume of lending. Clearly speaking, researchers
might want to know the effect of price sensitivity on the commercial banks’
lending operations. The very term is so called the elasticity of demand and
properly addressed by Abba Lerner (1934) after his name ‘The Lerner Index’.
Another influential factor of determining the bank lending rate is the
industry competition. Bain (1956) in his famous Structure Conduct
Performance (SCP) hypothesis originally proposed as the tool for analysis of
the performance of an industry. The approach was quite popular among the
empirical researchers until the beginning of the 1990s.The SCP hypothesis
argues that higher concentration in the banking market causes banks less
competitive and leads to higher bank profitability but a lower performance
from a social point of view. A proxy for market concentration that is, an
concentration ratio or a Hirschman-Herfindahl Index (HHI) can be used as
regressor (Xi) on the performance variable (Yi) (Berger and Hannan, 1987,
Berger 1995).
In this present paper, we studied the determinants of the commercial banks
lending rate with particular emphasize on the effect of the Lerner Index and
the industry concentration on the lending rate. The paper considered the panel
data set of 42 commercial banks in Bangladesh for the data period of 2011 to
2017. Using the fixed effect (FE) as the base line model estimator, we also
used the random effect (RE) and the ordinary least square (OLS) model
estimators as the alternative model estimators. For better confidence of our
model estimators, we also performed the robustness check using alternative
variable.
In the subsequent parts of the paper, we presented the review of literature,
empirical approach and sample description succeeded by empirical results,
conclusion followed by the references and appendix.
2. Literature Review
There exists a long history of literature in the field of applied economics
where the researchers investigated the determinants of the commercial banks’
lending rate in order to optimize the optimal debt contract. Starting from
Stiglitz and Weiss (1981), where they studied that banks cannot always set
high interest rates as this would lead the adverse selection and moral hazard
issues. If banks set interest rates too high, they may induce adverse selection
problems because high-risk borrowers are willing to accept these high rates.
The Determinants of Lending Rates of Commercial Banks in Bangladesh: 5

In their seminal work, Ho and Saunders (1981) studied the determinants of

the so called ‘bankers’ markup’ in the famous dealership model. In the
dealership model, Ho and Saunders (1981) argued for the economics of
charging interest spread as the stochastic behavior of loan and deposit
markets. Flannery (1981) exclusively studied the determinants of bank
interest rates using the historical data of the US banking and found that the
size of the banking firm and their respecting lending rates have significant
relationships. Diamond and Rajon (1998) studied the importance of optimality
condition of bank lending rates and their possible impact on the bank lending
operations using cross country panel data. Moudos and Guevara (2004)
studied the importance of industry concentration and its effect on the lending
rate determination of the commercial banks in the EU banking markets.
Olokoyo (2011) studied the lending rate determinants of commercial banks
of Nigeria and found that cost of borrowing has statistically significant effect
on the lending rate. Maledi (2014) studied the determinants of lending rate of
commercial banks using Ethiopian banks data and concluded the size and
liquidity having significant impact. Mousa and Chedia (2016) studied the
determinants of the lending rate of commercial banks and found return on
assets and liquidity among other bank specific variables has significant impact
on lending rate.
Studies on the measures of market concentration and banking spread have
been critically illustrated by Gilbert (1984) and Berger et al. (2004). Berger
and Hannan (1989) used the deposit rate – concentration link for the US retail
deposit markets. The structure-conduct-performance (SCP) paradigm has
been used as the proxy to study the industry structure and its effect on the
firms’ profitability.
Islam and Nishiyama (2018) studied the effect of the structure-conduct-
performance (SCP) hypothesis using the panel data set of 39 commercial
banks of Bangladesh and found that relatively larger banks have monopolistic
behavior in their lending rate determination.

The present study on the determinants of lending rate of commercial banks

have contribution to the existing literature as we viewed the determinants of
the lending rate as the function of bank specific and industry specific factors.
We used the panel data set notably speaking our dataset covers the post global
financial crisis (GFC) period. Our particular focus in this study is to show the
impact of the Lerner index on the interest rate determination. We also
addressed the effect of industry concentration using the Hirschman Herfindahl
6 Journal of Banking & Financial Services

Index that is also unique addition to the literature of the determinants of

lending rate of commercial banks.
3. Empirical Approach
The present study viewed the determinants of commercial banks’ lending
rates as the function of some bank-specific and industry-specific factors with
particular emphasis on the Lerner Index. Regarding the variable selection, we
were much more intuitive. We think that among the bank-specific variables,
marginal cost of offering services along with size of the operating firm play
significant roles. We emphasized on the deterministic power of the Lerner
Index on banks’ lending rate as this index reveal the elasticity of market
demand, as in our study the elasticity of the demand for loans. We included
the industry-specific variable, Hirschman and Herfindahl Index (HHI) to
capture the industry influence on the bank lending rate.
In the following table-1, the description of the variables used in the study
has been presented.
Table-1: Description of variables used in the study
Variables Description Expected
effect
Interest rate charged by the commercial
Dependent variable: Bank banks on their lending; lending rate in
lending rate (P) (%) percentage
Independent variables
(a). Bank-specific variables
Inverse demand elasticity (see details of +/-
derivation in the variable description
i. Lerner Index (L) section)
ii. Marginal Cost (MC) Changes in total cost (TC) with respect to +/-
(%) time (t) expressed in percentage
iii. Total Asset (TA) (in Total Assets (TA) volume of the +/-
mil. BDT) respective bank expressed in volume
iv. Total Equity (TE) (in Total Equity (TE) volume of the +/-
mil. BDT) respective bank expressed in volume
(b). Industry-specific variables
v. Hirschman +/-
Herfindahl Index Sum of square of market share (in terms
(HHI) based on Total of total assets) is a proxy for market
Asset (TA) structure variable
vi. Hirschman +/-
Herfindahl Index Sum of square of market share (in terms
(HHI) based on Total of total equity) is a proxy for market
Equity (TE) structure variable
The Determinants of Lending Rates of Commercial Banks in Bangladesh: 7

3.1 Variables

3.1.1 Dependent Variable

Bank lending rate
In this study on the determinants of the commercial banks’ lending rate, we
used the lending rates of banks on their loan services have been used as the
dependent variable. In the literature of banking, lending rate is
interchangeably used as the lending interest rates. The borrowing rates have
been termed as the cost of borrowing or the borrowing rates, for the
commercial banks, the bank lending rate is actually the price of the loans.
According to Rose (2003), the lending interest rate is the cost of loan i.e. the
ratio obtained by dividing a commitment fee by the loan amount. In our study,
we extracted the lending interest rates from the Bank Focus database.

3.1.2 Explanatory Variables

3.1.2.1 Bank Specific Explanatory Variables
(i) Lerner Index
Lerner (1934) formulated by his name, the Lerner Index that in the later
period has been extensively used in the literature of applied economics as the
firm’s market power. Initial form of Lerner Index is

P − MC 1
= =−
P Ed
Where, L = Lerner Index
P = Price (In case of banking operation, the price of the loans) and MC=
Marginal cost of operation. stands for elasticity of demand. The initial
formula is the inverse elasticity of demand. And can be derived as follows.
If, P = price, Q = quantity and C= cost, then,
8 Journal of Banking & Financial Services

The Lerner Index ranges from 0 to 1. The interpretation of the index is as,
in a perfectly competitive firm charges P = MC, and in that case, L = 0;
literally, such a firm has no market power. An oligopolistic or monopolist
charges P > MC, so its index is L > 0, but the extent of its markup depends on
the elasticity (the price-sensitivity) of demand and strategic interaction with
competing firms. The value of Lerner Index could rise to 1 if the firm has MC
= 0.

Another interpretation is that, the Lerner Index value can never be greater
than 1 (one). As a result, if the firm is maximizing profit, the elasticity of
demand facing it can never be less than one in magnitude (|E|<1). If it were,
the firm could increase its profits by raising its price, because inelastic
demand means that a price increase of 1% would reduce quantity by less than
1%, so revenue would rise, and since lower quantity means lower costs,
profits would rise. Put another way, a monopolist never operates along the
inelastic part of its demand curve.

The Lerner Index has been extensively used as the indicator of competition
with solid theoretical foundations. Following the organization approach of
banking and applied economics literature, Prescott and McCall (1975),
Maudos and Fernandezdez Guevara (2004) used the Lerner Index to
determine the inter-bank competition and their impact on bank lending rates.

In this study on the determinants of the lending rate of the commercial

banks of Bangladesh, we gave particular focus on Lerner Index and its
deterministic power on the lending rates. The intuition to include the Lerner
Index in the regression model is to see the bank behavior in charging from the
customers.
(ii) Total Asset

Size of the bank is used as the proxy variable of information asymmetry in

our econometric model of determinants of net interest margins. We want to
The Determinants of Lending Rates of Commercial Banks in Bangladesh: 9

see how information asymmetry affects the lending rates of banks. But it is
hard to find the information asymmetry variables from the disclosed chapters
of the bank information from their financial statements. Then we aimed to
characterize banks as small and large (size) in terms of their holding of assets.
Following Islam and Nishiyama (2016a), we calculated the size of the bank as
the holding of total asset of respective banks. Size of the bank in our model as
explanatory variable, answers the question of whether the large banks are
charging more or less in relation to the small banks or not. Our hypothesis is
that, holding others remaining constant, the size of the bank affect the net
interest margin inversely.

(iii) Total Equity

Total equity measures the capitalization of a bank considering the regulatory

requirements regarding the minimum equity holdings. Following McShane
and Sharpe (1985), we also used equity variable as the proxy of degree of risk
aversion of banks. Among others, Saunders and Schumacher (2000) Maudos
and Guevara (2004) used the variable in the same way but Hawtrey and Liang
(2008) used different approach to calculate the risk averseness of the banks by
dividing securities plus other assets by volume of loans.

As cited by Saunders and Schumacher (2000), ‘banks are special’ and

customers are willing to pay for that specialness. To address the systematic
risk and other regulatory reasons, banks maintain certain equity level. So,
everything remains constant, the risk averse bank tends to charge more.
Hence, we expect the positive relationship between equity to total asset ratio
and the net interest margin.

(iv) Marginal Cost of Operation

Marginal cost (MC) is the changes in total cost (TC) due to every unit
changes in the quantity. In commercial banking, total cost includes both fixed
and variable cost of operation. Historically fixed cost has been viewed as
irrelevant to decision making but operating expenses found to be significant
determinant to bank interest rates. Controlling for these costs promotes
efficiency of the bank and enhances the competitiveness as well. Among
others, Kunt et. al. (1999), Maudos and Guevara (2004), Hawtrey and Liang
(2008) studied the effect of overhead expenses on determining interest of
banks. We employed the marginal cost variable in our model to see how this
variable affects the lending interest rates of a bank. Principally, if a bank’s
unit operating expenses is relatively higher (less efficient), that bank will try
10 Journal of Banking & Financial Services

to compensate that by charging additional on the regular margins. So, a

positive sign has been expected.
3.1.2.2 Industry Specific Explanatory Variable

(V) Hirschman Herfindahl index

We used the Hirschman Herfindahl Index (HHI) in our econometric model of
determinants of net interest margins of banks to find out the relationship
between market concentration and the interest of commercial banks in
Bangladesh. Hirschman Herfindahl index has been defined as the sum of
squares of individual bank asset shares to the industry and the formula as
follows: Where, Si = Share (.) of individual bank to the
industry.
This is a common and widely used measure of market concentration where
higher market concentration means lower competition and vice versa. Past
literature has contrasting views regarding the relationship between market
concentration and interest margins of banks. Most of the recent studies1 on
the developed countries found positive sign coefficient for the variable. But
Hesse (2007) and Fungacova and Poghosyan (2011) who studied Kenyan and
Russian banking respectively found negative relationship between market
structure and the interest rates. We expected positive relationship between the
market concentration and net interest margins of banks supportive to the Ho
and Saunders’ (1981) proposition that, if a bank faces relatively inelastic
demand and supply functions in the markets in which it operates, it may be
able to exercise monopoly power by demanding a greater prices than it could
get if banking markets were competitive. We calculated HHI of the banking
industry of Bangladesh considering two variables. First, we calculated the
HHI considering total assets (TA) and then total equity (TE) as the proxy of
size variable.
3.2 Econometric Model

The present study viewed each and every commercial bank (i) as the profit
maximizing agent in the economy. Each and every firm exercises its
competitive power or the degree of concentrationϴ),( if any. Hereby, we
assume the lending rate (L) of bank i at time t as a function of some bank
specific variable and industry specific market conditions as in the following
equations:

1
Angbanzo (1997), Saunders and Schumacher (2000), Maudos and Guevara (2004), Williams
(2007) for reference.
The Determinants of Lending Rates of Commercial Banks in Bangladesh: 11

= F [Bank Specific Factors, Industry Specific Factors]

or,
= F[ (.), (.)]
Thus, the econometric approach to estimate the model will be as in the
following linear form:

......Equation-1
Where, is the lending interest rates of commercial bank i at time t where
i = 1,....., N, t = 1,....., T and α is a constant term. The superscripts j and m of
denote the bank-specific and industry specific determinants
respectively. is the disturbance with the unobserved bank-specific
effect and the idiosyncratic error. The error components of the regression
model is distributed as ~IIN (0, ) and independent of ~ IIN (0, ).
We examined whether the individual effects are fixed or random. The
relevant Hausman test (the null hypothesis that the individual effect and the
explanatory variables are uncorrelated) for Equation -1 confirms the evidence
in favor of a Fixed Effect (FE) modeling2. Though, we explained the
regression estimation of the equation-1 as the baseline estimator, but we also
presented the Random Effect (RE) and Ordinary Least Square (OLS)
estimation outputs as the alternative estimators. We tested the robust standard
errors for the beta coefficients as the Modified Wald test (xttest3)3 for group-
wise heteroskedasticity suggest for the inclusion.
4. Sources of Data and Sample Description
In this present study of the determinants of the lending rate of the commercial
banks in Bangladesh, we used data of 42 commercial banks both from
conventional and Islamic banking systems. The unbalanced panel dataset
covered the period from 2011 to 2017. We extracted the secondary data from
the Bureau Van Dijk’s Bank Focus database (Bank Focus, 2018) using the
universal model of banking database. We estimated the regression model
using the STATA econometric software. In table-2, we described the

2
The relevant Hausman, test chi-squared statistics is ) = 24.67 with p-value of 0.0000
3
Modified Wald test (xttest3) for group-wise heteroskedasticity statistics is ) =
1.3e+31 with p-value of 0.0000
12 Journal of Banking & Financial Services

summary statistics of the dependent and independent variables. From the table
we find that, in the sample period average lending rate was 8.77% with a
standard deviation of 2.52. Average variation of the total cost that is the
Marginal Cost (MC) was slightly more than 6.5%. The crucial target variable,
the average value of the Lerner Index was 0.043.As the Lerner Index is
greater than zero (0), there exist either oligopolistic or monopolistic behavior
among the banking firms in Bangladesh. Whereas, the Hirschman Herfindahl
Index (HHI) value is 0.049 considering size of the bank in terms of total
assets and 0.044 considering the size of bank in terms of total equity.

Table-2: Summary statistics of the variables used in the study

Number of
Variable observations Mean Std. Dev.
Bank lending rate (P) (%) 240 8.767587 2.517339
Marginal Cost (MC) (%) 240 6.583675 2.273289
Total Asset (TA) (in mil. BDT) 240 2328503 2208773
Total Equity (TE) (in mil. BDT) 240 200434.4 152225.6
Lerner Index (L) 197 0.042514 0.195136
Hirschman Herfindahl Index
(HHI) based on Total Asset (TA) 294 0.048924 0.002234
Hirschman Herfindahl Index
(HHI) based on Total Equity (TE) 294 0.04409 0.005829
Source: Bank Focus database and author’s calculation
5. Regression Analysis and Findings
In this paper, we studied the determinants of the lending rates of commercial
banks of Bangladesh. This empirical study includes the panel data of 42
commercial banks for the period of 2011 to 2017; notably the post global
financial crisis era. We used fixed effect (FE) model to capture the specific
characteristics of each group, using the within-group estimator. First, we will
present our baseline model result of the pooled estimation using the baseline
econometric model in equation1. Then we presented the robustness check
result of our baseline model. In all cases, we allowed for individual
heterogeneity and used robust standard error 4.
5.1 Baseline Result
Result of our baseline model of fixed effect regression, where we assumed
each country’s banking sector as a single representative firm, has been
presented in table 3. The first column of the table presents the list of the

4
Confirmed by LM Heteroskedasticity test and the test statistics (p-value) are presented in the
respective tables.
The Determinants of Lending Rates of Commercial Banks in Bangladesh: 13

dependent and independent. Another feature of the presentation of table 3 is

that there are three models- model 1 is the base line fixed effect estimation
output. Model 2 and model 3 present the Random effect (RE) and Ordinary
Least Square (OLS) as the alternative estimation outputs. The independent
variables, coefficients of the independent variables and the robust standard
errors of the coefficients have been presented according to the initial
hypotheses developed in the empirical approach section.
From table3 of the regression estimation output, we find that the Lerner
Index and the lending rate are positively related. The relationship is
statistically significant and the magnitude is high.
Table-3: Factors determining the bank lending rate of the commercial
banks in Bangladesh: Total sample from 2011 to 2017
Variables Fixed Effect Random Effect OLS Estimation
(FE) Estimation (RE) Estimation
Dependent Variable: Coefficient (β) Coefficient (β) Coefficient (β)
Lending rate of (Robust Standard (Robust Standard (Robust Standard
commercial banks Error, σ) Error, σ) Error, σ)
Independent Variables
Bank Specific
Lerner Index 0.778*** 0.396 -0.422
(0.288) (0.416) (0.551)
Total Asset -0.0000008** -0.0000005*** -0.00000031**
(0.0000003) (0.0000001) (0.00000005)
Marginal Cost 0.890*** 0.848*** 0.706***
(0.0965) (0.0977) (0.0553)
Industry Specific
Hirschman Herfindahl -4.824*** -1.424 4.926**
Index_TA
(0.864) (1.741) (2.214)
Constant -9.742*** -0.0197 19.77***
(2.815) (6.113) (6.890)
Number of 197 197 197
observations
Wald χ2 , F –Stat (p F (4,40)=150.79 F(4)= 537.70 F(4,192)=111.98
value)
(0.0000) (0.0000) (0.0000)
R-squared (R2) 0.878 0.8701 0.700
Adjusted R2 - - 0.6937
Hausman Test, χ2 24.67 - -
(3)(p-value)
(0.0000) - -
LM Heteroskedasticity 1.3e+31 - -
test, χ2 (p-value)
(0.0000) - -
Note: The table reports the regression output from Fixed Effect estimation of the net interest margins
determinants. as the baseline estimator. The Coefficients that are significantly different from zero at the
1%, 5% and 10% level are marked with ***, **, and * respectively. Wald test is the test for the goodness of
fit of the model while Hausman test confirm the justification of using fixed effect estimator and LM
heteroskedasticity test justify the use of robust standard error for the models.
14 Journal of Banking & Financial Services

The interpretation of positive beta coefficient of Lerner Index is that, the

commercial banks in Bangladesh having less price sensitivity. This means
every 1 percent increase in price (lending rate) would decrease the quantity of
demand by less than 1 percent. In such a state of the economy, banking firms
can raise their revenue by increasing price. The reality, at least for the sample
period is somehow similar to the findings in this research.
Size in terms of total asset and the lending rate of commercial banks found
negatively related and the coefficient is statistically significant. Size variable
actually capture the role of asymmetric information in determining bank
lending rate. We found expected sign of the coefficient as in line of Islam and
Nishiyama (2016a) found the same sign in their empirical study.
We found our expected positive sign of the beta coefficient of marginal
cost variable. Mousa and Chedia (2016) also found positive coefficient in case
of Tunisian banking markets. The regression output says that for every 1
percent increase in marginal cost would increase the lending rate by 89 basis
points.
Industry concentration and its impact on the bank lending rate, in case of
Bangladesh is negative. Fungacova et al., (2007) in case of Russian banking,
William et al. (2007) in case of Australian banking, Hesse (2012) in case of
Kenyan banking found negative coefficient of industry concentration index.
This means, large banks are enjoying influential deterministic power in
charging capacity for loan granting decisions.
5.2 Robustness Check

We ran the regression equation1, the baseline econometric model of fixed

effect regression, using the alternative variable in order to check the
robustness of our estimation outputs. We used the total equity (TE) instead of
total assets (TA) as the alternative variable. Also, we calculated and included
the Hirschman Herfindahl Index (HHI) using the size in terms of total equity.
In robustness regression model, we ran fixed effect (FE) as the baseline
estimator. We also estimated the model using random effect (RE) and
ordinary least square (OLS) estimators.

We found the same order, sign and statistical level of significance in our
robustness check as we found in the base line estimations presented in table-3.
Thus, we can confidently claim that our baseline estimation output is robust.
The Determinants of Lending Rates of Commercial Banks in Bangladesh: 15

Table-4: Factors determining the bank lending rate of the commercial

banks in Bangladesh: Total sample from 2011 to 2017 (Robustness
check using total equity instead of total asset as the alternative variable)
Variables Fixed Effect Random OLS
(FE) Effect (RE) Estimation
Estimation Estimation
Dependent Variable: Net Coefficient (β) Coefficient (β) Coefficient (β)
Interest Margins (NIM) (Robust (Robust (Robust
Standard Error, Standard Error, Standard
σ) σ) Error, σ)
Independent Variables
Bank Specific
Lerner Index 0.637 0.313 -0.526
(0.398) (0.468) (0.573)
Total Equity -0.000008*** -0.000006*** -0.000004***
(0.000002) (0.000001) (0.0000007)
Marginal Cost 0.934*** 0.852*** 0.700***
(0.0634) (0.0962) (0.0579)
Industry Specific
Hirschman Herfindahl -3.270*** -0.609 5.635**
Index_TE
(1.124) (1.879) (2.301)
Constant -5.694 2.531 21.98***
(3.770) (6.583) (7.173)
Number of observations 197 197 197
Wald χ , F –Stat (p value)
2
F (4,40)= F(4)= 512.4 F(4,192)=100.
133.19 02
(0.0000) (0.0000) (0.0000)
2
R-squared (R ) 0.8705 0.6531 0.6761
Adjusted R2 - - 0.6694
Hausman Test, χ2 (3)(p-value) 24.67 - -
(0.0000) - -
LM Heteroskedasticity test, χ 2
1.3e+31 - -
(p-value)
(0.0000) - -
Note: The table reports the regression output from Fixed Effect estimation of the net interest margins
determinants. as the baseline estimator. The Coefficients that are significantly different from zero at the
1%, 5% and 10% level are marked with ***, **, and * respectively. Wald test is the test for the goodness of
fit of the model while Hausman test confirm the justification of using fixed effect estimator and LM
heteroskedasticity test justify the use of robust standard error for the models.
16 Journal of Banking & Financial Services

6. Conclusion

In this paper, we studied the determinants of the lending rate of commercial

banks in Bangladesh. We used the panel dataset of 42 commercial banks from
the year of 2011 to 2017. Notably, our sample period reflects the post global
financial crisis (GFC) period s covering the impact of that in the banking
markets in Bangladesh.
We studied the extensive literature starting from Ho and Saunders (1981),
Fraser (1984), Moudos and Guevara (2004) and also the recent literature in
the field of empirical banking research literature. We focused particular
emphasize on the Lerner index and its possible impact on the lending rate set
by the lending organizations; here, in our study, the commercial banks in
Bangladesh. As in our study, we found that loan markets in Bangladesh are
less sensitive to loan price. Commercial banks can raise revenue by increase
price of the loan (lending rate).

We found that marginal cost having positive and size have negative
relations with the bank lending rate. The negative Herfindahl index reveals
that, commercial banks in Bangladesh are still enjoying some monopolistic
behavior in loan pricing.
Our research is contemporary and can be greatly used by the bank
management, policy makers and the bank-borrowers. The findings of the
research will help them to formulate policy and access to the loan market
decisions. We see that, there exist huge future prospects of the research.
Including new explanatory variables, using next level of econometric
methodology and updated data period, analyzing cross country experiences,
we see prosperous future direction of research.

References
1. Allen L., 1988. The determinants of bank interest margins: a note. Journal of
Financial and Quantitative Analysis, 23, 231-235.
2. Bank Focus., 2018. Bureau Van djik
3. Berger, A. N., 1995a. The profit structure relationship in banking: test of market
power and efficient structure hypothesis. Journal of Money, Credit and Banking,
27 (2), 404-31.
4. Berger, A.N., and Hannan, T.H., 1989. The Price-Concentration Relationship in
Banking. Review of Economics and Statistics, 71, pp. 291-299.
The Determinants of Lending Rates of Commercial Banks in Bangladesh: 17

5. Flannery, M.J., 1981. Market Interest Rates and Commercial Bank Profitability:
An Empirical Investigation. The Journal of Finance, Vol. 36, Issue 5, December
1981, pp. 1085 - 1101
6. Fungacova, Z., Poghosyan, T., 2011. Determinants of bank interest margins in
Russia: Does bank ownership matter? Economic Systems, 35 (2011), 481-495.
7. Hesse, H., 2007. Financial intermediation in the pre-consolidated banking sector
in Nigeria. World Bank Policy Research Working Paper. 4267, Washington, DC.
8. Ho, T., Saunders, A., 1981. The determinants of bank interest margins: theory
and empirical evidence. Journal of Financial and Quantitative Analysis, 16, 581-
600.
9. Islam, Md. S., Nishiyama, S., 2016a. The determinants of bank net interest
margins: A panel evidence from South Asian countries. Research in International
Business and Finance, 37 (2016), pp. 501-514, Elsevier B.V.
10. Islam, Md. S., Nishiyama, S., 2016b. The determinants of bank profitability:
Dynamic panel evidence from South Asian countries. Journal of Applied Finance
and Banking. Vol. 6, Issue 3, pp. 77-97, Scienpress.
11. Islam, Md. S., Nishiyama, S., Structure Conduct Performance (SCP) Paradigm
and its Effect to Determine the Spread in Banking Industry: Empirical Evidence
from Bangladesh, Journal of Banking and Financial Services, Vol. 10 No. 1, pp.
1 –14, ISSN: 1990-5157, June 2018
12. Lerner, A. P. (1934). "The Concept of Monopoly and the Measurement of
Monopoly Power". The Review of Economic Studies. 1 (3): 157–175
13. Malede, M., 2014. Determinants of Commercial Banks Lending: Evidence from
Ethiopian Commercial Banks. European Journal of Business and Management,
ISSN 2222-1905 (Paper) ISSN 2222-2839 (Online), Vol.6, No.20, 2014
14. Maudos, J., Fernandez de Guevara, J., 2004. Factors explaining the interest
margin in the banking sectors of the European Union. Journal of Banking &
Finance, 28, 2259-2281.
15. Mousa, M.A.B., Chedia, H., 2016. Determinants of Bank Lending: Case of
Tunisia. International Journal of Finance and Accounting, 2016, 5(1): 27-36
16. Olokoyo, F. O., 2011. Determinants of Commercial Banks’ Lending Behavior in
Nigeria. International Journal of Financial Research, Vol. 2, No. 2; July 2011
17. Tarus, D.K., Chekol, Y.B., Mutwol, M., 2012. Determinants of net interest
margins of commercial banks in Kenya: A panel study. Procedia Economics and
Finance, 2 (2012) 199-208.
18. Valverde, SC., Fernandez, FR., 2007. The determinants of bank margins in
European banking. Journal of Banking & Finance, 31 (2007) 2043-2063.
19. Williams, B., 2007. Factors determining net interest margins in Australia:
domestic and foreign banks. Financial Markets, Institutions and Instruments, 16,
145-165.
18 Journal of Banking & Financial Services

Appendix

Table-A.1: Correlation matrix

Lerner Total Total Marginal

Variables Price Index Asets Equity Cost HHI_TA HHI_TE

Price 1

Lerner Index -0.3875 1

Total Asets -0.471 0.229 1

Total Equity -0.4404 0.2394 0.9102 1

Marginal
Cost 0.7826 -0.4216 -0.2543 -0.282 1

HHI_TA 0.4698 -0.1628 -0.1342 -0.105 0.5026 1

HHI_TE 0.5752 -0.3644 -0.153 -0.1423 0.5336 0.5162 1

Source: Stata output

Volume 12, Number 1, June 2020

Bank-Specific and Macroeconomic Drivers of Islamic

Bank Profitability: Dynamic Panel Evidence from
Bangladesh

Md. Asif Nawaz1

Raad Mozib Lalon2

Abstract: Considering the importance of analyzing the dynamics of the

bank profitability and gaps in the extant literature, this study attempts to
analyze the determinants of Islamic bank profitability in Bangladesh. To
do so, the study has utilized a balanced panel dataset from 6 Islamic banks
currently operating in Bangladesh involving a period of 2007-2018, and
the dynamic panel data method namely, System Generalized Method of
Moments (SGMM). The analysis reveals that profitability, measured by
both Return on Assets (ROA) and Return on Equity (ROE), is significantly
persistent in the Islamic banking sector of Bangladesh. The study found
that profitability measured by ROA is significantly positively influenced
by bank capitalization level, expense management, investment risk, non-
investment income, growth of foreign exchange business, and money
supply growth rate. On the other hand, employee productivity, and stock
market development have been found to significantly negatively influence
the ROA. Again, profitability measured by ROE is found to be
significantly positively influenced by employee productivity but
significantly negatively influenced by capitalization, and money supply.
Keywords: Islamic bank profitability; System GMM; Bank profitability
determinants

1. Introduction

The banks in Bangladesh are currently facing a challenging environment due

to rising regulatory pressure, persistent lower interest rates, rising non-
performing loans (NPLs), political uncertainties, and tensions in the
international trade. Furthermore, declining margins and the increasing
digitization of the financial sector will also continue to drive structural
restructuring in the banking sector in the upcoming years. Moreover, currently
operating 39 Non-bank Financial Institutions (NBFIs) are also providing some

1
Corresponding Author: Assistant Professor, Department of Banking Insurance,
University of Dhaka, Dhaka-1000, E-mail: [email protected]
2
Associate Professor, Department of Banking Insurance, University of Dhaka,
Dhaka-1000, E-mail: [email protected]
20 Journal of Banking & Financial Services

sort of banking facilities making the banking sector more competitive as there
are already more than 60 banks in Bangladesh while the journey of Banking
in Bangladesh has started with just 6 nationalized banks in 1972. It is needless
to say that the above-mentioned changes and challenges have an influence on
the banking sector of Bangladesh by influencing banks’ ways of doing
business and their ways of earning income.
Alongside the conventional (interest-based) commercial banks, the Islamic
banks (IBs) of Bangladesh has shown tremendous growth in past decades and
has earned a very important place in the policy and strategic issues from the
regulators. Islamic banks are like conventional banks but follow the Sharia’h
principles in all of its operations (Alharbi, 2017). Currently, there are 8 full-
fledged Islamic banks operating in Bangladesh and two more are going to
start their operations very soon. Besides, 19 branches of 9 conventional
commercial banks and 41 Islamic banking windows of 8 other conventional
banks are also providing the Islamic financial services to serve the increased
demands by the majority Muslim community of Bangladesh. According to the
June-2018 report by the Bangladesh Bank, the total asset and the total
investments (financing in accordance of Sharia’h rules) of the industry has
increased to USD 29806.671 million (23.77% of the total banking sector) and
USD28 879.673 million (24.26% of the total banking sector) respectively.
According to the financial stability report of Bangladesh Bank, IBs in
Bangladesh has lower NPLs as compared to their conventional counterparts
(4.8% versus 9.3%) and IBs enjoy higher ROA than that of the conventional
commercial banks operating in Bangladesh. The support from the government
and central bank, and a strong public demand from the religious perspective
have fueled the current growth of the sector (Development of Islamic Banking
in Bangladesh, Bangladesh Bank, 2018). Furthermore, to meet the liquidity
requirements, there is an active Islamic Inter-bank Money Market (IIMM) and
to fulfill the capital market needs of IBs, Bangladesh Securities and Exchange
Commission (BSEC), the regulator of the capital markets, has recently issued
Bangladesh Securities and Exchange Commission (Investment Sukuk) Rules,
2019.

In a nutshell, it is reasonable to believe that Islamic Banking in Bangladesh

has a very strong footing and any policy formulation from the regulators not
considering the sector will be a waste of effort. However, now the question is
what are the drivers of the growth of this sector? Alongside the above
mentioned regulatory and structural changes influencing the profitability of
the banking sector, a number of other bank-specific and macroeconomic
factors influencing the profitability of the IBs have evolved over times.
Bank-Specific and Macroeconomic Drivers of Islamic Bank Profitability: 21

Therefore, besides the other researches, the analysis of the factors influencing
bank profitability are growing day by day to unveil the success factors of the
IBs. The results of these analyses not only help bank managers and board
members to build stronger banks but also helps policy makers and regulators
in formulating efficient regulations for the banking industry. Following
Molyneux and Thorton (1992), Demirguc-Kunt and Huizunga (1999), Micco
et al. (2007) and majority of other researches analyzing the determinants of
bank profitability, this study attempts to analyze the bank-specific and
macroeconomic drivers of the profitability of Bangladeshi Islamic banks. The
purpose of this paper is to contribute to the existing literature of bank
profitability analysis which will help us to understand the extent of influence
of the bank-specific and macroeconomic factors on the profitability of Islamic
banks.

The contribution of this study lies in the fact that it is the first study
analyzing the factors of Islamic bank profitability with a dynamic panel
dataset. To the best of our knowledge no study has specifically analyzed the
profitability performance of the Bangladeshi Islamic banks. Further, this study
is incorporating some additional factors namely stock market index, growth
rate of foreign exchange business by IBs, variability of the exchange rate, and
most importantly the practice of government borrowing from the banking
sector. The analysis of these factors will reveal some important insights on the
uncontrollable factors of banks influencing the profitability as very few
studies have incorporated these determinants in their analysis. Finally, the
study will help the policy makers and regulators in finding out the recent
drivers of Islamic bank profitability as it is employing the most recent dataset
in the analysis.

In the other parts of this paper, the literature review presents a picture of
previous studies on bank profitability, the variable section describes the
variables in use and provides the measures and expected impact of the
variables, the data and methodology section is concerned with the data and
model specification, and results section discusses the findings of our analysis,
and the conclusion and further research section indicates the scope of further
research in this area of research.

2. Literature Review

The studies, Short (1979) and Bourke (1989) are the pioneering ones in the
area of analyzing bank profitability determinants. Since then a number of
studies have then been conducted in this area of literature on bank
22 Journal of Banking & Financial Services

performance analysis. This research demands the review of the- studies

conducted on analyzing the internal and external determinants of banks’
profitability; studies conducted on analyzing the internal and external
determinants of Islamic banks’ profitability; and studies conducted on
analyzing the internal and external determinants of Bangladeshi’ banks’
(either Islamic or conventional or Islamic and conventional banks)
profitability.

Most of the studies investigating the cross-country panel have used very
common internal determinants of bank profitability (e.g. size, capital ratio,
loan ratio, cost ratio, risk ratio etc.) and found expected results. Berger et al.
(1987) found that large banks often enjoy scale efficiency and increased size
can reduce the cost of the banks thus can lead to better profitability. Similarly,
Pasiouras and Kosmidou (2007) found a significantly positive relation
between size and bank profitability. However, Micco et al. (2007) found no
association between bank size and profitability. Abreu and Mendes (2002)
used loan to assets ratio as a proxy for risk and found that risk has a positive
impact on banks’ profitability. Oppositely, Bourke (1989) and Molyneux and
Thornton (1992) among others, found a negative association between risk and
profitability may be because of the fact that high-risky loans leads to higher
accumulation of unpaid loans and loan losses and eventually to lower
profitability. Regarding capital level of the banks as an important determinant
of profitability, Bourke (1989), Goddard et al. (2004), Pasiouras and
Kosmidou (2007), Abreu and Mendes (2002), and Naceur and Goaied (2001,
2005) state that well capitalized banks are more profitable than banks
inadequately capitalized because banks with higher capital are able to obtain
cheaper funding due to the fact that they seem less risky with higher capital.
Finally, Athanasoglou et al. (2008) found a negative relation between
overhead costs and bank profitability.

In relation to the important external determinants, like interest rate,

inflation, economic development, taxation, and variables regarding market
characteristics and financial sector structure there is a mixed evidence in the
literature. For example, the studies of Molyneux and Thornton (1992)1 in their
cross-country studies on Europe along with Demirguc-Kunt and Huizinga
(1999), and Athanasoglou et al. (2008) reported a positive relationship
between central bank interest rates, inflation, GDP growth and bank

1
The theory of expense preference hypothesis suggests that high profits earned by firms in a regulated
industry may be appropriate in the form of higher payroll expenditures [Follow Molyneux and Thorton
(1992) for further clarification]
Bank-Specific and Macroeconomic Drivers of Islamic Bank Profitability: 23

profitability. Further, Demirguc-Kunt and Huizinga (1999) and Albertazzi and

Gambacorta (2009) found a negative relation between taxation and
profitability as banks try to pass on the burden of their taxes on the borrowers,
depositors, or purchaser of fee-generating activities (Dietrich and
Wanzenried, 2011). In relation to the impact of market structure on the
profitability, Bourke (1989) and Molyneux and Thornton (1992) observed a
positive impact of the market concentration on the profitability of the banks
because of the presence of structure-conduct-performance (SCP) hypothesis.
However, Demirguc-Kunt and Huizinga (1999), Berger (1995), Mamatzakis
and Remoundos (2003) and Staikouras and Wood (2004), contradicting SCP
hypothesis, found a negative association between concentration and bank
profitability.

On the other hand, a large number of studies analyzed the profitability

determinants of Islamic banks. The first study analyzing the profitability
determinants of Islamic banks was a thesis conducted by Haron in 1997. The
study found that liquidity, funds invested in Islamic securities, total
expenditure, profit-sharing ratio between bank and investment taker, bank
size, and market share were highly correlated with Islamic banks’
profitability. The study also found the association of interest rates, current
deposits, profit-sharing ratio between bank and the depositors, capital and
reserves to the profitability of Islamic banks. Again, Hasan and Bashir (2003)
analyzed the profitability determinants of Islamic banks and found that equity,
deposit and short-term funding, macroeconomic environment, credit risk, and
concentration were positively linked to profitability. However, the study
found that size, non-interest earning assets, loans and taxes had a negative
impact on the Islamic banks’ profitability. Similarly, Ben Khaderi and Ben
Khaderi (2009) analyzed the profitability determinants of Islamic banks of
MENA countries during 1999-2006 and they found that well capitalized
banks are more profitable and GDP growth rate and market concentration
positively influence the profitability of Islamic banks. However, they found a
negative association between Islamic bank profitability and cost to income
ratio and no association between profitability and stock market capitalization
and loans to total assets. Smaoui and Salah (2011) analyzed the profitability
determinants of Islamic banks of GCC countries during 1995-2009
considering ROA, ROE, and NIM as the profitability measures and found that
equity, asset quality (measured by the level of non-performing assets), GDP
growth, and size of the banks positively and concentration and loans to assets
24 Journal of Banking & Financial Services

ratio negatively influence the profitability of Islamic banks. Furthermore,

Masood and Ashraf (2012) revealed that size and capital positively and asset
quality, deposit growth, operating efficiency, and GDP negatively influence
Islamic banks’ profitability. Similarly, Mokni and Rachdi (2014) found that
interest rate risk, cost-to-income ratio, GDP, capital, off-balance sheet
activities, and liquidity risk significantly positively influence profitability of
the concerned Islamic banks. However, they found a significantly negative
association between profitability and credit risk and size. Among the most
recent studies, Alharthi (2016) used ROA and NIM as the profitability
measure and found that size and deposits were positively related to ROA and
NIM. Whereas, capital, credit risk loan intensity, foreign ownership of banks,
and GDP were negatively correlated to the profitability of Islamic banks. On
the other hand, Alharbi (2017) used ROAA and NIM as the proxy for
profitability and found that capital ratio, GDP per capita, other operating
income, bank size, oil price and concentration positively affect Islamic bank
profitability.

Finally, a number of studies have also been conducted to analyze the

determinants of profitability of Bangladeshi banks. Sufian and Habibullah
(2009) studied the performance of 37 commercial banks during 1997-2004
and found that size, credit risk, loan intensity, GDP growth and cost have
significantly positive impact on the bank profitability. Whereas, costs and
inflation found to be significantly negatively influencing bank profitability in
Bangladesh. Similarly, Hossain and Ahmed (2015) using GMM analyzed the
profitability determinants for Bangladeshi banks taking interest rate spread
and margin as profitability variables and reported persistency in interest rates
spread and margins and found a significant impact of administrative costs,
high non-performing loan ratio, and some macroeconomic determinants on
bank profitability. Suffian and Kamaruddin (2014) reported an impact of
capitalization, liquidity, non-traditional activities, management quality, size,
concentration, inflation and GDP growth rate on bank profitability. Similarly,
Jahan (2014) found that operational efficiency and size positively, and asset
utilization negatively influence bank profitability. Furthermore, Abdullah et
al. (2014), examining bank-specific, industry-specific, and macroeconomic
determinants of profitability reveals that size, higher cost efficiency,
capitalization, higher concentration, labor productivity, and nontraditional
activities of banks positively and only credit risk and inflation negatively
influence profitability of Bangladeshi commercial banks. Among the most
Bank-Specific and Macroeconomic Drivers of Islamic Bank Profitability: 25

recently, Rahman et al. (2015), analyzing data from 25 commercial banks and
taking ROA, ROE, and NIM as the proxies for profitability variable, reported
size, capital strength, and loan intensity have a significantly positive
association with bank profitability whereas, inflation, off-balance sheet
activities, and cost efficiency have significantly negative impact on the bank
profitability. Finally, Palas et al. (2017), the only study analyzing the
determinants of profitability of only Islamic banks operating in Bangladesh,
used a static model on a panel dataset from 6 Islamic banks during 2003-2014
and found that capital, size, employee productivity, inflation, GDP growth
rate, money supply growth rate, and share market index have positive impact
on the profitability ratios (ROAA and ROAE).

The analysis of the literature on the determinants of bank profitability

reveals that due to the differences in the dataset used, considered time periods,
considered environmental factors, and geographical locations with varying
characteristics of the economies in the considered countries, the studies’
observed results expectedly vary. Hence, this study aims to fill the gaps in the
literature taking these determinants into consideration and conducting an
analysis involving only Islamic banks of Bangladesh. Furthermore, the study
is using a dynamic model which will help to observe the persistency of the
profitability in the Islamic banking sector of Bangladesh so that it will be a
significant contribution to the literature of studies analyzing the determinants
of Islamic bank profitability.

3. Methodology

3.1 Type of Research

This paper is an empirical research showing the causation between ROA

being dependent variable and several Bank specific variables being
explanatory variables along with macro variables to control the impact of
exogenous variables.

3.2 Empirical determinants of Bank Profitability

From the discussion of the important determinants of bank profitability in the

literature section we have selected few for our study. The following table
incorporates the variables names, notations, measurement methods, and their
expected relationship with the profitability measuring variables (ROA and
ROE).
26 Journal of Banking & Financial Services

Table 1: Description of variables included in the model

Expected Data
Variables Notation Measurement Method
Impact Source
Dependent
variables
Return on Profit after tax/total Annual
roa n/a
Assets assets reports
Return on Profit after tax/total Annual
roe n/a
Equity equity reports
Independent
variables
Annual
Capitalization capital Total equity/total assets Positive
reports
Expense Operating Annual
expm Negative
Management expenses/total assets reports
Provision for loss of
Investment Annual
invrisk investment/total Negative
Risk reports
investment
Log of total assets per Annual
Size size Positive
branch reports
Non-
Non-investment Annual
investment noninv Positive
income/ total assets reports
income
Growth rate of (total
Employee Annual
emp income/number of Positive
Productivity reports
employees)
Foreign Growth rate of banks’
Annual
Exchange fxb foreign exchange Positive
reports
Business business
Money Growth rate of M2 Bangladesh
ms Negative
Supply (broad money) bank
Government
Growth rate of
borrowing Bangladesh
gb government borrowing Negative
from banking Bank
from the banking sector
sector
Foreign Fluctuation of foreign
Bangladesh
Exchange fxr exchange rate between Inconclusive
Bank
Rate USD and BDT
Dhaka
Stock market DSEX (index of Dhaka
dsex Negative Stock
development Stock Exchange)
Exchange

Source: Authors’ estimation

Bank-Specific and Macroeconomic Drivers of Islamic Bank Profitability: 27

The summary statistics of the data looks consistent with very lower values of
standard deviation and lower gaps in ranges (measured by minimum and
maximum values).
3.3 Construction of Hypothesis and the Empirical Models

Followings are the hypothesis developed to divulge the impact of bank

specific and macro variables on Profitability of Islamic banks in Bangladesh:

H1: ROA being profitability of Islamic banks is significantly affected by Bank

specific variables such as Capitalization, Expense management, investment
risk, non-investment income, employee productivity, Foreign exchange
business and Macro-economic variables such as Money supply, Foreign
exchange rate, Government’s borrowing from banking sector and Capital
Market development.

H2: ROE being profitability of Islamic banks is significantly affected by Bank

specific variables such as Capitalization, Expense management, investment
risk, non-investment income, employee productivity, Foreign exchange
business and Macro-economic variables such as Money supply, Foreign
exchange rate, Government’s borrowing from banking sector and Capital
Market development.

Usually, the model to be estimated for revealing the impact of Bank

specific and Macro-economic variables on profitability of Banks has been
constructed as follows:

Here, ROA = Return on assets calculated with dividing net income by total
assets being a proxy for measuring the profitability of banks. ROE = Return
on equity calculated with dividing net income by total equity capital being a
proxy for measuring the profitability of banks. αit is the intercept of the model.
The subscript k and j denote the bank-specific and macro-economic
determinants respectively. In addition, εit is the error term with vi the
unobserved bank-specific effect and υit the idiosyncratic error term.
28 Journal of Banking & Financial Services

The profitability of bank reveals a tendency to persist over time

considering impediments to market competition or sensitivity to
macroeconomic shocks to the extent that these are serially correlated (Berger
et al. 2000). Therefore, following dynamic panel data autoregressive
econometric modeling has been adopted to test the hypothesis divulging the
causation between ROA along with ROE being dependent variable as a proxy
for measuring profitability of banks and other bank specific along with macro
variables being explanatory variables considering a lagged dependent variable
among the regressors:

where,
ROA(t-1) = One year lagged Return on asset adopted as endogenous variable
due to the correlation with past and present error term of the model.

ROE(t-1) = One year lagged Return on equity adopted as endogenous variable

due to the correlation with past and present error term of the model.

β = magnitude of adjustment to equilibrium; A value of β between 0 and 1

implies that the persistence of profitability in the industry but tends to return
to the normality level. β closure to 0 means high speed in a fairly competitive
market and β closure to 1 means a less competitive market (Islam S., &
Nishiyama S., 2016)
∑X = all explanatory Bank specific variables adopted in the models such as
capital, Expense Management ratio, Investment risk, Non-investment income
ratio, size of the banks, Growth rate of employee productivity, growth rate of
foreign exchange business.
∑Y = all explanatory macro-economic variables adopted in the model such as
M2 growth rate, government borrowing from banking sector, fluctuation of
foreign exchange rate between USD and BDT, DSE standing for Dhaka Stock
Exchange Index.

3.4 The Empirical Method

According to the literatures, Fixed effect (FE) or Random-effects (RE)

method can be implemented to estimate the coefficients of the model showing
Bank-Specific and Macroeconomic Drivers of Islamic Bank Profitability: 29

static type of relationship but these estimation approaches produce biased

result in case of dynamic relationship especially when the data period
becomes smaller (Baltagi, 2001). Furthermore, using fixed effects model or
random effects model to account for the unobserved heterogeneity makes the
models incapable of using dummy variables (Greene 200 ; Garc a-Herrero, et
al. 2009) and turns into one which cannot adequately account for
endogeneity2, especially when the model is a dynamic one.As a consequence,
we have adopted One-step system GMM (Generalized Method of moments)
approach to estimate the coefficients of the models as developed earlier
considering the steps recommended by Athanasoglu et al. 2008 as mentioned
below:
First, the data set has been tested for non-stationary using LLC unit root
test to avoid the criticism of non-stationary in a model of bank profitability
where the null hypothesis of non-stationary is rejected at 0.1% level of
significance.3
Second, whether the individual effects are fixed or random have been
tested using Hausman test on model followed by equation number 03 and 04
confirming the evidence in favor of fixed effect approach4. In addition, the F-
statistic of fixed effect regression method is statistically significant at 0.1%
level with a value of F (12, 48) = 4.98& a p-value of 0.000 and with a value of
F (12, 48) = 2.59 along with p-value of 0.009 for ROA model and ROE model
respectively. Nevertheless, the model estimated under fixed effects (within)
regression method in presence of a lagged dependent variable among the
explanatory variables is biased as well as inconsistent.
So, we have adopted one-step system GMM (generalized methods of
moments) recommended by Arellano and Bond (1991) paradigm suggesting
that efficiency and consistency can be attained by using all available lagged
values dependent variable along with the exogenous regressors as instrument.
In addition, the purpose of using one step system GMM is the estimation of
augmented one-step difference GMM followed by more moment conditions
than one-step difference GMM along with efficient & robust
heteroscedasticity and autocorrelation.

2
A situation when explanatory variables are correlated to the error term or in a sense with the
omitted or excluded variables. Endogeneity forces the estimates of the regressors’ coefficients
to be biased and inefficient.
3
The relevant adjusted t-value for ROA and ROE is -8.6973 with p-value of 0.000 and -19.0229
with p-value of 0.000 respectively.
4
The relevant Hausman test Chi-square statistic is 69.3 with a p-value of 0.002 and 19.41 with a
p-value of 0.042 for ROA and ROE model respectively.
30 Journal of Banking & Financial Services

However, the dynamic models are more prone to endogeneity problem

because the lagged values and their lagged error terms have more chance to be
correlated with the current error term. Furthermore, the use of efficiency
scores in the profitability model, because of the existence of substantial
reverse causality between the bank efficiency and profitability again fuels the
problem of endogeneity. For example, more cost-efficient banks are more
profitable, but the level of profitability or profit target also influence efficient
expense management. Therefore, we should take good care of the endogeneity
problem while explaining bank profitability.

In this paper the issue is whether the capital variable (measured with
dividing equity capital by total assets) and Investment risk variable (measured
with dividing provision for loss of investment by total investment) are
endogenous and predetermined or not. As we know that capital and risk
variables are endogenous and predetermined respectively while measuring
profitability with ROE being dependent variable. So, we execute the same
model twice separately for ROA and ROE respectively. When we run the
model for both ROA and ROE considering the capital and investment risk
variable being exogenous first and then endogenous, the Sargan5 test for
overidentifying restrictions reveals that no endogeneity and pre-determined
assumptions are valid for ROA but converse for ROE.

At last, we have incorporated the unobserved time effects in the error

components of the said model as depicted below:

Here, θt is the unobserved time effect and we tested the joint significance of
time effects considering null hypothesis is θ2 = θ3 = θT = 0. The LM test6
doesn’t allow us to include time dummies as per the value of test statistic so
that our final models estimating the dynamic impact of Bank-specific along

5
Considering capital and investment risk as exogenous, the p value of 0.001 is found for both
models of ROA and ROE while considering capital and risk as endogenous, the p-value is
0.000 and 0.279 for ROA and ROE models respectively.
6
The LM test statistic Chi-square value is 7.248 with a p-value of 0.171 for ROA model and
4.793 with a p-value of 0.261 for ROE model
Bank-Specific and Macroeconomic Drivers of Islamic Bank Profitability: 31

with macro-economic variables on profitability of Islamic Banks in

Bangladesh is as follows:

3.5 Data and sample selection procedure

We have used secondary sources of data for last 12 years (2007-2018)

collected from annual reports of 06 (six) Islamic commercial banks operating
in Bangladesh. The banks are selected using spatial convenience
sampling approach depending on the availability of data from Islami Bank
Bangladesh Limited, Shahjalal Islami Bank Limited, EXIM Bank Limited Al-
Arafah Islami Bank Ltd, Social Islami Bank Ltd and First Security Islami
Bank Ltd. So, the total observation is 72.

Table 2: Summary Statistics of all variables included in the models

Variables Observation Mean Std. deviation

Return on Assets (ROA) 72 .0188 .0182
Return on Equity (ROE) 72 .3071 .3963
Capitalization 72 .1074 .1711
Expense Management 72 .0179 .0158
Investment Risk 72 .0088 .0047
Size 72 7.062 2.840
Non-investment income 72 .0183 .1177
Employee Productivity 72 .4368 .9010
Foreign Exchange Business 72 .2225 .2798
Money Supply 72 .1749 .0270
Government borrowing from
72 .1827 .1214
banking sector
Foreign Exchange Rate 72 .0281 .0393

Stock market development 72 .2497 .3816

Source: Authors’ estimation

32 Journal of Banking & Financial Services

The summary statistics of the data looks consistent with very lower values
of standard deviation and lower gaps in ranges (measured by minimum and
maximum values).
4. Empirical Results
According to the estimates mentioned in the following table 03, the
profitability of Islamic banks in Bangladesh measured with ROA was
supposed to be affected by several bank-specific as well as macroeconomic
variables but one year lagged value of ROA, investment risk, employee
productivity, growth of foreign exchange business, money supply growth
followed by M2 and stock market development followed by DSE Index are
found statistically significant at chosen level of significance in explaining the
changes of ROA measuring profitability of banks as per the coefficients
estimated with one-step system GMM reported under the Model-01. As the
one period lagged dependent variable (L.ROA) is found statistically
significant at 1% level of significance, it justifies the use of dynamic panel
data model estimated with one step system GMM showing a low degree of
profit persistence in Islamic banking sector. This level of profit persistency in
Islamic banks seems similar market condition to the European region because
Goddard et al. (2004) also found significant statistical evidence of low degree
of profit persistency. Investment risk (credit risk) is found statistically
significant at 5% level with a positive direction in explaining the changes of
profitability (ROA) of Islamic banks as we know risk and return are positively
related with a view to generating high profit due to the significant investment
in risky investment portfolios. This finding is also supported by Chowdhury et
al. (2017) in their paper on re-examining the determinants of Islamic Bank
Performance. In addition, Growth of foreign exchange business becoming
proxy for foreign exchange business of banks is found positively related with
ROA of the banks at 1% level of significance as more foreign exchange
transactions will generate enormous commissions accelerating adequate
volume of profit for Islamic banks. This assumption is also claimed and found
significant in the paper contributed by Hossain and Ahamed (2015). In
contrast, Employee productivity is found individually statistically significant
in explaining the changes in the profitability of banks with an inverse
direction as decreasing return to scale may cause inefficiency in employee and
thereby decrease the profitability of banks also supported by Islam and
Nishiyama (2016). Another reason responsible for this outcome is Islamic
banking labour in Bangladesh is dominating over technology and well behind
the banking progress all over the globe. This weak productivity of employee
can be mitigated by adopting technological advancement and digitization of
banking industry which is also supported by Athanasoglou et al. (2008).
Bank-Specific and Macroeconomic Drivers of Islamic Bank Profitability: 33

Moreover, money supply measured with M2 currency is also found

significant at 1% level with positive relationship in explaining the variation of
ROA of banks as increase of money supply will boost up the investments of
Islamic banks to generate profit. In contrast, DSE Index becoming proxy for
stock market development is found inversely statistically significant in
explaining the changes in the profitability of banks as high volatility of capital
market will increase the risk of capital loss for the bank and therefore
reducing the profitability of banks. This finding is also found significant and
supported by Masood and Ashraf (2012).
According to the estimated coefficients reported under Model 02
considering only Bank-specific variables in following table 03, one year
lagged ratio of ROA, employee productivity, foreign exchange business are
found statistically significant at chosen level of significance because of the
same reasons as explained earlier in case of model 01. Moreover,
capitalization, expense management and non-investment income are found
statistically significant at chosen level of significance in the variation of ROA
of banks. Capital is found positively related with the profitability of Islamic
Banks as holding more capital to comply with BASEL accord will
substantially reduce the investment risk as well as market risk and thereby
increasing the opportunity of generating profit for banks due to significant
investment in optimum portfolios also supported by Chowdhury et al. (2017).
Expense management is also found positively related with the profitability of
Banks as efficient control of expenses will accelerate the operational
efficiency and thereby increase the profitability of banks. In addition, Non-
investment income is found statistically significant with positive direction as
generating more non-investment income will increase the total income of
banks and subsequently increase the net income of banks. These have been
supported by the findings contributed by Pasiouras and Kosmidou (2007).
However, the chi-square value of 611.52 and 525.11 estimated with one-
step system GMM reported under GMM Model 01and GMM Model 02
respectively indicates the joint significance of all bank specific as well as
macroeconomic factors in explaining the changes of ROA. Precisely, all
regressors in the aforesaid model estimated with one-step system GMM
method are jointly significant at 0.1% level according to the output. we can
also conclude that rejection of null hypothesis at 1% level of significance
followed by Arellano-Bond test for AR(1) in first difference model, non-
rejection of null hypothesis for AR(2) in first difference model and rejection
of null hypothesis at 1% level of significance in Sargan test of
overidentification restrictions reported under both models (GMM model 1 &
GMM model 2) solace all the conditions of GMM estimation.
34 Journal of Banking & Financial Services

Table 3: Bank-specific and Macro-economic drivers of Islamic Banks’

Profitability in Bangladesh
Estimation of Models
Dependent GMM Model- GMM Model-
Variable 01 02
ROA (Considering (Considering
(Return on all variables) only Bank-
Assets) specific
variables
Bank-Specific Variables
L.ROA (Profitability .2097*** .2023***
Persistency)
Capitalization .0028 .0313**
Expense Management .0058 .1781**
Investment Risk .4292** .2684
Size of Bank .0013 -.0022
Explanatory .0595 .2635**
Non-investment income
variables
Employee Productivity -.0013* -.0016**
Foreign Exchange Business .0098*** .0085***
Macro-economic variables
Money Supply .1196***
Government borrowing from -.0079
banking sector
Foreign Exchange Rate -.0191
Stock market development -.0046*
Constant -.0197*** .0016
No. of observations (N) 66 66
Wald Chi-square test with P-value λ2 (13) = λ2 (9) =
611.52 525.11
0.000 0.000
AB test AR (1) with P-value Z = -3.53 Z = -2.89
0.000 0.004
AB test AR (2) with P-Value Z= 0.23 Z= -0.83
0.821 0.408
Sargan Test of over identification restriction λ2 (38) = λ2 (42) =
with P-value 611.52 75.94
0.001 0.001
No. of Instruments 52 52
Note: This table represents the output estimated by one-step system GMM on the
profitability determinants of Islamic Banks. *, **, *** indicate the level of
significance at 10%, 5% and 1% respectively for the coefficients that are significantly
different from zero. AB test AR(1) and AR(2) navigate to the Arellano-Bond test that
average co-variance in residuals of order 1 and order 2 is 0. (Ho = non-presence of
autocorrelation)
Source: Authors’ estimation
Bank-Specific and Macroeconomic Drivers of Islamic Bank Profitability: 35

According to the estimates mentioned in the following table 04, the

profitability of Islamic banks in Bangladesh measured with ROE is found to
be affected by several bank-specific as well as macroeconomic variables such
as one year lagged value of ROE, capitalization, employee productivity,
money supply growth followed by M2 as per the output reported under GMM
Model 01 and GMM Model 02 estimated with one step system GMM. Again,
the one period lagged dependent variable (L.ROE) is found statistically
significant at 1% level of significance that justifies the use of dynamic panel
data model estimated with one step system GMM showing a low degree of
profit persistence in Islamic banking industry of Bangladesh. Moreover, it is
usual to believe that profit of current year has been affected with recent or
immediate preceding year’s profit due to the concept of retained earnings as
this will be utilized to generate profit in forwarding year if required so that
our model shows the one year lagged ratio of dependent variable ROE being
one of the regressors followed by Autoregressive AR (1) model is found
statistically significant at 5% level with a positive relationship in explaining
the variation of the profitability of Islamic banks. In contrast, Capital is found
inversely related with the profitability of Islamic Banks as sometimes holding
more capital to comply with BASEL capital accord will substantially reduce
the opportunity of generating profit for banks due to insignificant investment
in lucrative sectors. This finding is also espoused by Mokni and Rachdi
(2014). Moreover, well capitalized banks are more profitable than banks
inadequately capitalized because banks with higher capital are able to obtain
cheaper funding due to the fact that they seem less risky with higher capital.
This is also stated in the findings contributed by Bourke (1989), Demirguc-
Kund and Huizinga (1999), Goddard et al. (2004) Pasiouras and Kosmidou
(2007), Abreu and Mendes (2002), and Naceur and Goaied (2001, 2005).In
addition, employee productivity reported under both models (GMM Model-01
& GMM Model-2) is found positively related with profitability as high
employee productivity accelerates operational efficiency to increase profit of
banks and money supply growth reported under GMM Model 01 is significant
with inverse direction due to the same reasons as explained earlier for Table
03.
However, the chi-square value of 422.34 and 455.31 estimated with one-
step system GMM reported under GMM Model 01and GMM Model 02
respectively indicates the joint significance of all bank specific as well as
macroeconomic factors in explaining the changes of ROA. Precisely, all
regressors in the aforesaid model estimated with one-step system GMM
method are jointly significant at 0.1% level according to the output. we can
also conclude that rejection of null hypothesis at 5% level of significance
followed by Arellano-Bond test for AR(1) in first difference model, non-
rejection of null hypothesis for AR(2) in first difference model and rejection
36 Journal of Banking & Financial Services

of null hypothesis at 5% level of significance in Sargan test of over

identification restrictions reported under both models (GMM model 1 &
GMM model 2) solace all the conditions of GMM estimation approach.
Table 4: Bank-specific and Macro-economic drivers of Islamic Banks’
Profitability in Bangladesh
Dependent Estimation of Models
Variable GMM Model- GMM_Model-02
ROE (Return 01 (Considering
on Assets) (Considering only Bank-
all variables) specific variables
Bank-Specific Variables
L.ROE (Profitability Persistency) .1305** .1458**
Capitalization -.0861 -.2104**
Expense Management -.1188 3.3163
Investment Risk -3.081 -1.5789
Size of Bank .0067 .00455
Explanatory -.7813 -4.1559
Non-investment income
variables
Employee Productivity .0480** .0470**
Foreign Exchange Business -.0776 -.1120
Macro-economic variables
Money Supply -2.6457***
Government borrowing from -.0758
banking sector
Foreign Exchange Rate -.3724
Stock market development -.0106
Constant 43.557*** 27.3915***
No. of observations (N) 66 66
Wald Chi-square test with P-value λ2 (13) = λ2 (9) = 455.41
422.34 0.000
0.000
AB test AR (1) with P-value Z = -2.07 Z = -2.18
0.038 0.042
AB test AR (2) with P-Value Z= -.78 Z= -0.14
0.438 0.889
Sargan Test of over identification restriction with λ2 (38) = λ2 (42) = 61.90
P-value 52.07 0.029
0.041
No. of Instruments 52 52
Note: This table represents the output estimated by one-step system GMM on the
profitability determinants of Islamic Banks. *, **, *** indicate the level of
significance at 10%, 5% and 1% respectively for the coefficients that are significantly
different from zero. AB test AR(1) and AR(2) navigate to the Arellano-Bond test that
average co-variance in residuals of order 1 and order 2 is 0. (Ho = non-presence of
autocorrelation)
Source: Authors’ estimation
Bank-Specific and Macroeconomic Drivers of Islamic Bank Profitability: 37

5. Conclusions and Scope for Further Research

The analysis of bank profitability determinants has a very important place

within the area of bank performance analysis as banks are important financial
institutions contributing towards the development of the financial sector and
economy as well. This study has analysed the determinants influencing
Islamic banks’ profitability. The Islamic banks are different from the
conventional banks in their operation by not being involved with the interest
in any way. Therefore, there are differences in the ways of the effects of the
determinants of profitability for conventional and Islamic banks. Around the
world most of the studies on Islamic banks have involved countries of the
MENA region or OIC, or Malaysia. However, few studies have focused on
the developing countries like Bangladesh (e.g. Palas et al., 2017). Therefore,
this study is a significant one for contributing towards the literature of bank
profitability analysis, Islamic bank profitability analysis, and profitability
analysis of Islamic banks from developing countries.

The findings of this research will help the bank managers, policymakers,
and regulators to take informed and knowledgeable decisions. The managers
of the Islamic banks and also banks in general (as there are also a lot of
similarities between conventional and Islamic banks) will be better equipped
to focus on the most important success factors for their banks and will also be
able to allocate their scarce resources more efficiently and effectively. The
policymakers and regulators on the other hand, will use these findings to
formulate and implement most required micro and macroprudential policies
and strategies to strengthen the profitability, soundness and stability of the
banking as well as entire financial system.

There is still scope for further research in this area of literature. The study
can be further conducted involving Islamic banks from different countries like
SAARC region or ASEAN countries to confirm that the outcomes of this
study still works in the same manner. Moreover, researchers can conduct a
comparative study between the conventional and Islamic banks to see if the
findings work in similar manner for both classes of banks and to get the
insight that the technical differences between these two kinds of banks have
no impact on the determinants’ way of influencing the profitability of the
banks. Furthermore, no technical, structural and regulatory changes and
impact of crisis (international or domestic) periods have been taken into
consideration of this analysis. Therefore, these variables can be included into
the further studies in this area of research.
38 Journal of Banking & Financial Services

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economics and management, 10(3), pp. 207-217.
39. Sufian, F. and Kamarudin, F., 2014. Efficiency and returns to scale in the
Bangladesh banking sector: empirical evidence from the slack-based DEA
method. Inzinerine Ekonomika-Engineering Economics, 25(5), pp. 549-557.
Bank-Specific and Macroeconomic Drivers of Islamic Bank Profitability: 41

Appendix

Table A5: Correlation Matrix of Variables

roa roe capital expm invrisk size noninv emp fxb ms gb fxr dsex
roa 1
roe .9184 1
capital -.0336 -.139 1
expm .1157 .162 .5008 1
invrisk .3101 .3534 -.1792 -.084 1
size -.5393 -.602 .1887 .1474 -.6353 1
noninv .0175 -.066 .3938 .6374 -.1485 .1705 1
emp .2683 .3376 -.0564 -.068 .3197 -.474 -.0759 1
fxb -.0472 -.163 -.0122 -.044 -.1723 .0358 .2012 .0591 1
ms .2943 .102 .1599 -.178 -.1384 -.026 .0856 -.004 .323 1
gb .1036 .0491 -.1171 -.071 -.0913 .0065 -.1423 -.070 -.065 .1705 1
fxr -.0126 -.006 -.0884 -.090 -.0152 -.027 -.0123 -.051 .326 .0821 .078 1
dsex -.0228 -.027 .0614 -.059 .1047 -.028 .1303 .025 .269 .2440 -.641 .081 1

Source: Output of STATA

Note: Refer to Table no. 01 of description of variables for the elaboration of variables

Table A6: Variance Inflation Factor (VIF) of variables

Variables with notation VIF value 1/VIF value
Capitalization (capital) 1.69 0.59
Expense Management (expm) 4.90 0.20
Investment Risk (invrisk) 1.90 0.52
Size of bank (size) 2.75 0.36
Non-investment income (noninv) 4.00 0.25
Employee Productivity (emp) 1.36 0.73
Foreign Exchange Business (fxb) 1.68 0.59
Money Supply (ms) 2.22 0.45
Government borrowing from banking 3.58 0.27
sector (gb)
Foreign Exchange Rate (fxr) 1.18 0.84
Stock market development (dsex) 3.70 0.27
Mean VIF 2.63
42 Journal of Banking & Financial Services
Volume 12, Number 1, June 2020

Competition and Profitability of Commercial Banks in

Bangladesh

Dr. Muhammad Saifuddin Khan 1

Jannatun Nayema 2

Abstract: This study investigates the impact of competition on the

profitability of 29 commercial banks listed in Dhaka Stock Exchange and
Chittagong Stock Exchange for the period from 2009 to 2018. Maximizing
profit is one of the goals of commercial banks. Bank competition is an
important determinant of bank profitability. The objective of this study is
to identify whether bank competition affects the profitability of
commercial banks of Bangladesh. Bank profitability is measured by net
interest margin, return on assets and return on equity. Bank competition is
measured by Lerner Index. Higher Index indicates lower bank competition.
This study finds that higher bank competition reduces the profitability. The
results of this study have policy implications to the regulators and
management of banks.
Keywords: Bank competition; Profitability; Lerner Index; Net interest
margin; Return on assets; Return on equity

1. Introduction

This study analyzes the effect of the bank competition on profitability of the
commercial banks which are listed in Dhaka Stock Exchange and Chittagong
Stock Exchange of Bangladesh. The study of bank competition and
profitability is very essential as banking sector in Bangladesh keep a
significant role in the up gradation of our financial system and economy.
However, profitability of banks largely depends on how they are managing
their assets and liabilities. Other than that, different market factors and
macroeconomic factors also influence the profitability of banks. Performance
evaluation of banks is very significant as in recent years banks are going
through fierce competition. The objective of this study is to identify whether
bank competition affects the bank profitability of commercial banks of
Bangladesh. This study intends to identify whether competition is good or bad
1
Corresponding Author: Associate Professor, Department of Finance, University of
Dhaka, Dhaka-1000, Email: [email protected]
2
Teacher, Mastermind English Medium School, Dhanmondi Branch, Dhaka,
Email: [email protected]
44 Journal of Banking & Financial Services

for the banks. Based on the findings of this study, regulators may take policies
to increase or decrease bank competition. The evidence between bank
competition and profitability is mixed. Some studies find that higher bank
competition reduces the bank profitability and efficiency (Hsieh, & Lee 2010;
Moudud-Ul-Huq, Halim, & Biswas, 2020; Sarpong-Kumankoma, Abor,
Aboagye, & Amidu, 2018; Tan & Floros, 2014; Whalen, 1988). However,
other studies find that competition increases the profitability of banks (Haron,
1996; Hu & Xie, 2016; Lee & Hsieh 2013; Pham, Talavera, & Yang, 2020;
Yuanita, 2019). The relation between bank competition and profitability is
also helpful to formulate policies of banks. Noticeably, competition in the
banking sector has a major impact on the financial health of an economy.
Many studies have been done to test the effect of bank competition on
profitability in developed countries (Abbasoglu, Aysan, & Gunes, 2007;
Hsieh & Lee, 2010; Pham, Talavera, & Yang, 2020). To the best of our
knowledge, this is first study to test the impact of competition on profitability
of Bangladeshi commercial banks. At present banking industry in Bangladesh
is exceedingly competitive and highly concerned of profitability. Specially,
private commercial banks of Bangladesh have larger market share, are highly
competitive and concerned about high growth in profitability. Private
commercial banks are consistently adding new innovation in services for their
diversified customers and they have opened automated services for which
now they are dominating the banking industry of Bangladesh. Besides, private
commercial banks are offering attractive returns, keeping role in sustainable
growth of economy as well as maximizing shareholders’ wealth.

Competition among banks is increasing consistently as well as there are

fluctuations of profitability every year. For financial progress of a country
banks’ sound performance is essential. Robust Banking system plays a great
role in circulation of money in the economy. In contrast, bank’s failure in
smooth operation can bring the economy of a country down. Consequently, it
is very essential to identify the factors which are affecting the performance of
the banks. Banks’ board of directors and financial specialists should be more
concerned of that situation. At present, banking sector of Bangladesh is
passing through tough time. They are having lower credit, increased non-
performing loans (NPL) and lower interest rate. And these factors are
gradually destroying their profitability. As a regulator of all banks of
Bangladesh, the central bank, Bangladesh Bank, has taken some necessary
steps to increase the reliability and productivity of banking system.
Competition and Profitability of Commercial Banks in Bangladesh 45

In this paper to measure the competition and profitability different proxies

have been used. At first, this study tries to identify the factors contributing
bank competition and then the relationship between different variables related
to competition and profitability of banks. To measure the bank competition,
this study uses Lerner Index as an independent variable for each bank and
each period which is now commonly used in recent studies (Beck, De Jonghe,
& Schepens, 2013; Moudud-Ul-Huq, Halim, & Biswas, 2020; Nguyen, 2019)
to measure bank competition. To assess the profitability of banks three ratios
have been undertaken-net interest margin (NIM), return on assets (ROA) and
return on equity (ROE). This study finds that banks facing lower competition
are more profitable. This study suggests that to ensure the profitability of the
banking system bank competition should be reduced. This study generates
some guidelines for the policymakers to formulate policy regarding bank
competition and profitability. Management of the commercial banks would
get to know the factors influencing the bank competition in Bangladesh. The
remainder of this paper deals with literature review of bank competition and
profitability which is under section 2. Section 3 presents data and section 4
describes methodology where empirical model, dependent variables,
independent variable and control variables. Section 5 highlights analyses and
findings, and finally section 6 is the conclusion part with some policy
guidelines.
2. Literature Review

The internal factors affecting bank profitability incorporate bank’s operational

proficiency, bank’s hazard revolution (capital proportion), bank liquidity, and
credit quality. They play a major part in characterizing bank profitability.
Increased competition enables banks to offer products at lower cost and attain
efficiency (Claessens & Laeven, 2004). The level of bank competition
influences the efficient production of financial services (Claessens & Laeven,
2004). Claessens & Laeven (2004) measure bank competitiveness of 50
countries using a structural model. Lack of entry restrictions, existence of
foreign banks increase bank competition whereas restrictions of activity and
number of banks in the country reduce bank competition (Claessens &
Laeven, 2004). Molyneux, Lloyd-Williams, & Thorton (1994) investigate the
competitive conditions of European countries from 1986-1989. European
banks face lack of integration and require supervisory arrangements, and the
elimination of capital controls to achieve full integration (Molyneux, Lloyd-
Williams, & Thorton, 1994). There is mixed evidence regarding the relation
between competition and profitability of banks in the existing literature.
46 Journal of Banking & Financial Services

Clerides, Delis, & Kokas (2015) measure the level of bank competition of 148
countries from 1997 to 2010. Bank competition worsened during the period
1997–2006, enhanced until 2008, and worsened again thereafter (Clerides,
Delis, & Kokas, 2015). Lee & Hsieh (2003) examine the relation between
competition, profitability, and risk of 171 Chinese banks from1993 to 2007.
Higher bank competition increases profitability but reduces risk of Chinese
banks (Lee & Hsieh 2013). Moreover, increased market concentration through
merger enables Indonesian banks to offer products at a lower price but reduce
profitability (Yuanita, 2019). Similarly, Islamic banks earn more profit in
competitive market compared to monopolistic market (Haron, 1996).
Additionally, competition positively affects profitability of Chinese banks (Hu
& Xie, 2016). Similarly, non-price competition measured by multimarket
contacts and profitability are positively related in Ukrainian banks (Pham,
Talavera, & Yang, 2020).
Turkish banks face monopolistic competition and there is no clear relation
between concentration and competition (Abbasoglu, Aysan, & Gunes, 2007).
Similarly, competition and risk do not affect the profitability of Chinese banks
(Tan, 2016). The threat of entry by potential competitors do not reduce bank
profitability (Whalen, 1988). Moreover, higher market power improves bank
profitability (Sarpong-Kumankoma, Abor, Aboagye, & Amidu, 2018).
Similarly, higher competitive pressure faced by banks can reduce the positive
impact of banking competition on profit (Hsieh, & Lee 2010). Positive
relation between competition and profitability can be weaker in countries
having a sound financial system or high per capita income (Hsieh, & Lee,
2010). Non-interest income market in the Chinese banking industry is more
competitive compared to deposit market and loan market (Tan, 2019).
Competition and profitability are negatively related in the deposit market but
this relation is positive in case of loan market for state-owned banks, joint-
stock banks and city commercial banks of China (Tan, 2019). Moreover, low
competition provides high profit in Chinese banks (Tan & Floros, 2014).
Similarly, Competition is negatively related to profitability in the banks of
Middle East and North African (MENA) countries (Moudud-Ul-Huq, Halim,
& Biswas, 2020). Moreover, the relation between competition and
profitability is non-linear in Vietnamese banks (Nguyen, 2019). At the lower
level of competition increases in competition reduce bank profitability
whereas at the severe higher level of competition increases in competition
provide higher profitability (Nguyen, 2019).
Sayeed, Edirisuriya, & Hoque (2012) analyze the impact of asset and
liability management on the profitability of 18 commercial banks of
Competition and Profitability of Commercial Banks in Bangladesh 47

Bangladesh during 1995-2006. High profitable banks earn higher returns from
their assets and pay lower costs for their liabilities than the low profitable
banks (Sayeed, Edirisuriya, & Hoque, 2012). Large commercial banks have
better asset management than small commercial banks but the result is
opposite in case of liability management (Sayeed, Edirisuriya, & Hoque,
2012). Abreu & Mendes (2002) finds that if a bank has enough capital and
utilize the resources efficiently can make profit. These types of banks are risk
averse, have low risk of bankruptcy and achieve public confidence. In
contrast, Athanasoglou, Brissimis, & Delis (2008) show that bank capital
adversely affects bank performance. Samad (2015) investigates the
determinants of the profitability of commercial banks in Bangladesh. Samad
(2015) considers financial risk, operational efficiency, bank size as well as
macroeconomic variables as potential determinants of bank profitability. Only
banks specific factors have impact on profitability of banks (Samad, 2015).
However, market concentration and bank risk has minor effects on
profitability whereas bank market size can explain the profitability (Jahangir,
Shill, & Haque, 2007). Moreover, the profitability of the Bangladesh banking
sector can be explained by bank size, higher cost efficiency, capitalization,
higher concentration (Abdullah, Parvez, & Ayreen, 2014).

Default rate, cost per loan assets and capital adequacy ratio negatively
affects the profitability of commercial banks in Nepal (Poudel, 2012). Alshatti
(2015a) find sound credit risk management policy is positively related to the
financial performance of the Jordanian commercial banks. Banks can improve
credit risk management policies by adopting strict lending policy, monitoring
and controlling credit risk to enhance performance and competitiveness
(Alshatti, 2015a). Banks need to maintain optimum level of liquidity to
increase profitability (Alshatti, 2015b). Zopounidis & Kosmidou (2008) find
that capital adequacy, operating efficiency, size and growth rate of gross
domestic product (GDP) are positively related to the profitability of the
commercial banks of Greece whereas inflation is negatively related to
profitability. Moreover, bank capital and credit risk increases banks' net
interest margin, cost efficiency, and profitability (Naceur, & Omran, 2011).

3. Data
To conduct the study, we have collected annual data from the annual reports
of listed commercial banks of Dhaka Stock Exchange and Chittagong Stock
Exchange for the period from 2009 to 2018. The sample period of this study is
recent 10 years. There are 30 listed commercial banks but we dropped one
bank named ICB Islamic Bank Ltd. because of negative equity and net
48 Journal of Banking & Financial Services

income during the entire sample. Final dataset contains 290 bank-year
observations. Summary statistics are reported in Table 1. Table 1 shows that
mean value of net interest margin, return on asset, return on equity are 0.0238,
0.0117, 0.1388 respectively which indicates that banks are profitable as a
whole. For our sample banks, the average value of Lerner Index is 0.2744
which indicates that on average Bangladeshi commercial banks can set price
above the marginal cost. The average value of natural logarithm of total assets
is 25.8273. On average, non-performing loans and total liabilities are 3.21%
and 91.84% of total assets respectively. The average value of inflation rate
and growth rate of gross domestic product are 6.86% and 6.45% respectively.
Table 1 Summary Statistics

Variable Mean Std. Dev. Min Max Observation

NIM 0.0238 0.0093 -0.0237 0.0501 290

ROA 0.0117 0.0066 -0.0008 0.0510 290

ROE 0.1388 0.0694 -0.2989 0.3880 290

Lerner Index 0.2744 0.0828 -0.1905 0.4875 287

Asset 25.8273 0.5738 24.4117 27.6285 290

NPL 0.0321 0.0213 0.0064 0.2472 290

Leverage 0.9184 0.0222 0.8457 1.0637 290

Inflation 0.0686 0.0175 0.0542 0.1140 290

GDP 0.0645 0.0079 0.0505 0.0786 290

Correlation coefficients of all variables are shown in table 2. The

correlation coefficients of Lerner Index with net interest margin, return on
assets, return on equity are 0.35, 0.69 and 0.57 respectively. Asset, non-
performing loans, leverage are negatively correlated with net interest margin,
return on assets, return on equity and Lerner Index. However, inflation is
positively related with profitability and competition. Table 2 shows that
control variables are not highly correlated. Therefore, multicollinearity is not
an issue in this study.
Competition and Profitability of Commercial Banks in Bangladesh 49

Table 2 Correlation Matrix

1 2 3 4 5 6 7 8 9

1 NIM 1.00

2 ROA 0.35 1.00

3 ROE 0.36 0.80 1.00

4 Lerner Index 0.35 0.69 0.57 1.00

5 Asset -0.05 -0.46 -0.42 -0.39 1.00

6 NPL -0.28 -0.28 -0.45 -0.27 0.28 1.00

7 Leverage -0.17 -0.47 -0.28 -0.44 0.17 0.15 1.00

8 Inflation 0.15 0.31 0.22 0.25 -0.32 -0.26 -0.30 1.00

9 GDP -0.09 -0.49 -0.40 -0.33 0.70 0.28 0.19 -0.24 1.00

Figure 1: Profitability and competition of banks over time

Figure 1 shows that net interest margin, return on assets, return on equity and
Lerner Index decrease for the period from 2009 to 2018. Higher Lerner Index
indicates lower profitability. Therefore, bank profitability decreases but bank
competition increases over time which indicates bank competition is
negatively related with profitability.
50 Journal of Banking & Financial Services

4. Methodology

4.1 Empirical Model

To examine the effect of bank competition on profitability, we use ordinary

least squares panel regression with heteroskedasticity robust standard errors.
To conduct the study dependent, independent and control variables have been
used. Bank fixed effects and time fixed affects are considered to capture
omitted bank-specific and time-specific factors.

The model, to test the effect of bank competition on profitability is:

Profitabilityi,t= β0+ β1LernerIndexi,t + β3Asseti,t+β4NPLi,t+ β5Leveragei,t+Time

Fixed Effects+ Bank Fixed Effects+ ε i,t (1)

The model to test the effect of bank competition on profitability including

macroeconomic factors is:

Profitabilityi,t = β0+ β1LernerIndexi,t + β3Asseti,t+β4NPLi,t+ β5Leveragei,t+

β5Inflationt+ β5GDPt +Bank Fixed Effects+ ε i,t (2)

The robust error term ε is clustered at the bank-level and allowed to be

heteroskedastic and autocorrelated.

4.2 Independent Variable

Bank competition is proxied by Lerner Index. At present Lerner Index is

widely used in the banking literature to measure bank competition (Beck, De
Jonghe, & Schepens, 2013; Moudud-Ul-Huq, Halim, & Biswas, 2020;
Nguyen, 2019).

The Lerner Index is the ratio of the difference between price and marginal
cost divided by price, i.e., it measures the market control of a bank to set a
price over marginal cost. In this way, high values of the Lerner Index are
related with significant market control. Price here is the average price of bank
output. Bank output is proxied by total assets. Specifically, price is the ratio of
total operating income to total assets (Beck, De Jonghe, & Schepens, 2013;
Horvath, Seidler, & Weill, 2016). Operating income includes both interest
income and non-interest income.

Marginal cost is valued using a translog cost function with one output
(total assets) and three input prices (price of labor, price of physical capital
Competition and Profitability of Commercial Banks in Bangladesh 51

and price of borrowed funds) followed by Horvath, Seidler, & Weill (2016).
We estimate a cost function, in which we include bank total effects, for all
periods. Symmetry and linear homogeneity restrictions on input prices are
imposed. The cost function is specified as follows (Beck, De Jonghe, &
Schepens, 2013; Horvath, Seidler, & Weill, 2016):

(3)

Here, TC and y denote total cost and total assets respectively, w1 denotes
the price of labor (the ratio of staff expenses to the number of employees), w2
denotes the price of physical capital (the ratio of the sum of general and
administrative expenses, depreciation and other operating expenses, divided
by total assets), and w3 denotes the price of borrowed funds (the ratio of the
costs of borrowed funds to borrowed funds). So, total cost is the sum of staff
expenses, general and administrative expenses, depreciation, other operating
expenses, and costs of borrowed funds. The estimated coefficients of the cost
function are then used to compute the marginal cost (MC):

(4)
Lerner Index is calculated as follows:

(5)

4.3 Dependent Variables

Three profitability ratios net interest margin, return on assets and return on
equity have been used in this study as dependent variables.

Net Interest Margin

Net interest margin is the difference between interest income and interest
expense of bank i in year divided by total assets of the bank i in the same
year .This ratio is calculated as shown in the equation below:

(6)
52 Journal of Banking & Financial Services

Return on Assets
Return on assets (ROA) is defined in this study as the net income available to
common shareholders of bank i in year divided by total assets of the bank i
in the same year . This ratio is calculated as shown in the equation below:

(7)

Return on Equity
Return on equity (ROE) is defined as net income available to common
shareholders for the financial period for a bank divided by shareholders’
equity in a bank in the same period t. In addition, this ratio is calculated as
shown in the equation below:

(8)

4.4 Control Variables

Control variables used in this study are natural logarithm of total assets
(Asset), the ratio of non-performing loans to total assets (NPL), total liabilities
to total assets (Leverage) as potential determinants on bank profitability. We
also use inflation rate (Inflation) and growth rate of gross domestic product
(GDP) as control variable.
5. Analysis and Findings
Higher Lerner Index indicates lower bank competition. Table 3 shows that
Lerner Index has positive relationship with net interest margin, return on
assets and return on equity and the results are statistically significant at 5%,
1% and 5% level of significance respectively. These results indicate that
banks facing lower competition experiences superior profitability. The results
indicate that Bangladeshi commercial banks are increasing competition at the
cost of their profitability. The results indicate that banks having higher market
power are more profitable. Natural logarithm of total assets has positive
relation with net interest margin, return on assets and return on equity whereas
non-performing loans and leverage have negative relation with the bank
profitability.
Competition and Profitability of Commercial Banks in Bangladesh 53

Table 3: Bank competition and profitability

The OLS panel regression results are shown in Table 3. Here the dependent
variables are banks profitability proxied by the ratios of net interest margin
(NIM), return on assets (ROA) and return on equity (ROE). The independent
variable is Lerner Index which is used to measure the bank competition. The
control variables are natural logarithm of total assets (Asset), the ratio of non-
performing loans to total assets (NPL) and total liabilities to total assets
(Leverage). Time fixed effects and bank fixed effects are included in the
regressions. By using heteroskedasticity-robust standard errors p values are
calculated and reported in parentheses. ∗, ∗∗, and ∗∗∗ represent statistical
significance at the 10%, 5%, and 1% level, respectively.
1 2 3
NIM ROA ROE
Lerner Index 0.0295** 0.0307*** 0.1921**
(0.0382) (0.0050) (0.0195)
Asset 0.0028 0.0066** 0.1176***
(0.5520) (0.0310) (0.0012)
NPL -0.0463** -0.0196 -0.5458**
(0.0492) (0.2370) (0.0117)
Leverage -0.0423 -0.0506 -1.0382*
(0.2766) (0.4355) (0.0938)
Constant -0.0153 -0.1096 -1.8390***
(0.8917) (0.1146) (0.0074)
Time Fixed Effects Yes Yes Yes
Bank Fixed Effects Yes Yes Yes
Adjusted R-sq. 0.2556 0.6460 0.5744
Observations 287 287 287

Table 4 shows the results between bank competition and profitability

including macroeconomic factors. Table 4 shows that Lerner Index has
positive relationship with net interest margin, return on assets and return on
equity and the results are statistically significant at 5%, 1% and 1% level of
significance, respectively. That means these profitability ratios increase when
Lerner Index increases and vice versa. Table 4 shows that growth rate of gross
domestic product is positively related to net interest margin but negatively
54 Journal of Banking & Financial Services

related to return on assets. These results indicate that banks facing lower
competition experiences superior profitability.

Table 4: Bank competition and profitability including macroeconomic

factors

Table 4 presents the OLS panel regression results including macroeconomic

factors. Here the dependent variables are three profitability ratios which are
ratios of net interest margin (NIM), return on assets (ROA) and return on
equity (ROE). The independent variable is Lerner Index which is used to
measure the bank competition. The control variables are natural logarithm of
total assets (Asset), the ratio of non-performing loans to total assets (NPL),
total liabilities to total assets (Leverage), inflation rate (Inflation) and growth
rate of gross domestic product (GDP). Bank fixed effects are included in the
regressions. By using heteroskedasticity-robust standard errors p values are
calculated and reported in parentheses. ∗, ∗∗, and ∗∗∗ represent statistical
significance at the 10%, 5%, and 1% level, respectively.
1 2 3
NIM ROA ROE
Lerner Index 0.0261** 0.0455*** 0.3928***
(0.0118) (0.0001) (0.0004)
Asset -0.0035 -0.0012 -0.0048
(0.1996) (0.4618) (0.7662)
NPL -0.0503** -0.0291* -0.7010**
(0.0381) (0.0853) (0.0138)
Leverage -0.0411 -0.0291 -0.6467
(0.2554) (0.5596) (0.3711)
Inflation 0.0086 0.0173 -0.2339
(0.6192) (0.3444) (0.2663)
GDP 0.2306** -0.1380** -1.1353
(0.0489) (0.0480) (0.1257)
Constant 0.1306* 0.0653 0.8608
(0.0656) (0.2809) (0.2386)
Time Fixed Effects No No No
Bank Fixed Effects Yes Yes Yes
Adjusted R-sq 0.2059 0.5804 0.4515
Observations 287 287 287
Competition and Profitability of Commercial Banks in Bangladesh 55

Lerner Index has been used to show the effect of bank competition. The major
finding is that Lerner Index has positive impact bank profitability. These
outcomes appear that competition challenges bank performance by expanding
the delicacy of banks. Hence, expanded bank competition can have negative
financial impacts by decreasing profitability of banks. So, higher bank
competition is detrimental for financial soundness of banks.
6. Conclusion
The research shows the result of competitiveness of banks on performance to
measure the gap within the current banking industry of Bangladesh. By using
Lerner Index as a proxy of bank competition we can conclude that when
competition of banks increases profitability decreases and vice versa. At
present, private banks are increasing their branches in Bangladesh. It falls
under non-price competition. The financial sector of Bangladesh is highly
underdeveloped although gross domestic product of the country is
continuously rising. In such scenario, business expansion of private banks
though inception of new branches may contribute a negative effect on
financial deepening of the country. So, on the basis of the findings of this
paper we can argue that Bangladesh Bank, Ministry of Finance and other
regulators of this sector should provide more incentives especially for banks
which are privately owned to increase their growth and efficiency. It can be
said without any hesitation many steps have been taken to boost the
competition level of industry. However, the question still remains whether the
level of changes to boost up industry competition correlates with improved
performance in terms of profitability. Under the mentioned circumstances of
this paper, it is paramount important that industry regulators analyze the
current structural condition the banking industry to revisit the changes
required to ensure stability of the industry for the overall growth of the
financial sector.

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58 Journal of Banking & Financial Services

Appendix A: Construction of Variables

Variable Construction

NIM (Interest Income - Interest Expense)/Total Asset

ROA Net Income Available to Common Shareholders/Total Assets

ROE Net Income Available to Common Shareholders/Total Equity

Lerner Index (Price - Marginal Cost) / Price

Asset Natural Logarithm of Total Assets

NPL Non-Performing Loans/Total Assets

Leverage Total Liabilities/Total Assets

Inflation Annual Inflation Rate

GDP Annual Growth rate of Gross Domestic Product

Volume 12, Number 1, June 2020

Determinants of Interest Rate Spread in the Banking

Sector of Bangladesh

Md Sajib Hossain 1
Shabnaz Amin 2

Abstract: The study attempts to investigate the determinants of the interest

rate spread (IRS) in the banking sector of Bangladesh. Using the data from
2011 to 2019 of the 22 listed conventional private commercial banks, the
study divides determinants of interest rate spreads of banks into three
categories: bank specific variables [non-performing loan (NPL), Bank size,
advance-deposit ratio (ADR), and capital adequacy ratio (CAR)], industry
specific variables [sectoral liquidity, weighted average deposit rate
(WADR), call money rate, 91-day treasury rate] and macro-economy
specific variables [gross domestic product (GDP) growth rate, and
inflation]. The study finds that bank-specific variables such as NPL ADR
and logarithm of total assets (LnTA) have negative effect on IRS and
results are significant whereas bank’s CAR ratio has positive effect on IRS
though result is not significant. Sectoral liquidity level affects interest rate
negatively, meaning that higher liquidity in the banking sectors leads to
lower IRS. Interest rate level measured in terms of 91-day Treasury bill,
WADR and call money rate contributes positively to IRS. Finally the study
reports that macroeconomic variables such as GDP affect positively to
interest rate spread in the banking sector of Bangladesh while inflation rate
has negative bearings on the IRS.
Keywords: Interest rate spread; Bank specific variable; Industry specific
variable; Macro-economy specific variable

1. Introduction
Interest rate spread (IRS) which is defined by the difference between lending
and deposit interest rate, is a fundamental indicator of financial performance
and efficiency in banking sector of Bangladesh. IRS reflects the cost of
financial intermediation that the banks incur (Robinson, 2002). IRS in
developing countries is higher compared to developed countries [Randall,
1998; Saunders and Schumacher, 2000] and Bangladesh is no exception. The

1
Corresponding Author: Assistant Professor, Department of Finance, University of
Dhaka, Dhaka-1000, Email: [email protected]
2
Associate Professor, Department of Finance, University of Dhaka, Dhaka-1000,
Email: [email protected]
60 Journal of Banking & Financial Services

documented underlying reasons for prevalence of such high IRS include

higher operating cost, high inflation, lack of competition and market power of
a few large dominant banks enabling them to influence the lending and
deposit rates, high risk premium for larger amount of classified loans, the
mindset of management to show profit at any cost which in turn, results to
agency cost problem and similar other factors. The issues like higher
operating costs and higher classified loans are indicative of the inefficiency of
the management for which the cost burden has to be borne by the borrowers
and the depositors According to the World Bank, the average IRS in
Bangladesh was hovering around 4 percent per annum from 1976 to 2019. If
we look at the last ten years’ data from 2009 to 2019, the average IRS was
about 5.5 percent (Monthly Economic Trends, Statistics Department,
Bangladesh Bank, June 2009- June 2019).
To facilitate private sector investment, government of Bangladesh has
taken policy decision to contain lending rate within 9 percent and the deposit
rate within 6 percent in banks which was made effective from April 01, 2020.
Following this initiative, Bangladesh Bank, on May 2018, directed all the
scheduled banks to bring down interest rate spread to 4 percentage points
from 5 percentage points. However, the instruction was largely ignored at
that time because of the increasing operating costs and bad loans in the
banking system. Besides, as the prevailing interest rates are not set by market
forces, banks tend to set their lending rates to cater their own business interest
(Khatun & Saadat, 2019).
The scenario in September 2018 showed that the average spread in the
foreign commercial banks was still 6.22 percent while the rate was 4.42
percent in the private commercial banks; the average interest rate spread in
the state-owned banks and specialized banks was 2.22 percent and 1.85
percent respectively (Interest rate spread, Statistics Department, Bangladesh
Bank, September 2018). The bankers and experts related to the banking
industry showed concerns and opined that even though it might be possible to
lend at 9 percent but collection of fund at 6 percent will be a challenge
especially when the prevailing inflation rate is 6 percent (BBS, 2019).

However, situation improved in December 2019 with average IRS

hovering around 4 percent while in May 2020, the average spread with state-
owned banks was 2.23 percent, the private banks 2.97 percent, the foreign
banks 5.39 percent and the specialized banks 2.03 percent. As of June 2020,
the spread between the weighted average interest rate on advances and
deposits of all banks decreased to 2.89 percent (Interest rate spread, Statistics
Determinants of Interest Rate Spread in the Banking Sector of Bangladesh 61

Department, Bangladesh Bank, May 2020 and June 2020). So there is a

declining trend in IRS as the banks managed to reduce the deposit rate more
than that of lending rate. The main reason for this is the availability of low-
cost refinancing funds available in the banking system which led to higher
liquidity in the banks. Bangladesh Bank has taken some policy measures for
which it would have been possible for banks to slash deposit rate and
continued to maintain the spread within 3 percent range. Government’s
borrowings from banking system through issuing T-bills and bonds have
increased significantly in 2020 compared to that of previous year, reduction of
cash reserve requirement (CRR) by Bangladesh bank to 4 percent from 5.5
percent were among other measures. These measures injected cash inflow in
the banking system and as a result, banks' excess liquidity hit the all-time high
of around Tk 1.40 trillion in June 2020 (Bangladesh Bank Quarterly, April –
June 2020). Besides, thanks to covid-19 pandemic situation, the private sector
credit growth slowed down significantly resulted in excess liquidity in banks.
Now the question is, for how long banks are going to rely on stimulus
packages and policy measures for liquidity where the success of these policy
changes also depend on other looming risk factors for example global
recession, unexpected inflationary pressure, cumulative non-performing loans
in banking sector and possible natural disasters? They will have to rely on
depositors at some point for funds and depositors would not be willing to
deposit at lower rate especially in the face of higher inflation and they will
look for other alternatives for example Sanchaypatra and stock market. So
maintaining a sustainable spread range for banks might be an issue in the
longer term.
Several empirical studies have identified bank-firm specific variables
(Almarzoqi and Naceur, 2015; Demirgüc-Kunt and Huizinga 1999; Doliente
2003, Were and Wambua 2014; Mujeri and Younus 2009) banking-industry
specific factors (Saunders and Schumacher 2000; Tennant and Folawewo
2007) and macroeconomic varibiables (Almarzoqi and Naceur 2015; Ghasemi
and Rostami, 2016; Shubiri and Jamil, 2017) affects IRS of banks. Based on
the existing literature and motivated by our research curiosity about how this
findings apply to banking sector of Bangladesh , our study attempts to
identify how bank-specific, industry-specific and macro-economic variables
jointly affect the IRS of banks with important policy implications in the
context of Bangladesh. The empirical analysis is based on panel data of 22
listed commercial banks for the period from 2011–2019. An efficient financial
system not only reduces uncertainty, cost of transactions, it also ensures
efficient allocation of resources. Therefore, understanding of these
62 Journal of Banking & Financial Services

determinants is important to tangibly improve the banking sector and

accomplish the target of financial deepening.
The rest of the paper is organized as follows: Section 2 and 3 provide a
survey of the literature on the determination of interest spreads and the recent
trends in interest rate spread in Bangladesh respectively, while the
methodology and description of the variables used in the empirical analysis is
outlined in Section 4. Section 5 provides an empirical analysis and discussion
of the results followed by findings and conclusion in Section 6.
2. Literature Review
Different empirical studies on developed and developing economies suggest
five main determinants of banks’ interest rate spread: bank-specific factors,
market structure, regulation, institutional environment, and the macro
economy (Almarzoqi and Naceur, 2015). It has been observed that the
banking systems in developing countries display larger IRS than those in
developed countries (Randall, 1998; Saunders and Schumacher, 2000).

Demirgüc-Kunt and Huizinga (1999) conducted a study on 80 countries

from 1988 to 1995 to assess the determinants of commercial bank interest
margins. They used bank characteristics, macroeconomic conditions, explicit
and implicit bank taxation, deposit insurance regulation, nature of financial
structure, and several underlying legal and institutional indicators and found
higher operating costs significantly responsible for higher interest rate
spreads. Saunders and Schumacher (2000) also argued that regulatory
framework in the form of interest-rate restrictions on deposits, reserve
requirements and capital-to-asset ratios have significant impact on IRS.
Barajas et al. (1999) examined the determinants of high intermediation spread
of the Colombian banking sector between pre-liberalization (1974-1988) and
post liberalization period (1991-1996) and found that in the post liberalization
period, the impact of operational costs, financial taxation and loan quality on
IRS was much significant than pre-liberalization period.
Doliente (2003) used the two step regression model on four Southeast
Asian Economies and employed bank specific factors such as collateral,
operating expenses, loan quality, capital requirements, liquidity and interest
rate volatility as determinants of net interest margins (as a proxy for IRS) of
banks for 1994 to 2001. The study found that non-competitive structure of
banking system was the reason for increase in net interest spread in the
region. Siddiqui (2012) found the similar findings while conducting a study
on bank-specific determinants of interest rate spread of a sample of 14
Determinants of Interest Rate Spread in the Banking Sector of Bangladesh 63

commercial banks in Pakistan for the period of 2000 to 2008 using fixed
effect model. The study found that lower operational efficiency, higher
nonperforming loans resulted an increase in IRS.
In addition to above mentioned variables, Tennant and Folawewo (2007)
used exchange rate volatility, Treasury bill rate, and discount rate as
determinants of IRS while conducting a study on 33 middle and low income
countries and found positive impact on the interest spread. The study
conducted by Were and Wambua (2014) also showed findings consistent with
these studies where bank-specific factors were the dominant determinants of
IRS. The study found that bank size, non-performing loan (NPL), return on
assets (ROA) and operating cost of Kenya’s banking sector all positively
impact IRS while the effect of real GDP growth and monetary policy rate was
not significant. Consistent results were documented in Beck and Hesse’s
(2006) study. Their findings showed that bank level characteristics (bank size,
operating costs and composition of loan portfolio) of Ugandan banks
explained the larger variation of IRS while macro- variables explained little.
These results contrast with some research which suggest that
macroeconomic factors have significant impact on IRS as well. Almarzoqi
and Naceur (2015) in their study on Caucasus and Central Asia (CCA) over
the period 1998–2013 found that aside from the bank-specific and market
structure variables, the macroeconomic environment— proxied by the
inflation rate and the policy rate—has a significant impact on interest margins
proving that a stable macroeconomic environment, with low inflation, low
interest rate, and low reserve requirement, will result in lower net interest
margins.

Similar results were documented in studies on middle eastern countries

[Ghasemi and Rostami, 2016; Shubiri and Jamil, 2017] where both bank
specific variables (NPL ratio, non-interest income, and interest assets to
assets, capital adequacy ratio, ROA) and macroeconomic variables (inflation
and exchange rate, monetary policy) had impact on IRS.
A number of studies were conducted on developed economies as well.
Claeys and Vander (2004) in their study on the determinants of IRS of banks
in Central and Eastern European and Western European countries found that
concentration levels, operative efficiency, capital adequacy and risk
management are important determinants of IRS.

Saunders and Schumacher (2000) employed Ho and Saunder’s (1981) two

step dealership model to a sample of banks of seven OECD countries
64 Journal of Banking & Financial Services

(Germany, Spain, France, Great Britain, Italy, United States and Switzerland)
and found that regulatory, market structure and risk premium components had
significant positive impact on IRS for almost all countries. Similar results
were documented in the study by Angbazo (1997) for the pooled sample of
US banks for the period from 1989 to 1993. The findings suggest that default
risk, opportunity cost of noninterest bearing reserves, leverage, and
management efficiency are statistically significant and positively related to
bank interest margins. The liquidity risk, however, was inversely related to
the bank interest margin.
Few studies on the determinants of IRS were done on the emerging
economies like Bangladesh. Mujeri and Younus (2009) used a bank profit
maximization model based on empirical industrial organization approach to
explain the interest rate spread (IRS) of 48 banks of Bangladesh from 2004 to
2008. The study found that for state-owned commercial banks and specialized
banks, operating costs and nonperforming loan had significant impact on IRS,
while for private commercial banks, inflation, operating costs, market share of
deposits, statutory reserve requirements, and taxes were significant. For
foreign commercial banks however, non-interest income, inflation, market
share, and taxes are the significant factors. In line with the above argument,
several other studies [Hossain, 2010; Ahmed and Islam, 2004, Younus and
Akhtaruzzaman, 2017] also showed a number of similar reasons behind high
IRS in Bangladesh such as: high administrative cost, higher amount of
classified loan, higher cash reserves and some macroeconomic variables such
as higher inflation. Rahman et al. (2019) identified cost of fund, market rate,
regulatory compliances, operating cost, asset-liabilities mismatch and NPLs
are some of the key factors that have significant impact on lending rates while
examining the recent move of single digit interest rates.
The present study goes beyond the previous studies on Bangladesh by
considering not only bank specific, industry specific and macro-economy
specific variables with credible statistical analysis but also covering wide and
the most recent period ranging from 2011 to 2019. It is worth mentioning that
since 2010 banks in Bangladesh officially have entered Basel II (the latest
version of risk-based capital standard) regime which has impact on policy
issues regarding interest rate spread. Thus this study is expected to the fill gap
in the literature in the area of banking and finance.
3. Interest Rate Spread Trend in Bangladesh
From Table 1, it can be observed that the overall interest rate spread in
Bangladesh was higher than 5 percent in June 2014 and before. The
Determinants of Interest Rate Spread in the Banking Sector of Bangladesh 65

movement shows a declining trend from 2015 to 2019. To boost the private
sector investment, government has taken a policy decision to reduce the IRS
to 3 percent which was made effective from April 01, 2020. Following the
directive, Bangladesh Bank, on May 2018, directed all the scheduled banks to
bring down interest rate spread to 4 percentage points from 5 percent. To meet
the target, the weighted average IRS of scheduled banks was on the process of
reducing the spread from late 2018 onwards. In the last four years i.e. from
2016 to 2019 it was hovering around 4.54 percent. However, if we look at the
bank category wise IRS, it is still higher i.e. 4.58 percent on average from
2016 to 2019 for private commercial banks (PCBs) and 6.91 percent on
average from 2016 to 2019 for foreign commercial banks (FCBs). Thus,
during this time the Bangladesh Bank’s directive has largely been ignored and
according to bankers, the rising NPL and the fear of profit fall are the prime
reasons. 1 In 2020 however, the IRS showed a declining trend which was
mainly due to reduction in deposit rate made possible for high inflow of
liquidity in the system as Bangladesh Bank took some policy measures.
Table 1: Movement of IRS in Bangladesh from 2006-2020
Period Weighted Average of all IRS by Bank Category
banks
Deposit Lending IRS SCBs SBs PCBs FCBs
Rate Rate
2006 6.68 12.06 5.38 5.37 3.64 5.05 8.52
2007 6.85 12.77 5.92 6.04 2.94 5.05 8.76
2008 6.95 12.29 5.34 4.48 3.19 5.09 8.91
2009 7.01 11.86 4.86 3.63 2.99 4.52 9.48
2010 6.01 11.31 5.30 3.64 2.26 5.49 9.33
2011 7.27 12.42 5.15 4.52 2.37 5.41 8.83
2012 8.09 13.88 5.79 5.07 2.95 5.85 9.09
2013 8.54 13.67 5.13 3.66 3.06 5.34 8.59
2014 7.65 13.15 5.50 3.56 2.97 5.95 7.93
2015 6.70 11.68 4.98 3.38 2.91 5.32 7.78
2016 5.54 10.39 4.85 4.23 1.90 4.96 6.80
2017 4.84 9.56 4.72 4.19 3.12 4.73 6.20
2018 5.5 9.95 4.45 3.57 3.24 4.33 7.07
2019 5.43 9.58 4.15 2.32 1.98 4.30 6.91
2020 5.06 7.95 2.89 2.33 2.10 2.88 5.30
Source: Statistics Department, Bangladesh Bank, June 2006 to June 2020.

1
http://www.dailyindustry.news/banks-increased-interest-spread-ignoring-central-bank-
instruction/
66 Journal of Banking & Financial Services

Figure 1: Trends in lending rates, deposit rates and IRS

Source: Statistics Department, Bangladesh Bank, June 2006 to June 2020.

The trend from figure 1 shows that that the IRS was the highest in 2007 and
lowest in 2020. The average IRS from 2006 to 2019 was about 5.1 percent.
The weighted average deposit and lending rates were highest in 2013 and
lowest in 2020 with average deposit and lending rate of 6.64 percent and
11.75 percent respectively. Overall the deposit rates, lending rates and IRS
show a declining trend.
Figure 2: Interest rate spread by Types of banks

Source: Statistics Department, Bangladesh Bank, June 2006 to June 2020.

From Figure 2 we see that IRS was highest in Foreign Commercial Banks
(FCBs) has always been higher compared to private commercial banks
Determinants of Interest Rate Spread in the Banking Sector of Bangladesh 67

(PCBs). The spread was within the reasonable limit in case of State Owned
Commercial Banks (SCBs) and Specialized Banks (SBs). IRS was highest for
FCBs at 6.91 percent in June 2019 followed by 4.30 for PCBs, 2.32 for SCBs
and the lowest of 1.98 for SBs. While IRS of SBs generally showed a
declining trend, IRS for other categories of banks showed fluctuating trend.

4. Data and Methodology

4.1 Data

For this study, all the listed commercial banks which have been in operation
from 2011 to 2019 in Bangladesh were selected. Later, 8 full-fledged Islamic
banks were dropped out form the sample due to the unique nature of their
liability and asset structure and different mode of their operations, and one
government-owned bank has been dropped due to distinct regulatory
framework resulting in sample size of 22 listed commercial banks. The
secondary data on bank specific variables were obtained from the annual
reports of the banks. The industry specific and macroeconomic data were
obtained from the different publications (Bangladesh Bank Quarterly,
Working Papers) of the Bangladesh Bank, the central bank of Bangladesh.

4.2 Definition of Variables

The variables selected for the study include bank specific, industry specific
and macro-economy specific. In this study, IRS is the dependent variable and
ten (10) independent variables are used. Of the ten independent variables, four
are bank specific variables such as NPL ratio, advance-deposit ratio (ADR),
capital adequacy ratio (CAR) and to control the size effect, logarithm of bank
total asset is used. The two macro-economy specific variables are GDP and
Inflation rate. The industry specific variable is sectoral liquidity ratio
measured by bank liquid reserves to bank assets ratio. These variables are
extensively used in the existing literature [Demirgüc-Kunt and Huizinga,
1999; Mujeri and Younus, 2009; Siddiqui, 2012; Were and Wambua, 2014
among others]. To measure effects of liquidity on interest rate spread in terms
of price of money, three alternative variables have been used. These are:
weighted average deposit rate of the overall banking industry, inter-bank
yearly average call money rate and 91-day Treasury bill yield [Hossain et al.
(2016)].
68 Journal of Banking & Financial Services

Table 2: Notations of the Variables and Description

Variable Notation Definition Expected

Sign
Interest rate IRS Difference between weighted average
spread lending rate and weighted average deposit
rate.
Bank Specific variables
Non- NPL Ratio of non-performing loan against total +/-
performing loans and advances (a proxy for credit
loan risk)
Advance- ADR Measured by total advance to total -
deposit ratio deposits ratio
Capital CAR Ratio of bank’s capital to risk-weighted +
Adequacy assets and current liabilities
ratio
Bank Size LnTA Logarithm of bank’s Total assets -
Industry specific variables
Bank SLiq Sectoral liquidity ratio measured by bank -
liquidity liquid reserves to bank assets ratio
Price of WADR Weighted Average Deposit rate +/-
Money (three
T-bill 91-day Treasury bill yield +
proxies are
used) Call Inter-bank yearly average call money rate +
Money
Macroeconomic specific variables
GDP gdp Annual GDP growth +/-
Inflation inf Annual CPI inflation rate +/-

4.3 Functional Model Specification

The study focused on examining the determinants of the commercial bank’s
interest rate spread. Based on extensive literature review, the study finds that
interest rate spread of commercial banks depend on three types of variables;
bank-specific variables, industry-specific variables and macroeconomic-
variables.
Determinants of Interest Rate Spread in the Banking Sector of Bangladesh 69

The basic model specification is as follows:

………………………............……..…Eqn. 1

Where IRSi,t is the interest rate spread of bank i at time t; BSVi,t is the
vector of bank specific variables for bank i; is a vector of industry
specific variables; and MEV is a vector macroeconomic variables; and µ is
the error term.

As far as the definition of IRS is concerned, there is no consistent method

on how to calculate the interest rate spread. In this study, the difference
between the weighted average lending and weighted average deposit rate is
used to calculate the IRS (Demirgüç-Kunt and Huizinga, 1999; Tennant and
Folawewo, 2007).

The vector of bank specific variables includes four commercial bank-

specific variables that are expected to affect the interest rate spread. First,
non-performing loan (NPL) is taken as an indicator of the quality of assets.
The second variable is ADR measured by total advance to total deposits ratio.
Banks with higher ADR means they are able to mobilize more deposits even
at relatively low deposit rates while at the same time attract large number of
loan applications with relatively higher rates, resulting in higher spreads
[Were and Wambua, 2014; Ahokpossi, 2013]. The third bank specific variable
is the size of the bank measured as natural log of the total asset of the bank.
The fourth bank specific variable is capital adequacy ratio of the banks; bank
with higher capital adequacy ratio is deemed more financially sound and able
to attract deposit at lower costs, resulting in higher IRS.

To capture the effect of industry specific factors, first we have taken

sectoral liquidity ratio measured by bank liquid reserves to bank assets ratio.
This is computed by ratio of domestic currency holdings and deposits with the
monetary authorities to claim on other government, non-financial public
enterprises, private sector and other banking institutions. This variable is a
proxy of the overall liquidity of the banking sector. To capture the effects of
liquidity on interest rate spread in terms of price of money, we have used
three alternative variables: weighted average deposit rate of the overall
banking industry, inter-bank yearly average call money rate and 91-day
Treasury bill yield. The expectation is that, as overall interest rate in the
industry goes up, bank-specific borrowing and lending rate should also go up
because it will affect the opportunity costs of both depositors and bankers.
70 Journal of Banking & Financial Services

To capture the effect of changes in the macroeconomic environment on IRS in

the model, the inflation rate (INF) as measured by the change in the consumer
price index and the growth rate of real GDP have been included. The inflation
variable is an indicator of the cost of doing business in an economy, and it is
expected to be positively related with IRS, particularly in developing
countries where inflation is high and variable (Claeys and Vanet, 2008;
Chirwa and Mlachila, 2004). Other studies such as Abreu and Mendes (2003)
and Maria and Agoraki (2010) however, found a negative relationship
between inflation and IRS, indicating that bank costs increase more than bank
revenues do, probably due to regulatory constraints on adjusting lending rates.
That is why a mixed result is expected as far as the relationship between
inflation and IRS is concerned. Mixed result is also expected between the real
GDP growth and IRS. Some studies found negative relationship [Nampewo,
2013] and others however, found a positive relationship [Grenade, 2007].
The model equations thus turn out as follows:
IRS it = λ + β1 x( NPL )it + β 2x( ADR )it + β 3 x( LnTA)it + + β 4 x(Car )it + β 5 x(CallMoney )it + β 6 x( gdp )t
+ β 7 x(inf)t + βx8( SLiq )t + µ it ...................................................................................................Eqn. 2

IRS it = λ + β1 x( NPL ) it + β 2x( ADR ) it + β 3 x( LnTA)it + + β 4 x(Car )it + β 5 x(T −bill )it + β 6 x( gdp )t
+ β 7 x(inf)t + β 8 x( SLiq )t + µ it .....................................................................................................Eqn. 3
IRS it = λ + β1 x( NPL )it + β 2x( ADR )it + β 3 x( LnTA)it + + β 4 x(Car )it + β 5 x(WADR )it + β 7 x( gdp )t
+ β 8 x(inf)t + β 9 x( SLiq )t + µ it .................................................................................................Eqn. 4

4.4. Econometric Model specification: Panel Data Estimation Method

(Fixed Effect vs. Random Effect)
As our data consists of cross sectional times series data, so our study utilized
the panel data (balanced) estimation methods. There are considerable
advantages of using panel data as opposed to using only time series or only
cross-sectional data (Frees 2004). One advantage of using panel data is that
we can capture the unique effects of individual bank on its interest rate spread
in the models. For example, a linear regression model of 𝑘 factors can be
expressed in the following way:
i= 1, n; t=1 T…..........Eqn. 5
Where is specific for each individual. A model such as the above allows
for the managing of the heterogeneity across individuals. The inclusion of this
parameter in the model can explain correlation between the observations in
time, which is not caused by dynamic tendencies. The individual specific
Determinants of Interest Rate Spread in the Banking Sector of Bangladesh 71

component can be fixed for each individual or it can be random (and be

treated like a random variable). This defines the existence of two major panel
data models called fixed effects model and random effects model.
This makes the estimates obtained from panel data models that use
individual-specific components more the individual-specific component
explains part of the heterogeneity in the data, which reduces the unexplained
variability and thus the mean squared error efficient than the ones from
models that do not include such parameter.

Panel data can also deal with the problem of omitted variable bias if those
variables are time-invariant. Let 𝜶 be a vector with length 𝑁=𝑛∙𝑡 and
elements 𝛼𝑖. Because of the perfect collinearity between the time-invariant
omitted variable(s) and 𝜶 in models like the fixed effects, one can consider
that this variable (s) has/have been incorporated in the individual-specific
component. Thus, it is possible to deal with bias in some cases.
Another advantage is in terms of time series analysis and is expressed in
the fact that panel data does not require very long series. In the classical time
series analysis some methods require series of at least 30 observations and
that can be a drawback for two reasons: one is the availability of data for so
many consecutive time periods and the second is that sometimes it is
unreasonable to use the same model for describing data in a very long period
of time. In panel data the model can be more easily inferred by making
observations on the series for all the individuals. By finding what is common
among the individuals, one can construct a model accurately without having
to rely on very long series. The available data across individuals compensates
for the shorter series.
A benefit of the panel data over cross section analysis is that a model can
be constructed for evaluating the impact that some time-varying variables (the
values of which also vary across individuals) have on some dependent
variable. The additional data over time increases the precision of the
estimations.
The fixed effects model for 𝑘 factors can be expressed in the following way:
...................................Eqn. 6
There is no constant term in the fixed effects model. Instead of the constant
term in pooled model, now we have an individual-specific component
that determines a unique intercept for each individual. However, the slopes
(the 𝛽 parameters) are the same for all individuals.
72 Journal of Banking & Financial Services

In the random effects model the individual-specific component 𝜶 is not

treated as a parameter and it is not being estimated. Instead, it is considered as
a random variable with mean 𝜇 and variance . The random effects model
can thus be written as:
…..........Eqn. 7
Where is the average individual effect. Let = and
the equation above can be rewritten as:
…...........Eqn. 8
To choose which model is appropriate to examine the determinants of the
interest rate spread of commercial banks in Bangladesh, we used the Hausman
test. Hypothesis under the Hausman test is as follows
: The appropriate model is Random effects. There is no correlation
between the error term and the independent variables in the panel data model.
, ) = 0…………………………………...............…………....Eqn. 9
: The appropriate model is Fixed effects. The correlation between the error
term and the independent variables in the panel data model is statistically
significant.
, ) ≠ 0………………………………………….................…Eqn. 10
Hausman statistic is calculated from the formula:

- [Var - - …...........Eqn. 11
Where and are the vectors of coefficient estimates for the
random and fixed effects model respectively. This statistic is 𝜒2 (𝑘)
distributed under the null hypothesis. The degrees of freedom 𝑘 equal the
number of factors.
5. Empirical Results and Analysis

Table-3 provides the descriptive statistics of IRS and all other explanatory
variables. The IRS of the banks ranges from 0.75 percent to 11.33 percent
with a mean of 4.5 percent. The wide range of the IRS among the banks
reflects the different business model of banks in Bangladesh operating
different segment of the industry. In general, banks whose business is
concentrated in retail and SME business earn more interest spread than those
concentrated in the corporate sectors. This makes sense given that fact more
Determinants of Interest Rate Spread in the Banking Sector of Bangladesh 73

information asymmetry and risk exists in the retail and SME sectors. The
mean NPL ratio of the banks are 5.13 percent that ranges from below 1
percent to as high of 33.07 percent. High NPL ratios reflect the facts that
banking industry in Bangladesh has been going through difficult time with
some banks experiencing financial distress. In the last few years, some banks
have to turn to Bangladesh Bank (BB) for liquidity support for their financial
distress with one bank facing technical bankruptcy and one Non-Bank
Financial Institution going officially bankrupt.
Table 3: Summary Statistics of the Variables

Std.
Variable Obs Mean Min Max
Dev.

IRS 198 4.50% 1.70% 0.75% 11.33%

NPL 198 5.13% 3.09% 0.22% 33.07%

CAR 198 12.35% 1.51% 9.43% 17.93%

ADR 198 87.43% 9.82% 58.41% 113.19%

LnTA 198 25.82 0.42 24.85 26.65

GDP 198 6.89% 0.69% 6.01% 8.15%

Inf 198 6.78% 1.78% 5.61% 11.46%

T-bill 198 5.73% 2.69% 2.98% 9.50%

Call Money 198 6.74% 3.19% 3.67% 12.82%

WADR 198 4.86% 0.45% 4.05% 5.51%

SLiq 198 11.41% 1.82% 8.90% 14.70%
Source: Authors’ calculation from annual reports of banks and monthly publication of
Bangladesh Bank

The average Capital Adequacy Ratio (CAR) is 12.35 percent while the
industry requirement is at least 10 percent. In the last decade, Bangladesh has
been experiencing average GDP growth rate of more than 6.5 percent without
any major surge in inflation.

The average price of the money measured in terms of T-bill yield, Call
Money rate and Weighted Average Deposit rate in the banking sectors all
were within a very decent range. The average Sectoral Liquidity Ratio was
11.41 percent, well above the minimum requirement of 5-6 percent during the
74 Journal of Banking & Financial Services

period, reflecting the fact that industry did not experience any liquidity crunch
during the period under study.
Table-4 provides the correlation matrix among the IRS and other
explanatory variables. As observed, almost all the explanatory variables are
significantly correlated with the IRS of the banks. Call Money, T-bill and
WADR explain the same things as observed in the high correlation among
them. So when we run the panel regression model, we have used them in
different regression model to show the impact of overall interest rate in the
industry on individual bank’s IRS.
Table 4: Correlation Matrix
lnBank Call
IRS NPL CAR ADR T-bill WADR GDP Inflation SLiq
size Money
NPL -0.258*** 1.000
0.000
CAR -0.001 -0.046 1.000
0.987 0.523
ADR -0.608*** 0.130* 0.252*** 1.000
0.000 0.068 0.000
LnTA -0.435*** 0.286*** 0.231*** 0.484*** 1.000
0.000 0.000 0.001 0.000
Call - - -
0.450*** -0.226*** 1.000
Money 0.261*** 0.405*** 0.697***
0.000 0.000 0.001 0.000 0.000
- - -
T-bill 0.459*** -0.116 0.857*** 1.000
0.279*** 0.368*** 0.603***
0.000 0.000 0.103 0.000 0.000 0.000
- - -
WADR 0.433*** -0.319*** 0.901*** 0.729*** 1.000
0.283*** 0.470*** 0.744***
0.000 0.000 0.000 0.000 0.000 0.000 0.000
- -
GDP -0.363*** 0.256*** 0.353*** 0.509*** 0.627*** -0.502*** 1.000
0.604*** 0.825***
0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000
- - -
Inf 0.229*** -0.198*** 0.620*** 0.657*** 0.629*** -0.429*** 1.000
0.291*** 0.212*** 0.586***
0.001 0.000 0.005 0.003 0.000 0.000 0.000 0.000 0.000
- - -
- -
SLiq 0.067*** -0.139* -0.1810** 0.2208** 0.2098** 0.450*** 0.2473** 0.433*** 1.000
0.443**** 0.054***
* * *
0.433 0.051 0.011 0.002 0.000 0.000 0.000 0.000 0.000 0.452 0.000

Note: ***Correlation is significant at the 0.01 level (2-tailed). **Correlation is

significant at the 0.05 level (2-tailed). *Correlation is significant at the 0.1 level (2-
tailed).

Source: Authors’ Calculation

Determinants of Interest Rate Spread in the Banking Sector of Bangladesh 75

In order to assess whether individual bank has any significant effect on its
IRS determination, we have run Hausman test which will suggest whether
fixed effect model or random effect model is appropriate for our panel data
estimation.
The individual-specific component 𝜶 might be correlated with the
independent variables in the random effects model, if there are omitted
variables, to which the fixed effect model is robust. The fixed effects model
estimates are always consistent, but they are inefficient compared to the
random effects model estimates. Table-5 provides the results of the Hausman
test which suggests that random effect model is appropriate for our panel data
estimation.

Table 5: Hausman Test

Model 1 Model 2 Model 3
Chi-Sq. Stat (X²) 12.12 7.25 13.89
Prob. X² 0.1459 0.5102 0.0846
No. of Observation 198 198 198
Est. tech REM REM REM

Source: Authors’ Calculation

Table 6 provides the main result of our study. In model 1, we have used
inter-bank call money rate as proxy for industry specific variable for price of
money in the banking sector. In model 2 and model 3, we have used
alternative definition namely 91-day Treasury bill yield and weighted average
deposit rate as proxy.

Although a positive correlation was expected between IRS and NPL, our
finding showed NPL has negative effect on the IRS, and the result is
significant at 1 percent significance level. The finding is consistent with
Almarzoqi and Naceur (2015) and William (2007) where they argued that
there could exist mispricing of risk as higher levels of NPL provisions would
not be fully compensated for by interest spreads. They also argued that the
practices of inadequate accounting standards and inappropriate classification
of loan loss provisions might also be responsible for this negative
relationship. Besides, banks with higher NPL will have to offer higher deposit
rate for the higher risk associated with high NPL in order to attract deposits. If
banks want to charge a higher lending rate, this might not be possible because
good corporate borrowers will go to other banks to borrow at a lower rate.
76 Journal of Banking & Financial Services

Alternatively, the bank might not be able to pass on all part of the higher
deposit rate to a higher lending rate to the borrowers, resulting in a net decline
in the IRS.

CAR has positive effect on IRS but the result is not significant. The
finding is consistent with Almarzoqi and Naceur (2015). This might be
attributed to the fact that our sample consists of only private conventional
commercial banks, among which CAR varies with a very narrow range
compared to state-owned banks and foreign banks and the effect of CAR
might already be captured by NPL and ADR ratio.
ADR has negative effect on the IRS and this goes with the basic economic
theory of diminishing marginal return. As banks lend more of their deposit,
marginal returns go down, reflecting in lower IRS
Table 6: Multiple Regression Analysis under Panel Data (Balanced)
Estimation Method (Random Effect)
Model 1 Model 2 Model 3
IRS IRS IRS
Explan. Explan. Explan.
Coef. z Coef. z Coef. z
Variable Variable Variable
NPL -0.077*** -4.13 NPL -0.071*** -4.83 NPL -0.078*** -4.93
CAR 0.042 1.03 CAR 0.03 0.74 CAR 0.042 0.96
ADR -0.092*** -8.95 ADR -0.085*** -7.71 ADR -0.094*** -8.74
In Bank size -0.018*** -4.17 In Bank size -0.017*** -4.54 In Bank size -0.018*** -3.52
Call Money
0.037 1.09 T-bill 0.093*** 2.99 WADR 0.003 1.02
Rate
Sector Sector Sector
-0.139*** -3.88 -0.091*** -2.85 -0.151*** -4.52
LR/Asset LR/Asset LR/Asset
GDP 0.261** 1.96 GDP 0.295** 1.77 GDP 0.341* 1.85
INFLATION -0.180*** -4.02 INFLATION -0.204*** -5.87 INFLATION -0.186** -4.94
_cons 0.598 5.26 _cons 0.568 5.76 _cons 0.594 3.95
2 2 2
R R R
Within 0.705 Within 0.7116 Within 0.7045
Between 0.229 Between 0.2281 Between 0.2272
Overall 0.424 Overall 0.4315 Overall 0.4209
Wald chi2
Wald chi2 Stat. 332.95 Wald chi2 Stat. 335.71 322.64
Stat.
Prob. > chi2 0 Prob. > chi2 0 Prob. > chi2 0

Note: *** significant at the 0.01 level (2-tailed). ** Significant at the 0.05 level (2-
tailed). * Significant at the 0.1 level (2-tailed).
Determinants of Interest Rate Spread in the Banking Sector of Bangladesh 77

The IRS of the banks is negatively influenced by the size of the banks and
the study is consistent with Angbazo (1997) and is reflective of reduction in
cost due to economies of scale. Besides, as banks get bigger, efficiency of
managing big portfolio declines and as a result IRS declines too. There are
regulatory issues as well; in Bangladesh, if banks want to open new branches,
they have to open a certain proportion of branch in rural area and banks are
bound by regulations to hold a certain portion of their portfolio in government
securities which often offer below market yield. This burden gets higher with
the size of the banks.

We have used call money rate, 91-day T-bill rate and WADR as alternative
definition of price of money in three different models to see how it affects the
individual bank’s IRS. All three variables have positive effect on the IRS
pointing the fact that banks earn higher IRS at the higher level of the interest
rate. However, the impact of 91-day T-bill rate on IRS shown in model 2 is
significant and is consistent with the finding of the study conducted by
Nampewo (2013). These results may be attributed to the fact that since both
the average call money rate and average WADR in the industry are impacted
by the industry outliers and that average interest rate in those proxies does
reflect the situation of the actual interest of the individual banks. On the other
hand, as 91-day T-bill rate is applied to every banks equally across the
industry, so it does have significant positive impact on IRS of the individual
banks. The bank liquid reserves to bank assets ratio has negative effect on the
IRS and this result is consistent with the existing literature because banks with
higher liquidity face lower liquidity risk and thus is likely to be associated
with lower spreads due to a lower liquidity premium charged on loans [Were
and Wambua, 2014].

Finally macroeconomic factor such as GDP has positive impact on the IRS
with statistically significant results and are consistent with the existing
literature [Grenade, 2007; Claeys and Vanet, 2008; Poghosyan, 2012]. Since
real GDP grows fast in an economy where return on capital investment is
relatively high, corporate borrower under such conditions are likely to accept
higher borrowing rate for firm expansion. The inflation variable is found to
have negative relationship with IRS, reflecting the fact that bankers cannot
totally pass on higher inflation costs to the borrowers, which affects their
operating profitability and sustainability negatively.
78 Journal of Banking & Financial Services

6. Conclusion and Policy Implications

The main objective of the study is to examine the determinants of the interest
rate spread in the banking sector of Bangladesh. The study divides
determinants of interest rate spreads of banks into three categories: bank
specific variables (NPL, Bank size, ADR, and CAR), industry specific
variables (Sectoral liquidity, WADR, call money rate, 91-day treasury rate)
and macro-economy specific variables (GDP growth rate, and Inflation).
Using the data from 2011 to 2019 of the 22 listed conventional private
commercial banks, the study finds that NPL has negative effect on interest
rate spread and results are statistically significant. The finding is consistent
with Almarzoqi and Naceur (2015) and William (2007) where they argued
that there could exist mispricing of risk as higher levels of NPL provisions
would not be fully compensated for by interest spreads. The policy
implications for our findings is that bankers should improve the quality of
loan to improve profitability and sustainability of banks as higher NPL costs
cannot be totally passed on to the depositors due to competitive nature of the
banking industry. The study finds that both size and ADR contribute
negatively to the bank’s IRS and results are statistically significant whereas
bank’s CAR ratio has positive effect IRS though result is not significant. The
implication of these findings is that regulators concerned with higher IRS
might encourage consolidation of small, underperforming banks through
merger and acquisition as this might bring the overall IRS in the industry
down, paving the way for faster industrialization and economic growth.

Sectoral liquidity level affects IRS negatively, meaning that higher

liquidity in the banking sectors leads to lower interest rate spread. Interest rate
level measured in terms of 91-day Treasury bill, WADR and call money rate
contributes positively to IRS and result is consistent with the existing
literature which suggests that banks earn higher IRS at the higher level of the
interest rate. The finding that higher sectoral liquidity and low level of interest
rate contributes to decline in IRS has important policy implications for the
regulators because central bank can push the overall IRS down by increasing
banking sector liquidity or lowering the policy interest rate such as CRR, repo
rate or bank rate which might later affect the WADR and call money rate and
treasury bill rate. Finally the study reports that macroeconomic variables such
as GDP affects positively to interest rate spread in the banking sector of
Bangladesh and results are consistent with the existing literature [Grenade,
2007; Claeys and Vanet, 2008; Poghosyan, 2012].
Determinants of Interest Rate Spread in the Banking Sector of Bangladesh 79

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82 Journal of Banking & Financial Services
Volume 12, Number 1, June 2020

Factors Affecting Customer Satisfaction in Islamic

Banking: Evidence from Islamic Banks in Bangladesh

Md. Amdadul Hoque 1

Md. Shahidul Islam 2

Abstract: The present study used as many as 20 dimensions of customer

satisfaction related variables to investigate the customer satisfaction of
Islamic Banks in Bangladesh. The study used the Non-Probability
Convenience sampling techniques and collected data from 10 full-fledged
Islamic Banks of which 350 respondents’ altogether. The study found that
the product range and customer service quality, trust, internet, and mobile
banking facilities, financial benefit and service charge have a significant
effect on customer satisfaction of Islamic Banks in Bangladesh. The
findings of the study will help the respective bank management and the
policymakers to re-design the retention strategies of existing customers and
attract new customers in the Islamic banks.
Keywords: Service quality; Islamic Bank; Islamic Shariah

1. Introduction

At present, Islamic Banking is a popular financial system concept in both the

Muslim and non-Muslim majority countries. A banking system that is
conducted by following the financial principles proposed by Islamic Shariah
that strictly prohibits the involvement of interest in transactions (Haron and
Azmi, 2008). So, Banking based on Islamic Shariah principles is called
Islamic Banking. As interest is prohibited in Islam, Islamic banks neither
charge nor offer interest. Instead, Islamic Banks operate their banking
operations based on profit motivation that is allowed in the Islamic Shariah.
Islamic banks make a profit through equity participation with the customers
and clients.

Islamic Banking in Bangladesh has seen impressive growth for strong

public demand. At the end of January-March 2019 quarter in Bangladesh,

1
Corresponding Author: Assistant Professor, Department of Finance and Banking,
Comilla University, Cumilla, Email: [email protected]
2
Associate Professor, Department of Banking and Insurance, University of Dhaka,
Dhaka-1000, Email: [email protected]
84 Journal of Banking & Financial Services

deposits, and investments of Islamic banking industry grew by 2.0% and

2.76%. It has been holding almost one-fourth share of the entire banking
industry in terms of deposits and investments (Developments of Islamic
Banking in Bangladesh, 2019).
Right now, a massive competition is appearing between the conventional
banking systems and the Islamic banking systems to retain the existing
customers as well as for attracting a large number of new customers.
Measuring and evaluating customer satisfaction is very crucial to sustain in
this competitive banking industry because a dissatisfied customer would not
be loyal and would want to switch one bank to another bank and not
interested to maintain long terms relationships (Amin etal., 2013). In the
banking industry, customer loyalty has become a real concern because of the
high expectations of the client and tough rivalry among the competitors
(Rasheed et al., 2015). Fornell, (1992) already exposed that, although quality
and customer satisfaction are significant in all firms, customer satisfaction is
more important in the case of service industries like banks. Nowadays,
customer expectations have also been increased regarding banking services,
so managers led to take the customer-focused policy to sustain in the
competitive banking industry. The significance of service quality in the
banking industry is shown by different researchers across the globe (Levesque
and McDougall, 1996; Jamal and Naser, 2002; Al-Hawari and Ward, 2006;
Pass, 2005), In Bangladesh, most of the studies emphasize on service quality
and customer satisfaction of retail banking and conventional banking (Rashed
& Chowdhury, 2014; Masukujjaman & Akter, 2010; Siddiqi, 2011) and very
few studies conducted on Islamic Banking on these issues (Khan et al. 2010;
Suhaily,2018, ).
Thus, it is obvious that more research is required in this ground to find out
the vital factors of customer satisfaction in the competitive banking industry.
This study analyses the level of customer satisfaction towards the Islamic
banks as well as tries to explore the crucial factors of customer satisfaction in
Islamic banking in Bangladesh and, the study will help to updates the
customer-centric Islamic banking framework for enhancing customer
satisfaction.

The rest of the paper has been designed as in section two motivation of the
study, in section three, literature review, in section four, objectives of the
study have been presented. In section five, research methodology, in section
six, analysis and findings, section seven, regression analysis has been
detailed. Section eight and nine are followed by a conclusion and references.
Factors Affecting Customer Satisfaction in Islamic Banking: ......Bangladesh 85

1.1 Motivation of the Study

Satisfied customers are a great resource for any bank. Banks thus try to know
the customers’ need and their feedback about the products they already have
offered. If any bank can satisfy the existing customers, they become loyal, and
keeping loyal customers is less expensive to the banks than getting new
customers. In this study, we try to identify the factors affecting customer
satisfaction towards Islamic Banking.

Loan recovery and various other financial measures, Islamic banks have
shown relatively better performance as compared to their conventional
counterpart. This is obviously an indication of the good loyalty level of
customers towards Islamic banking. Developing and having customer loyalty
is imperative to face the challenging environment because customers could
favorably impact business outcomes such as deposit amounts, cost of
operation and marketing, customer retention rates, and subsequently future
revenues (Bakar et al., 2017). Taken into consideration the potential role of
having loyal customers, recent literature has shown that customer satisfaction
is one of the most important factors to increase customer loyalty in the
perspective of Islamic banking (Hoq et al., 2010). That’s why researchers are
inspired to explore the main factors of service quality that affect the customer
satisfaction of Islamic banks in Bangladesh. This will be a great help to the
policymakers to be acquainted for formulating the strategy to satisfy their
customers in the Islamic banking industry of Bangladesh.

2. Literature Review

In this study on the customer satisfaction of Islamic banks in Bangladesh: an

explorative study, we studied the responses of customers of different Islamic
banks operating in different cities in the country. The identification of the
factors that affect customer satisfaction of banks is one of the most imperative
topics for researchers in the field of customer satisfaction in the banking
industry. Many researchers have conducted studies to analyse the
determinants of the level of customer satisfaction across the world and
identified a set of factors that affect the degree of customer satisfaction
towards services quality of the banking industry.

Sabir et. al (2014) conducted a study to identify the factors influencing the
customer to be satisfied and to observe the relation between service quality,
customer satisfaction, and customer loyalty. They found a noticeable
relationship between the quality of service and customer satisfaction and
86 Journal of Banking & Financial Services

showed a positive relationship between customer satisfaction and customer

loyalty.
Mylonakis, John. (2009) examined the Greek bank's customer satisfaction
level, buying pattern, and attitude towards banking products and services.
Most of the clients have marked themselves satisfied with the bank products
and services that they are offered with.
Uddin and Akhter (2012) investigated those determinants of customer
satisfaction in the banking industry in Bangladesh. Using the measurement
model and structural model revealed that service quality and service charge
have a positive impact on customer satisfaction.
In 2012, Rahman, A. A., examined the relationship between customer
satisfaction and six dimensions of service quality in Islamic banks of
Pakistan, The UK, and the UAE. They found that assurance, reliability, and
empathy as crucial factors for customer satisfaction according to the customer
of Pakistan and the UK. On the other hand, Islamic bank customers of UAE
took assurance and tangibility into consideration as the crucial factors of their
satisfaction.
Bashir (2013) researched to examine the effects of both service quality and
product quality and satisfaction awareness of Islamic banking in Brunei
Darussalam. It showed that the impacts of service quality and product quality
were positive and significant with customer satisfaction.
Parvez (2014) stated in their study that Islamic Banking gaining popularity
among the non-Muslim population in Bangladesh. They found that customers
prefer Islamic banking services not because of the non-interest-based
principle but because of their better quality of services.
Chowdhury et al. (2019) conducted a study on factors affecting the choice
of Islamic banking by the customers and found that religion is the most
influential factor that affecting customers towards Islamic Banking. It is also
observed that both male and female groups choose this banking because of
their religious preference. In Bangladesh, Islamic banking is in a convenient
position as above 90% of people are belonging to the Muslim ethnicity.
Zeyad et al. (2013) conducted a study to determine the level of satisfaction
and loyalty among the consumers of Islamic Banking in Malaysia. They
investigated the relevance of customer loyalty with satisfaction, trust,
perceived value, and service quality and found that a positive relationship
between locality and these variables.
Factors Affecting Customer Satisfaction in Islamic Banking: ......Bangladesh 87

Marimuthu et al. (2010) offered a special focus on the determining factors

that are affecting the acceptance of Islamic Banking in Malaysia. The study
revealed that whether Muslims or non-Muslims, factors such as cost-benefit,
convenience, service delivery, friends/relatives' influence have a significant
relationship with the acceptance of Islamic Banking, and among these
variables, cost-benefit has the most important criterion for the acceptance of
Islamic Banking.
Echchabi et al. (2012) conducted a study on the preference of customers of
Malaysian banks for Islamic Banking attributes. The main purpose of the
study was to detect the selection criteria of Islamic Banks in Malaysia and
also to find out the priority of customers towards these criteria. Findings of
the study revealed that in Malaysia convenience factor does play a significant
role in the decision-making process of the customers while choosing Islamic
banks.

Iqbal, M. and Nisha, E. (2018) conducted a study on retail customers of

Islamic a bank in Bangladesh found that competence, the commitment of
banks employees, and corporate image are the most significant factors and
compassion and convenience have relatively less influence on the selection
criteria of Islamic Banks in Bangladesh.
Khan. et al. (2010); Farah et al. (2015) conducted the study to examine the
behavior and attitude of Islamic bank customers in Bangladesh and both of
them found that religion is one of the important factors for choosing the
Islamic banks in Bangladesh.
Considering the number of factors, the present study contributes by the
existing literature in many ways. The present study used the semi-structured
questionnaire to collect first-hand data from 10 full-fledged Islamic banks
operating in Dhaka, Cumilla, and Chattagram cities and unveiled the
responses of 350 customers and processed the data in a way to find the
contemporary factors to influence the customer’s choice to select the Islamic
Banks in Bangladesh.
3. Objectives of the Study
In this study on customer satisfaction of the Islamic Banks in Bangladesh, the
main objectives are to discover and analyze the factors that affect the
customer’s satisfaction towards the Islamic Banking systems in Bangladesh.
Specifically speaking, (i) to explore the crucial factors that affect the customer
satisfaction of Islamic banks in Bangladesh. And (ii) to examine the
88 Journal of Banking & Financial Services

relationship between the selected independent variables and the overall

customer’s satisfaction as well as to measures the strength of association.
4. Research Methodology

4.1 Sample design and Procedure

Various factors may affect the customer satisfaction of Islamic banks. Hence,
this paper focused is to identify the most crucial factors that influence the
customer satisfaction of Islamic Banks in Bangladesh. Given the nature of the
study, it was required to collect data from primary sources. The study has
used 20 dimensions of customer satisfaction. A total of 350 respondents have
been taken from 10 full-pledged Islamic Banks located in Dhaka, Chattagram,
and Cumilla; the three megacities in Bangladesh. The respondents were
informed that their participation was voluntarily and all the information
provided would be kept private and confidential.

4.2 Questionnaire Design and Data Collection

To collect the primary data a semi-structured closed-ended questionnaire has
been used and Non-Probability convenience sampling methods have been
taken to data collections. A five-point Likert scale was used to measure the
respondent’s opinion (From 1 “Strongly Disagree” to 5 “Strongly Agree”).
There are two sections in the questionnaire consisting of Section A:
Demographic information of respondent Like Full name, Name of the bank,
Gender, Religion, Length of getting services, Educational Qualifications,
Income, etc., Section B: Factors affecting overall customer satisfaction.
4.3 Analysis and Reporting
The statistical package for social science (SPSS) windows version 22 was
used to analyze the data. The study also tested the reliability of the instrument
so that it enables to produce a robust and valid result.
4.4 Statistical Tools

Factor analysis is a data reduction or structure detection method which is used

to reduce the number of variables and to draw the relationships between these
variables. Performing a series of stages could identify this. The first stage of
factor analysis is Data appropriateness; it suggests that factor analysis may
not be appropriate if a few correlations between the variable above 0.3 are
found. Besides, Bartlett’s test of Sphericity should be significant (p<.05), and
The KMO index should be .6 or higher for the factor analysis to be considered
Factors Affecting Customer Satisfaction in Islamic Banking: ......Bangladesh 89

appropriate (Tabachnick & Fidell, 2001). The second stage is Factor

extraction where Kaiser’s criterion, Scree test are done vigorously to
determine the factors to be retained. The third stage is factor rotation, naming
of the factor, and obtaining factor score, where the factors are rotated using
the varimax method. From about Twenty (20) Variables, the five-factor
solution resulted and has been used as independent variables in the regression
analysis and overall customer satisfaction served as the dependent variable.
Factors are named based on factor loading observing the rotated component
matrix. After the identification of factor name, factor score is obtained using
the regression method and these factor scores were used as inputs in
regression analysis to identify the relationship between those factors and
customer satisfaction. Then the multiple regression models have been used to
investigate the relationship between different factors relating to overall
customer satisfaction.

5.1 Analytical model for the multiple regression Analysis

The following econometric technique has been used to formulate and measure
the customer satisfaction of the Islamic Banks in Bangladesh.

Y= α+ β1X1+ β2X2 +β3X3 +…………+ βkXk.....................................Eqn. 1

Where,

Y= Dependent Variable

X= Independent Variable

α= Intercept

β1=Slope of the line

5.2 Research Hypotheses

Hypothesis 1

Ho= There is no correlation among the twenty identified variables of service

quality towards the customer satisfaction of Islamic banks in Bangladesh.
That means twenty identified variables are uncorrelated.

Hypothesis 2

Ho= There is no relationship among the dependent variable (overall customer

satisfaction of Islamic Banks in Bangladesh) and the independent variable
90 Journal of Banking & Financial Services

(obtained uncorrelated factor e.g. product range and customer service quality,
financial benefit and service charges, tangible product facilities and comfort,
trust and internet and mobile banking facilities).

6. Analysis and Findings

6.1.1 Testing Hypothesis 1: KMO and Bartlett’s Test

Table 1: KMO and Bartlett’s Test

KMO and Bartlett’s Test
Kaiser-Meyer-Olkin Measure of Sampling Adequacy. .904
Approx. Chi-Square 2294.608
Bartlett's Test of Sphericity df 190
Sig. .000
The Kaiser-Meyer Olkin (KMO) and Bartlett's Test measure of sampling
adequacy generally used to inspect the suitability of Factor Analysis.
Generally, the approximate Chi-square is 543.556 with 153 degrees of
freedom, which is significant at a 0.05 Level of significance. From Table:1, it
has been seen that the approximate chi-square is 2294.608 with 190 degrees
of freedom that is significant at 0.05 level. The adequacy of the sample in any
study assessed by using the Kaiser-Meyer-Olkin Measure (Kaiser, 1970) and
high value (close to 1.0) generally specifies that factor analysis may be
expedient with the data. In this study, the Kaiser-Meyer-Olkin Measure of
sampling adequacy is 0.904. So, this sample of this study is adequate and
well-accepted for conducting factor analysis, and the Null Hypothesis, there is
no correlation among the twenty (20) identified variables service quality
towards customer satisfaction of Islamic banks in Bangladesh is rejected.
6.1.2 Communalities, Initial Eigenvalues and Extraction Sums of Squared
Loadings
Eigenvalue measure the amount of variation in the total sample accounted for
each factor and it is calculated for each factor extracted and used to determine
the number of factors to extract. A cut-off value of 1 is generally used to
determine factors based on eigenvalues and a factor with an eigenvalue of 1.0
or more is retained. The above table shows that, five (5) factors that have
eigenvalues greater than 1. The cumulative percentage of five factors is
65.408 and factor 1 account for a variance of 7.813, which is (7.813/20) or
39.066% of the total variance. And the remaining four factors explained
8.239%, 6.841%, 6.093%, and 5.168% of total variance respectively. The
 Factors Affecting Customer Satisfaction in Islamic Banking: ......Bangladesh 91

“Extraction Sums of Squared Loadings” displays the variances associated

with the factors that are taken and these are also similar as under “Initial
Eigenvalues”
Table 2: Initial Eigenvalues, Extraction Sums of Squared Loadings,
Rotation Sums of Squared Loadings
Total Variance Explained
Component Initial Eigenvalues Extraction Sums of Squared Rotation Sums of Squared
Loadings Loadings
Total % of Cumulative Total % of Cumulative Total % of Cumulative
Variance % Variance % Variance %
1 7.813 39.066 39.066 7.813 39.066 39.066 2.705 13.524 13.524
2 1.648 8.239 47.306 1.648 8.239 47.306 2.670 13.349 26.873
3 1.368 6.841 54.147 1.368 6.841 54.147 2.623 13.114 39.987
4 1.219 6.093 60.240 1.219 6.093 60.240 2.594 12.968 52.955
5 1.034 5.168 65.408 1.034 5.168 65.408 2.491 12.453 65.408
6 .812 4.058 69.466
7 .693 3.464 72.930
8 .626 3.132 76.062
9 .601 3.007 79.069
10 .568 2.842 81.910
11 .493 2.463 84.373
12 .485 2.423 86.796
13 .445 2.225 89.020
14 .406 2.029 91.050
15 .388 1.941 92.990
16 .331 1.656 94.646
17 .301 1.505 96.151
18 .277 1.384 97.535
19 .258 1.289 98.824
20 .235 1.176 100.000
Extraction Method: Principal Component Analysis

6.1.3 Determining the number of factors

Generally, the scree plot is used to decide the total number of factors to keep
in exploratory factor analysis or principal components to retain in the
principal component analysis. The above scree plot represents that five factors
explicate most of the variability as a distinct break down occurs at factor 5.
92 Journal of Banking & Financial Services

The residual factors are less significant as it donates a very lesser percentage
of the variability.

Figure- 1: Scree plot

6.1.4 Rotated Component Matrix
Table 3: Rotated Component Matrix
Rotated Component Matrix
Component
1 2 3 4 5
My mobile banking transaction is processed
accurately (X1) .823 .218 .097 .097 .202

Mobile banking enables me to complete a

.786 .151 .021 .034 .297
banking transaction quickly (X2)
Speeds, accuracy and accessibility of the
internet banking services of my bank are .720 .061 .350 .242 .070
satisfactory (X3).
I feel secure while making transaction
through mobile banking and internet .678 .230 .299 .239 -.070
banking (X4)
I trust my current banks that I use (X5) .122 .798 .078 .245 .134
Factors Affecting Customer Satisfaction in Islamic Banking: ......Bangladesh 93

I believe that I can trust my current bank

because the company will not try to cheat .196 .760 .131 .118 .194
me(X6)
I feel that I can rely on my current bank
.176 .673 .242 .301 .177
services to serve me as well(X7)
I trust the billing systems used by my
.281 .550 .264 .315 .182
current Banks(X8)
Average profit charged on investment by
.209 .147 .788 .099 .137
the bank is satisfactory(X9)
Method of imposing charges, fees and
.159 .212 .737 .128 -.012
penalties is acceptable(X10)
I am satisfied with the profit rate provided
.039 .108 .658 .227 .296
by the bank(X11)
I am satisfied with the financial service
.188 .068 .631 .157 .327
advices(X12)
Facilities of the bank including ATM,
number of counters, seating arrangement are .223 .194 .229 .728 -.006
satisfactory(X13)
The bank has modern looking equipment
.112 .242 .050 .699 .270
and infrastructure(X14)
The service materials such as forms,
brochures, statements etc. are easy to .115 .239 .199 .666 .123
understand(X15)
The physical layout of equipment and
furniture is comfortable for customer .080 .130 .136 .655 .347
interaction with bank staffs(X16)
Employees of bank are courteous and quick
.213 .026 .146 .153 .749
responsive in service(X17)
Customer services of the bank are
.160 .212 .121 .369 .700
excellent(X18)
Bank maintain compliance with as my
.074 .302 .296 .053 .655
expectations(X19)
I am satisfied with the range of products and
.072 .428 .135 .219 .575
services offered by my bank(X20)
Extraction Method: Principal Component Analysis.
Rotation Method: Varimax with Kaiser Normalization.
a. Rotation converged in 6 iterations.
94 Journal of Banking & Financial Services

The rotated component matrix denoted as the loadings are the main output of
principal components analysis. It covers estimates of the correlations between
each of the variables and the projected components, and five factor solution
resulted in the twenty (20) variables, the factor being labeled as
1. Product range and Employees of a bank are courteous and quick
customer service quality responsive in service (X17), Customer services of
the bank are excellent(X18), Bank maintain
compliance with as expectations(X19),
Satisfactory range of products and services offered
by my bank(X20)
2. Financial benefit and Average profit charged on an investment by the
service charges bank (X9), Method of imposing charges, fees, and
penalties are acceptable(X10), Profit rate provided
by the bank(X11), Adequate financial service
advice(X12)
3. Tangible product ATM Booth, number of counters, the seating
facilities and comfort arrangement in the bank (X13), Modern looking
equipment and infrastructure(X14),
Understandable service materials such as forms,
brochures, statements(X15), Comfortable physical
layout of equipment and furniture is for customer
interaction with bank staffs(X16)
4. Trust Trust with current banks (X5), Enough belief
towards the current bank(X6), Reliability towards
the current bank services (X7), Trust the billing
systems used by the Banks(X8)
5. Internet and mobile Accurate mobile banking transaction(X1),
banking facilities Mobile banking enables a complete a banking
transaction quickly (X2), Speeds, accuracy, and
accessibility of the internet banking services
(X3), Adequate security while making
transaction through mobile banking and internet
banking (X4)

6.2 Regression Analysis

6.2.1 Reliability and Validity of data
The Reliability denotes the uniformity of a set of items in evaluating the study
variables (Cooper & Schinder, 2001). Cronbach’s alpha is a measure used to
measure the reliability or internal consistency of a set of scale or test items. A
commonly recognized rule is that α of 0.6-0.7 specifies a satisfactory level of
consistency, and 0.8 or larger a very good level l (Netemeyer, and Cudeck,
Factors Affecting Customer Satisfaction in Islamic Banking: ......Bangladesh 95

2001). In this study, Cronbach’s Alpha values of the independent variables are
0.802, 0.781, 0.773, 0.828, and 0.838 respectively (Table: 5) which shows the
satisfactory level of inner consistency for the scale.
Table 4: Case Processing Summary
N %
Valid 350 100.0
Cases Excludeda 0 .0
Total 350 100.0
a. List wise deletion based on all variables in the procedure.

Table 5: Test of reliability and validity

Variables Number of Cronbach’s

Items Alpha

Product Range and Customer Service Quality 4 0.802

Financial Benefit and Service Charges 4 0.781
Tangible Product Facilities and Comfort 4 0.773
Trust 4 0.828
Internet and Mobile Banking Facilities 4 0.838

6.2.2 Model Summary and ANOVA

Regression analysis is to clarify the variation of the dependent variable, based
on the variation in one or more other independent variables. The five (5)
factors that have been identified from the factor analysis are used as
independent variables in the regression analysis and the dependent variable is
“overall customer satisfaction”. Model Summary (Table: 6) shows that the
multiple correlation coefficient, R is 0.704 which means there is a significant
positive relationship existing among dependent and independent variables. So,
the overall satisfaction of Islamic banks customers is highly correlated with
the identified independent variables (product range and customer service
quality, financial benefit and service charges, tangible product facilities and
comfort, trust, internet and mobile banking facilities). R2 Value 0.525
indicates that 52.5% of the variation overall customer satisfaction of Islamic
banks customers is explained by independent variables. That means the model
is fit and the data is extremely well. The value of adjusted R2 is close to R2.
96 Journal of Banking & Financial Services

This is suggested that all independent variables make a contribution in

explaining the variation of overall customer satisfaction of Islamic Banks in
Bangladesh.
Table 6: Model Summary
Model Summary
Model R R Square Adjusted Std. Error of Change Statistics
R Square the Estimate
R Square F df1 df2 Sig. F
Change Change Change
1 .704a .525 .513 .597 .525 34.657 5 244 .000

a. Predictors: (Constant), internet and mobile banking facilities, product range and
customer service quality, financial benefit and service charges, tangible product
facilities and comfort, trust

Table 7: ANOVA
ANOVAa
Model Sum of df Mean Square F Sig.
Squares

Regression 61.799 5 12.360 34.657 .000b

1 Residual 87.017 244 .357
Total 148.816 249
a. Dependent Variable: Overall Customer Satisfaction.
b. Predictors: (Constant), internet and mobile banking facilities, product range and
customer service quality, financial benefit and service charges, tangible product
facilities and comfort, trust

6.2.3 Testing Hypothesis 2

6.2.3.1 Significance of the overall regression Equation (ANOVA)
The F test is used to assess the null hypothesis for the overall test that the
coefficient of multiple determination in the populationR2pop=0, In this study
R2 = 0.525 which means that the null hypothesis can be rejected. In the
ANOVA (Table: 7) it has seen that F=34.657 which is significant at a 5%
level of significance with 5 and 244 degrees of freedom. beta’s value
associated with each of the independent variables of the model are not the
same and that means the null hypothesis can be rejected. So, it can be said that
the overall satisfaction of Islamic Banks customers in Bangladesh can be
explained by product range and customer service quality, financial benefit and
service charges, tangible product facilities and comfort, trust and internet and
mobile banking facilities.
Factors Affecting Customer Satisfaction in Islamic Banking: ......Bangladesh 97

6.2.3.2 Significance of the partial Coefficients (Coefficientsa)

Table 8: Coefficients
Coefficientsa

Model Unstandardized Standardized t Sig.

Coefficients Coefficients
B Std. Error Beta
1 Constant) .857 .259 3.315 .001
Product range and customer
.219 .069 .207 3.163 .002
service Quality
Financial benefit and service
.188 .058 .151 2.490 .004
charges
Tangible product facilities and
.068 .071 .064 .954 .341
comfort
Trust .331 .076 .305 4.383 .000
Internet and mobile banking
.215 .056 .235 3.856 .000
facilities
a. Dependent Variable: Overall customer satisfaction.

In Table: 8, it has seen that the partial regression coefficient for the product
range and customer service quality is 0.219.and the beta coefficient is 0.069,
and the value of statistics t=3.163 with 244 degree of freedom that is
significant at α=0.05 and the partial regression coefficient for financial benefit
and service charges is 0.188 with beta coefficient is 0.058 and t value is 2.490
with 244 degrees of freedom is also significant at α = 0.05. The significance
of the coefficient for all other independent variables is tested in the same way
and found that trust along with internet and mobile banking facilities are
significant and tangible product facilities, and comfort are insignificant
towards the overall customer satisfaction of Islamic Banks in Bangladesh.

The regression model shows the following relationship among the

identified independent variables and the overall customer satisfaction of
Islamic banks customers in Bangladesh.

Overall customer satisfaction= 0.857+0.219*(product range and customer

service quality) 0.029*(financial benefit and Service charges) +0.331*(trust)
+ 0.215*(internet and mobile banking facilities).
98 Journal of Banking & Financial Services

Based on the findings of the study, Firstly, it is suggested that to satisfy the
present customers as well as attracts new customers' Islamic banks should
give more devotion to offer diversified products and services as well as ensure
better customer service quality. It is also found that trust is one of the most
crucial factors that stimulate the level of satisfaction of Islamic banking
customers in Bangladesh. So, the management of the bank must preserve the
reliability and faith of the existing customer to fascinate potential customers.
As internet and mobile banking facilities also have a significant influence on
customer satisfaction so banks should try to expand the e-banking facilities to
accelerate easy and quick transactions. From the multiple regression analysis,
it is also seen that the level of customer satisfaction also influences the
financial benefit and charges. So, Banks should provide an attractive financial
benefit on the deposit as well as impose a reasonable charge on the service.

7. Conclusion

We studied the customer satisfaction determinants of Islamic banks in

Bangladesh. The study has exposed to explore the crucial factors as well as
examine the relationship among the service quality and satisfaction of Islamic
banks customers in Bangladesh. The study finds that product range and
customer service quality, trust, financial benefit, and service charge as well as
internet and mobile banking facilities significantly affect the satisfaction level
of customers of Islamic banks in Bangladesh. The findings of the study will
help the Islamic banks to discover new insight into customer satisfaction as
well as to help with the extension of a more functioning policy to please the
customers. To sustain this competitive banking industry in Bangladesh, study
findings can be greatly used to formulate better retention strategies. The
study has some limitations as well. Firstly; the entire respondent has taken
from three cities in Bangladesh, more realistic findings will be possible if an
investigation would include from major cities in Bangladesh and secondly
only five major factors have considered to measures the level of customers of
satisfactions of Islamic banking systems in Bangladesh. The forthcoming
study should observe customer satisfaction towards the Islamic banking
systems in Bangladesh from the viewpoint of other important elements that
have an influence on the level of customer satisfaction.
Factors Affecting Customer Satisfaction in Islamic Banking: ......Bangladesh 99

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102 Journal of Banking & Financial Services
Volume 12, Number 1, June 2020

Predicting the Bankruptcy Risk: Evidence from Banking

Industry of Bangladesh

Md. Nazmul Hasan 1

Kanij Fatama 2

Abstract: Financial bankruptcy models play a crucial role in predicting the

firms with high possibility of turning into a trouble. The very nature of
these models works as the early-warning signals for myriad categories of
firms from manufacturing to financial service institutions. The current state
of banking industry of Bangladesh seems bleak due to unprecedented
volume of non-performing assets, fixation of single-digit interest rate,
controlling banks by certain industrialist groups, fake lending connected to
board members or directors' firms, unprecedented corruption and political
interference in credit sanction and disbursement process, non-existent
punitive measures for miscreants and extremely poor corporate governance
issues. These are significant concern from the academia and industry
experts and regulator that in the coming days, several banks might fall into
the run or bankruptcy risk which might affect the sustainability of the
banking system and the denying contagion risk it may spur into the total
financial system of Bangladesh. Keeping this in mind, the authors
endeavor to predict the financial vulnerability or bankruptcy risks of the
selected commercial banks in Bangladesh which might serve the interests
of the stakeholders in general and banks’ board, management, bank
owners, depositors, and regulators, in particular.

Keywords: Financial vulnerability; Altman Z-score; Bankruptcy models;

Financial performance; Bank run

1. Introduction

A bank, by its true nature, is a financial intermediary which bridges the gap
between the surplus units and the deficit units of an economic system. In
doing so, it renders myriad forms of financial services, among which,
ensuring the safety and security is one of the prime considerations. People, in
1
Corresponding Author: Assistant Professor, Department of Banking and Insurance,
University of Dhaka, Dhaka-1000, E-mail: [email protected]
2
Independent Researcher who attained an MBA degree from the Department of
Banking and Insurance, University of Dhaka, Dhaka-1000, Email:
[email protected]
104 Journal of Banking & Financial Services

general and businesses in particular heavily rely on banks and keep the hard-
earned savings and surpluses to those banks. Since, majority of the clients
depends on bank services, failure of a bank may bring catastrophic
consequences to those clients and businesses relying banks for safekeeping of
deposits, receiving credit and many other services which only banks can
profitably provide to customers in the long run. Therefore, with the current
state of dwindling banking industry, the prediction of financial distress of our
banking industry bears special interests to bank owners, managers, financial
analysts, depositors and regulators. Financial distress is a situation when a
firm cannot satisfy their current obligations because of lack of operating cash
flows and the corrective action should be taken immediately by the firm. For
economic growth and stability of a country, the financial health of the banking
industry is a significant prerequisite factor. There are several tools used for
estimating the financial capability of a business firm. Among those tools, the
more reliable tool is the Altman’s Z-score model. Edward I. Altman in 1968
developed the most famous corporate failure forecasting model, Known as the
Z-score model. The model is convenient to forecast the likelihood that a firm
will face bankruptcy situation or not. The Z-score uses financial statements of
a firm; mostly income statements and balance sheet items to assess the
financial strength of a firm. This paper investigates the possibility of banks
falling into bankruptcy risk or financial distress situation using the Altman’s
Z-score model with 12 selected commercial banks with a data set covering
period of 2012-2018.
The remainder of the paper is divided into several sections. Section two
reviews the existing literature on corporate bankruptcy and Altman’s Z-score
model. The next section discusses the data and methodology of the research
and model used to analyze the paper. Section four presents the empirical
results and findings of this paper where authors categorically identify whether
the sample banks are in safe zone, gray zone or distress zone based on the
predicted Z-score. Finally, in section five, findings and policy
recommendations have been prescribed.
1.1 Research Motivation

The prediction of bankruptcy possibility of a firm has long been a concern for
the pertinent stakeholders including, shareholders, financial managers,
investors, credit agencies, business partners in general and in particular
government agencies or regulatory bodies (Martin et al. 2011). This scenario
is especially pertinent to financial service institutions especially banks, which
are considered as the cornerstone of the financial transaction in an economy
Determinants of Intellectual Capital Disclosure: Evidence from.......Bangladesh 105

and holder of the people’s trust and money. Additionally, the stakeholders of
banking industry including bankers, economist and regulators generally agree
that banks are very special type of corporate body and a bank run or failure is
very expensive to the economy as a whole and thus the stability of banking
industry which in turn affects the total financial system bears utmost
significance and needs special care, monitoring and supervision to ensure
that (Rahman et al. 2004). Therefore, for a growing economy like ours and a
dwindling banking industry with skyrocketing bad debts, predicting the banks
that are more prone to financial distress is required to be diagnosed
before those rogue banks trigger the instability into the total financial system.

The authors intend to forecast the bankruptcy risks of banks operating in

Bangladesh amidst mounting trend of non-performing assets, excessive
government borrowing from banking sector as well as the escalating
competitive stance among the different financial services institutions in
general and banks in particular. The authors aim to achieve the following
objectives.

Objective 1: To calculate the possibility of bankruptcy risk for the selected

commercial banks by using Altman Z-score model.

Objective 2: To categorise banks into Safe or Distress Zones and suggest

some policy recommendations to the bank boards, management, owners,
depositors, and the regulators, i.e., mainly to Bangladesh Bank.

2. Literature Review

The prediction of financial distress of firms, be it manufacturing or service

institutions, has been at the forefront and of special interests to the relevant
stakeholders for the three decades. The possibility of corporate bankruptcy or
insolvency is very common to any company, even in case of a giant company
having long history of being in operation. In such a case, it is not surprising to
analyse the early signs of bankruptcy or financial distress in order to forecast
the future state of financial condition of a company Husein and Pambekti
(2015). The firms facing the financial difficulties are affected by the internal
and external factors. Internal factors, in their very nature, emerge from the
poor financial management, where incomes so generated are not sufficient to
cover the expenses, and the lack of proper capital management. External
factors are beyond the control of the firm and especially influenced by the
industry-wide factors and overall macroeconomic scenario of the nation.
106 Journal of Banking & Financial Services

According to Pangkey, et al. (2018), “Bankruptcy is a situation in which

the company’s assets exceed liabilities, generally occurs due to the lack of
capital as it does not utilize capital resources well, not maintain sufficient
cash, inefficient management, decline in sales and market
situation.” Bankruptcy does not show up by its own rather can be identified
following specific models to estimate so. Financial woe or difficulty of a
company is an early symptom of the bankruptcy of the corporation Haryetti
(2010). There has been a misconception regarding financial distress and
bankruptcy. Many people believe, both are same thing, unfortunately, it’s not.
Rather, financial difficulty is the early indication of the future financial
bankruptcy possibility in case the firm fails to improve their financial
woes Husein and Pambekti (2015)

The first-ever multivariate bankruptcy prediction model, which is

popularly known as Z-score model, was brainstormed and developed by
Edward I. Altman (1968) in the late 1960s. After his pioneering work, this
multivariate approach caught the attention of academics and practitioners
simultaneously came into forefronts as corporate bankruptcy or financial
distress model in the fields of finance, banking and particularly in measuring
the credit risk or default risk of firms being in operation (Altman, E.I et al.,
2017). These prediction models are particularly important assessment tool for
bankers, investors, asset managers, credit rating agencies, and even the
distressed firms too. Bankers can utilize the Altman’s model to assess the
requirement for capital adequacy and internal ratings based approach
suggested under Basel Accords. Asset management firms and institutional
investors heavily depend upon the bankruptcy score for their due-diligence
process before making crucial investments. Credit rating agencies assess the
vulnerability and creditworthiness of firms in servicing the debt payments and
provide their opinion on the risk of entities towards the valued clientele and
various interest groups.

The myriad forms of financial distress model or bankruptcy model has

evolved over the time. Beaver (1966) used univariate model, Altman (1968)
pioneered multiple discriminant analysis model (MDA) hugely regarded as Z-
score model, Norton and smith (1979) used linear analysis based on ratios,
Ohlson (1980) invented a logit model, Taffler (1984) proposed a new
discriminant model for the United Kingdom, Zmijewski (1984) referred a
probit model, Gahlon and Vigeland (1988) comparing ratios between
Determinants of Intellectual Capital Disclosure: Evidence from.......Bangladesh 107

bankrupt and non-bankrupt firms. During 2000s and onwards, majority of the
studies applied a multiple-variable approach for the forecast of financial woes
by combining accounting and non-accounting or market based data. Salehi
and Abedini (2009) consider that Altman’s 1968 model is the best known for
early studies which has been the benchmark for multiple models developed
later on. The Altman’s (1968) Z-score model successfully predicted the 24
firms out of 25 failed firms ahead of one-year of the failure. Subsequently, for
the second sample, out of 66 non-failed firms with temporary earnings
disruptions, the discriminant-function criterion was in error only in 14 cases
out of 66 cases.

Jackson and Wood (2013) in their paper, tabulated the frequency of

occurrence of different specific prediction techniques where they classified
the five-most popular bankruptcy models as, one, Z-score Model two, legit
models three, neural networks four, contingent claims and five, univariate
analysis. Further research works on the efficacy of the these bankruptcy
prediction models have been extended by Agarwal and Taffler (2008), Das et
al. (2009) and Bauer and Agarwal (2014) based on the accounting data
models, market data models and hazard models. Agarwal and Taffler (2008)
couldn’t trace significant difference on the effectiveness of accounting and
market based models but explored former model provides higher level of risk-
adjusted rewards for credit operations. Das et al. (2009) found that accounting
data based models outperform market-based models particularly for credit-
default spread (CDS) forecasting. However, Bauer and Agarwal (2014) by
using the United Kingdom’s data, the hazard models better predicted the
possibility of corporate bankruptcy against ROC analysis and information
content. According to Altman, E.I et al., (2017), ‘while making
comprehensive international comparisons, Z-score model works reasonably
well for most countries (the prediction accuracy is about 0.75 and
classification accuracy approximately 0.90 by using country-specific
estimations.’

After the rigorous review of literature, it is clearly evident that with

particular attention to financial or banking industry, the Altman’s Multiple
Discriminant Criterion has some special merits. 1) The Z-score model
depends on the accounting-data, which is available for all firms i.e., publicly
held or privately held, rather than the market-data, which is susceptible to
frequent and abrupt changes with the market conditions. 2) Majority of the
108 Journal of Banking & Financial Services

banks operating in our country, are privately owned and controlled and thus
no market data like stock prices is available only accounting data is relevant
to them. 3) From a global regulatory perspective like BASEL Accords, more
emphasis has been given developing a standardized model which can be used
for all banks operating locally and globally and thus enabling the comparisons
among banks in terms of bankruptcy possibility, separating failure possible
banks from failure-distant banks. In this case, only multiple discriminant
function, commonly known as Z-score model can be equivocally
implemented since it depends on accounting data (instead of market data)
which is available for all firms in operations. Although, it has been almost 50-
year, the Altman’s Discriminant Function pioneered, Z-score model still
continues to be the main building blocks or supporting tool for majority of the
financial bankruptcy-prediction models equally used in academics and in
practice. Therefore, Altman’s Z-score model or multiple discriminant
functions still has special appeals to academicians and practitioners, amidst
myriad of new models developed on bankruptcy prediction literature.

3. Data and Methodology

This section depicts the research design, population of the study, the basis of
sampling, the data collection in addition to data analysis procedures which are
used to attain the objectives of the study.

3.1 Research Type

This is essentially a quantitative research that entails the perspective of total

scenario of banking industry in Bangladesh in terms of state of financial
condition, possibility of bankruptcy and aftermath of such crisis.

3.2 Population

In this study, the population comprises of 62 Scheduled Banks (i.e., 6 State-

Owned Banks, 3 Specialized banks, 35 conventional private commercial
banks, 9 Islami shariah banks and 9 foreign commercial banks) currently
operating which are licensed and regulated by the Central Bank of
Bangladesh, namely Bangladesh Bank under the ‘Bank Company Act 1991.’ 1
Authors have randomly chosen 3-bank from each category of banks.

1
https://www.bb.org.bd/fnansys/bankfi.php
Determinants of Intellectual Capital Disclosure: Evidence from.......Bangladesh 109

3.3 Sample

A sample is a group of objects, people, or items that are chosen from a large
population for measurement. While conducting the study, the authors have
chosen the samples randomly from each cluster or category of banks in order
to ensure the best representation of the whole banking system. The sample
comprised of 3 State-owned out of 6, 3 Private commercial out of 35 banks, 3
Islamic and foreign commercial banks out of 9 banks respectively. The
samples are as follows:
State-Owned Private Islamic Banks Foreign
Commercial Commercial Banks Commercial
Banks Banks
1. Sonali Bank 4.Dhaka Bank 7. Al-arafahIslami 10. Bank Al-
Limited Limited Bank Limited Falah Limited
2. Janata Bank 5.Dutch-Bangla 8. First Security 11. Commercial
Limited Bank Limited Islami Bank Bank of Ceylon
(DBBL) Limited PLC
3. Agrani Bank 6.Prime Bank 9. Shahjalal Islami 12. State Bank of
Limited Limited Bank Limited India

Data: While conducting the study researchers have used the secondary data
collected from published sources namely published financial statements of
selected banks, Bangladesh Bank and Dhaka Stock exchange.
3.4 Methods & Data Analysis
In this study, Altman’s Z-score model was used for predicting the financial
distressed and non-distressed banks. The data collection was summarized in
tables. The period of analysis covered 7 financial years from 2012 to 2018.

3.5 Multiple Discriminant Analysis/Z-score Model

Altman (1968) was the pioneer who applied the Multiple Discriminant
Analysis (MDA) approach for predicting the financial distress of firms. His
model, popularly known as, Z-score model has been extremely popular and
extensively accepted measure of financial distress. He used a sample of 33
financially sound companies and 33 distressed companies. Further, a Z-score
bankruptcy prediction model and a cutoff point of Z-score (2.675) was
established to categorise safe and distressed zones. The prior literature
indicates that the Altman’s prediction model has sound forecast performance
one year and two years before financial distress. In his pioneering model, the
110 Journal of Banking & Financial Services

author used and weighted a set of ‘five financial ratios’ to enhance the
predictive power of the model. Altman’s model establishes an overall
discriminant score which is popularly referred as the Z-score. The Altman’s
multiple discriminant function is a linear combination of a number of ratios
that measure the profitability or risk. Original Z score which is relevant to
public manufacturing firms was as follows:
Z-Score = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + .999X5
The ratios are as follows:
X1= (Current Assets – Current Liabilities)/ Total Assets
X2= Retained Earnings/ Total Assets
X3= Earnings before Interest and Taxes (EBIT) / Total Assets
X4= Market Value of Equity/ Total Liabilities
X5= Sales/ Total Assets

Altman extended his original model and rename “Market Value of Equity” to
“Book Value of Equity”, where the model was suitable for both private and
non-manufacturing firms. He also show up different coefficients for the ratio
as follows-
Z-Score=0.717X1 + 0.847X2 + 3.107X3 +0.420X4 + 0.998X5
In 1983, Altman reclassified the model which could be used for both
private and public firms as well as manufacturing and non-manufacturing
companies. The model has different cut-off points and coefficients as:
Z- Score=6.56X1+3.26X2+6.72X3+1.05X4

Variables Selected Abbreviations Measurement

Ratios

X1 NWC/TA Current Assets - Current Liquidity

Liabilities) / Total Assets

X2 RE/TA Retained Earnings (RE) / Total Ownership

Assets (TA)

X3 EBIT/TA Gross Profit/Total Asset Profitability

X4 BVE/TL Book Value of Equity / Total Ownership

Liabilities (TL) Structure
Determinants of Intellectual Capital Disclosure: Evidence from.......Bangladesh 111

Decision Trees of Financial Distress

The following table serves as the decision tree for categorizing the banks
according to their predicted Z-score and thus assigning the safe, gray and
distress zone symbolization.
Z-Score Zones or Signals
Areas
When Z > 2.6 Safe Zone Signals that the banks are financially sound and
there is least possibilities of financial
vulnerability or distress in near future i.e., Least
Vulnerable
When 1.1≤Z ≤2.6 Gray Zone Indicates the weak financial standing than Safe
Zone, but less possibilities of financial distress
situation in coming days, Moderately
Vulnerable
When Z < 1.1 Distress Refers to high possibilities of financial hardship
Zone and to the extreme, bankruptcy risk is evident
i.e., Extremely Vulnerable

4. Empirical Findings
In this section, the authors present their findings based on the calculation of
relevant data by using the bankruptcy model Altman’s multiple discriminant
functions for the selected 12-bank.
4.1 Z-score Analysis of State-Owned Banks
Table 1: Z-score analysis of State-Owned Banks
Year 2012 2013 2014 2015 2016 2017 2018 Average
Z-Score
Sonali 0.48 1.52 1.38 1.38 0.98 1.24 1.29 1.18
Bank
Limited
Janata 0.43 0.69 0.61 0.56 0.54 0.50 -0.44 0.41
Bank
Limited
Agrani 1.06 2.71 2.41 2.12 2.00 1.80 1.39 1.92
Bank
Limited

In this graph, horizontal axis shows different year and vertical axis shows
different z-score value of State-Owned Banks. From the graphical
112 Journal of Banking & Financial Services

presentation we can see that Agrani bank performed very well than other two
banks in every particular year, in year 2013 it had a z-score value more than
2.6, that indicates its operation was under “Safe zone” and after 2013 it was
under “Gray zone”; which was less healthy position than “Safe zone” but still
it had less possibilities to face any financial hardship in near future. In
contrast, the performance of Janata bank was very poor, every year it had a
value less than 1.1, even last year it had a negative value, that means its
performance was very vulnerable and it was under “Distress zone”; any time
it can face financial difficulties even bankruptcy situation. Moreover, Sonali
bank’s performance falls under “Gray area” in every year except the year
2012 and 2016. Overall, Sonali bank shows a satisfactory trend whereas
Janata and Agrani bank shows bleak scenario in their performance.

Figure 1: Z-score analysis of State-Owned Banks

4.2 Z-score Analysis of Private Banks
Table 2: Z-score analysis of Private Banks
Year 2012 2013 2014 2015 2016 2017 2018 Average
Z-Score
Dhaka Bank 1.54 1.66 1.39 1.26 1.01 0.58 0.73 1.17
Limited
Dutch-Bangla 1.38 1.27 1.10 0.93 0.90 0.59 0.85 1.00
Bank Limited
(DBBL)
Prime Bank 1.11 1.86 2.01 1.68 0.93 0.25 0.18 1.15
Limited

From the graphical presentation we can see that the performance of Dhaka
Bank Limited (DBL) and Dutch-Bangla Bank Limited (DBBL) was almost
same in every year, however the financial health of Prime Bank Limited
(PBL) was fluctuating year to year and its performance drastically fell after
the year 2015. From year 2012 to 2015 both the DBL and PBL, and from the
Determinants of Intellectual Capital Disclosure: Evidence from.......Bangladesh 113

year 2012 to 2014 DBBL was under “Gray area”; which means they have less
chance to face financial distress in that period. However after the year 2015
Private Banks were facing many difficulties because their z-score values were
lower than 1.1; which means they were under “Distress zone” and can face
bankruptcy situation anytime. Finally it can be said that, Private Banks had a
very poor performance in last few years, every bank was under “Distress
zone” and there was a high possibility to face financial difficulties in a short-
span of time. The management of the banks should carefully trace out the
reasons behind their poor performances and initiate necessary actions to
prevent the financial uncertainty.
Figure 2: Z-score analysis of Private Banks

4.3 Z-score Analysis of Islamic Banks

Table 3: Z-score analysis of Islamic Banks
Year 2012 2013 2014 2015 2016 2017 2018 Average
Z-Score
Al-Arafah Islami 1.06 0.56 0.99 0.76 0.57 0.48 0.51 0.70
Bank Limited
First Security Islami 0.93 1.08 1.22 1.33 1.22 0.71 0.41 0.99
Bank Limited
Shahjalal Islami 0.68 0.92 0.96 0.78 0.17 -0.31 0.07 0.47
Bank Limited

In this graphical presentation, it is evident that the financial health of the

Islami Banks was very poor from 2012 to 2018 and their performances were
deteriorating for the same periods. In the year 2014 and 2015 Al-Arafah
Islami Bank and Shahjalal Islami Bank was in the same position, except these
two years their position varied, at the same time they were under “Distress
114 Journal of Banking & Financial Services

zone” because they represented a z-value less than 1.1, even Shahjalal Islami
Bank was at its worst position in year 2017 as it had a negative value in that
year. First Security Islami Bank was also under “Distress zone” from the
beginning to end apart from the year 2014 to 2016 as it had a value more than
1.1 in these years which means it was under “Gray zone” and had a less
possibility to face financial difficulties. The management of the Islami Banks
should take proper action to prevent them from getting bankruptcy position in
future.
Figure 3: Z-score analysis of Islami Banks

4.4 Z-score Analysis of Foreign Banks

Table 4: Z-score analysis of Foreign Banks

Year 2012 2013 2014 2015 2016 2017 2018 Average

Z-Score
Bank Al-Falah 4.08 2.89 3.25 3.58 3.27 3.05 3.20 3.33
Limited
Commercial 1.78 2.00 1.26 1.10 0.78 0.55 0.56 1.15
Bank of Ceylon
PLC
State Bank of 2.90 2.85 2.69 2.19 1.01 0.19 0.03 1.69
India

In this graph, it is clearly noticeable that the financial health of the foreign
banks was conveying a mixed signal since the Bank Al-Falah has excellent
financial strength whereas Commercial bank of Ceylon and State bank of
India were experiencing the rough phases. From the year 2012 to the year
2015, Commercial Bank of Ceylon and State Bank of India were not in the
Determinants of Intellectual Capital Disclosure: Evidence from.......Bangladesh 115

“Distress zone”, Commercial Bank of Ceylon was under “Gray zone” and
except the year 2014 State Bank of India was also in the “Gray area”. After
2015, both the banks were in a difficult situation and they had a value less
than the cutoff value of 1.1 and thereby meaning they can face financial
hardship even bankruptcy in near future. On the contrary, Bank Al-Falah
Limited was in the “Safe zone” in every year because it had a value more than
2.6 and retained its position till the year 2018. Apart from Bank Al-Falah, the
financial health of the foreign banks depicts a declining performance trend.

Figure 4: Z-score analysis of Foreign Banks

4.5 Comparison between Public and Private Banks

As per the following graph, average z-scores of selected public banks for the
last three years (2016-2018) is better than that of private banks. Ironically, X2
and X4 have negative impact on public banks; that means public banks are
less aware about their Retained earnings and the proportion of Shareholders
equity. Here, X1 shows a decreasing trend for both public and private banks.
Then the trend of X3 shows that except year 2012 and 2016 both sector is
consistent. Hence, it can be said that due to government support or the
trademark of State-Owned banks (i.e., which ultimately boosts up the morale
and confidence of the mass people), public banks are better managing their
financial distress issues in comparison to the management of the private
commercial banks (i.e., since government protection is absent when they are
in the brink of financial failure or collapse).
116 Journal of Banking & Financial Services

4.6 Z-score Analysis of all Scheduled Banks

Table 5: Z-score analysis of Scheduled Banks

Year 2012 2013 2014 2015 2016 2017 2018 Average
Z-Score
State-owned 0.66 1.64 1.47 1.35 1.18 1.18 0.74 1.17
Banks
Private Banks 1.34 1.60 1.50 1.29 0.95 0.47 0.58 1.10
Islamic Banks 0.89 0.86 1.06 0.96 0.66 0.29 0.33 0.72
Foreign Banks 2.93 2.58 2.40 2.29 1.69 1.26 1.26 2.06

In this graph, all the 4-categories of banks have been brought into together. In
every respective year, foreign banks hold their sound position and they were
under “Safe zone” which indicated there were least possibilities that the banks
would face financial distress in near future. On the other hand, State-Owned
Banks faced difficulties in the year 2012 and 2018, as they had a Z-value less
than the cutoff point for distressed group i.e., 1.1 in those particular years.
Apart from these two years, State-Owned banks were under “Gray zone” that
refers less healthy position than “Safe Zone”, whereas it had fewer
possibilities to face financial distress situation. Private Banks maintain
healthy position before the year 2016, because they had a value more than 1.1
in those years but after year 2015 they were under “Distress zone” and their
performance were gradually degrading in terms of the overall profitability,
capital accumulation and stability of business. Moreover, from the year 2012
to 2018, Islami Banks were under “Distress zone” and there were no sign of
improvement in their financial position thus these banks may face bankruptcy
anytime in the future. To put it in a nutshell, it can be referred that, foreign
banks managed to securely hold their position while Islami Banks were at the
worst-performing banks.
Figure 5: Z-score analysis of all Scheduled Banks
Determinants of Intellectual Capital Disclosure: Evidence from.......Bangladesh 117

Comparison among all 4-Category of scheduled banks

According to the following graph average z-scores of selected foreign banks

were much better than other category of banks in every particular years,
whereas Islamic banks Z-scores shows their performance were not better
compared to others. Average z-scores of selected public banks for the last
three years (2016-2018) is better in comparison to the private commercial
banks. Although public banks’ performance was not good in individual areas,
such as X1, X2, X3, X4 but foreign banks maintain their performance well in
every aspects.

X4
1
0
2012 2013 2014 2015 2016 2017 2

Public Private Islami Fore

118 Journal of Banking & Financial Services

Table 6: Discriminant Zone Table of 12-Scheduled Banks Based on

Average Z-score
Bank Name 2012 2013 2014 2015 2016 2017 2018 Avg. Z- Discriminant
Score Zone
Sonali Bank 0.485 1.519 1.383 1.380 0.982 1.236 1.286 1.1818 Gray Zone
Janata Bank 0.432 0.693 0.606 0.561 0.544 0.505 -0.443 0.4141 Distress Zone
Agrani Bank 1.060 2.708 2.412 2.117 2.000 1.803 1.392 1.9276 Gray Zone
Dhaka Bank 1.536 1.660 1.391 1.260 1.014 0.580 0.728 1.1671 Gray Zone
DBBL 1.383 1.271 1.097 0.935 0.899 0.589 0.847 1.0031 Distress Zone
Prime Bank 1.113 1.864 2.008 1.680 0.931 0.250 0.176 1.1459 Gray Zone
Al-Arafah 1.063 0.563 0.988 0.761 0.574 0.476 0.509 0.705 Distress Zone
Islami
First Security 0.935 1.085 1.217 1.326 1.221 0.706 0.410 0.986 Distress Zone
Islami
Shahjalal 0.684 0.919 0.962 0.783 0.173 -0.305 0.070 0.469 Distress Zone
Islami
Bank Al-Falah 4.076 2.892 3.255 3.582 3.269 3.048 3.202 3.332 Safe Zone
C. B of 1.781 1.998 1.259 1.103 0.776 0.548 0.557 1.146 Gray Zone
Ceylon, PLC
State Bank of 2.900 2.845 2.692 2.190 1.010 0.191 0.031 1.694 Gray Zone
India

The above table shows very bleak and horrendous picture of the current state
of banks in Bangladesh. Out of the sample of 12 banks, only one bank has
managed to secure the ‘Safe Bank’ level (i.e., Z-score of 3.332) representing
the healthy financial conditions and conveying the safe signals to its
shareholders, boards, management and the mass-people. Of the sample banks,
we see that 6-bank leveled as ‘Gray Zone’ with score from (i.e., 1.146 to
1.928) whereas 5-bank possesses the possibility of financial distress or
bankruptcy possibility during a period of 1-5 years if the management fails to
identify and initiate corrective measures. These banks are Janata Bank (i.e.,
worst level of Z-score 0.4141), Shahjalal Islami bank (i.e., 0.469), Al-Arafah
Islami (i.e., 0.705), First Security Islami bank (i.e., 0.986) and only privately-
owned commercial bank, DBBL with a Z-score of 1.0031. The management
of the ‘Distressed banks’ should seriously take into consideration of the
incumbent risks that may jeopardize their operation and put them into ‘real-
crisis.’
Determinants of Intellectual Capital Disclosure: Evidence from.......Bangladesh 119

5. Major Findings

In Bangladesh, during the last few years banking sector has been experiencing
a number of difficulties. From this study, our overall study findings are
described below.

5.1 For State-Owned Banks

a) Z-score of Sonali Bank Limited indicates that the financial health of the
bank is increasing. Although in 2012 it had its lowest value ever, which
occurred because of its negative Earnings before Interest and Taxes
(EBIT) and Retained Earnings, but it hardly focuses on its weaknesses
and trying best to take its position in a better condition.

b) The Z-score value of Janata Bank Limited specified that its overall
performance was not good, even in last year it had a negative Z-score
value, which is extremely alarming. Its financial condition was volatile
and degrading in several aspects, if the bank does not take corrective
action timely it will suffer a lot.

c) The Z-score of Agrani Bank Limited demonstrated that its financial

condition was much better in all the years except year 2012. In each year,
it had a value which is more than 1.10, only in year 2012 it had z-score of
1.06. So, it has less chance to face financial difficulties.

To summarize about the State-Owned Banks in a few words, it can be said

that Agrani Bank Limited was doing better whereas Janata Bank Limited was
in a poor condition and Sonali Bank Limited was trying to improve its
financial condition.

5.2 For Private Banks

a) Z-score of Dhaka Bank Limited drastically went down, from year 2012 to
2015 it had a position under gray zone but during 2015 to 2018 it was
under distress zone, which indicates that its financial condition are
becoming poorer day by day.

b) The Z-score value of Dutch-Bangla Bank Limited (DBBL) indicates that

its overall position was very unhealthy. In 2017 it had lowest z-score
value which was because of its smallest amount of EBIT.
120 Journal of Banking & Financial Services

c) From year 2012 to 2015 the Z-score value of Prime Bank Limited was
good because during that time it was under gray zone, but during 2016 to
2018 it was under distress zone and its performance was unsatisfactory.
To summarize about Private Banks in short, it can be inferred that, both the
Dhaka bank and Prime bank were in a good condition before year 2016 after
that their performance were not that much good. Whereas DBBL worked
better in year 2012 and 2013 only, after that its condition was unsatisfactory.
5.3 For Islamic Banks
a) In 2014 and 2015, Al-Arafah Islami Bank and Shahjalal Islami Bank were
in the similar position, except these two years their position varied, at the
same time they were under “Distress zone” because they had a value less
than 1.1. They also had decreasing amount of working capital and EBIT
which was the reason behind this poorer performance.
b) First Security Islami Bank was also under “Distress zone” in each year
except the period of 2014 to 2016. Lowest amount of retained earnings in
every year and increasing amount of current liabilities in last two years
were responsible for its gloomy performance.
c) The financial health of the Islami Banks was very fragile in every single
year and their performances were in falling trend during 2012 to 2018.
5.4 For Foreign Banks
a) Negative working capital and increased amount of total liabilities after
year 2015 put both the Commercial Bank of Ceylon and State Bank of
India in a difficult situation. Although from 2012 to 2015, they were not
in the “Distress zone”.
b) Increased amount of total assets, retained earnings and EBIT in Bank Al-
Falah Limited took the bank’s position in a good condition. It also
decreased total liabilities and its performance was very good throughout
the whole period.
c) Bank Al-Falah Limited was in the “Safe zone” in each year, whereas
Commercial Bank of Ceylon and State Bank of India were under
“Distress zone” after 2015.
5.5 For all Scheduled Banks

a) The overall Z-score value of State-Owned Banks was significantly better

than Private Banks and Islami Banks during 2015 to 2018.
Determinants of Intellectual Capital Disclosure: Evidence from.......Bangladesh 121

b) Foreign Banks hold their sound position and they were under “Safe zone”,
their performance was very good than other three type of banks.

c) Private Banks and Islami Banks were under risky situation and their
performance was unsatisfactory and declining year after year.

d) Among the 12 banks, overall performances of 6 banks indicate that they

were under “gray zone” and 5 banks were under “distress zone” and only
1 bank was under “Safe zone”.

6. Conclusion and Policy Recommendations

Banking sector for a developing country like ours, where capital market is in
nascent stage, is considered as the 'lifeline of the economy.' For a nation like
us, banking sector has been serving the short-term and long-term financing
needs of businesses irrespective of their sectoral differences. Unlike other
economies in Asia, people heavily depend upon the banking sector in
Bangladesh and its scope is paramount as compared to the other components
of a financial system. As a consequence, the stability of our financial system
essentially depends on the stability of commercial banks and their business
operations. Keeping this in mind, the authors intend to assess the bankruptcy
risks of the selected commercial banks and convey the research outcome to
the stakeholders. On that perspective, this paper discloses the financial health
of the banking sector in Bangladesh by using the Altman’s Z-score model
with accounting ratios and some statistical techniques. The findings of the
study concluded that state-owned banks were in a little healthy position than
private and Islami and foreign banks performance were very satisfactory. In
case of durability of financial health, state-owned banks are gradually
improving their situation than private and Islami banks over the years. On the
other hand, the position of private and Islami banks were consistently
decreasing over the last three years which bears very alarming signals to the
total banking industry. The regulatory bodies should intervene immediately
and ‘a banking commission’ may be formed to initiate an industry-wide
rigorous study which will shed some lights in terms of policy insights and
outline the future set of regulations to check the excessive level of bad debts,
identify major defaulters, and stop the loopholes of the banking sector.
Bangladesh Bank should initiate the redesigning the ‘Loan Classification and
Rescheduling Guidelines’ with special attention to willful defaulter and to
enforce those very strictly since bad debts is the prime cause for the
possibility of financial distress for us. Additionally, Bangladesh bank should
122 Journal of Banking & Financial Services

closely monitor the banks in the distress zone and if needed can appoint
strong administrator to supervise the performance of problem banks. Bank
management should properly utilize the internal control and compliance
department which is a prerequisite to uncover the major anomalies done while
sanctioning credit by internal bodies within the bank. Moreover, banks should
accelerate the automation and ensure the transparency and accountability of
the internal procedures. The board of the distressed banks should put special
emphasis to recover the problem loans, enforce strict rules for new and
existing loan sanction and plan to enhance capital base amidst the possibility
of bankruptcy risk. If the boards and management of the banks fail to initiate
proper steps for improving their current positions they will face serious
financial hardship even bankruptcy situation in future which may destabilize
the total financial system.

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Appendix
Sonali Bank Limited
Year Current Current CA-CL Total Retained EBIT B.V of Total
Asset Liability Asset Earnings Equity Liability
2012 207456 144118 63338 754616 -18728 -1925 22400 732216
2013 306684 153772 152912 852223 -12850 41338 50009 802214
2014 317162 173314 143848 934592 -14598 49125 59579 875013
2015 368437 197662 170775 1026109 -20652 44430 58383 967726
2016 388392 265545 122847 1200590 -13051 50770 67375 1133215
2017 438879 262856 176023 1240332 -14450 52474 66087 1174245
2018 470107 265476 204631 1306842 -13458 45252 70137 1236705

Janata Bank Limited

Year Current Current CA-CL Total Retained EBIT B.V of Total
Asset Liability Asset Earnings Equity Liability
2012 227310 219103 8207 511129 -16288 29944 17206 493923
2013 285731 275584 10147 586083 -933 44838 37116 548967
2014 314187 305703 8484 629454 366 41717 39462 589993
2015 345386 335979 9407 683158 719 40543 42037 641120
2016 426637 410503 16134 779602 8461 34981 49830 729771
2017 430682 413956 16726 807146 9160 31303 51359 755786
2018 347317 447563 -100246 866046 7815 27895 54556 811490

Agrani Bank Limited

Year Current Current CA-CL Total Retained EBIT B.V of Total
Asset Liability Asset Earnings Equity Liability
2012 12109 5512 6597 37872 -1454 127 717 37155
2013 19076 4278 14798 44416 -225 2958 3564 40852
2014 20289 5226 15063 49487 -12 2392 3957 45530
2015 26195 11058 15137 56535 93 2234 4468 52067
2016 29199 11853 17346 62357 -587 1311 3658 58699
2017 28982 13953 15029 67392 -103 2786 4073 63319
2018 32268 18949 13319 78915 -68 2689 4159 74757
126 Journal of Banking & Financial Services

Dhaka Bank Limited

Year Current Current CA-CL Total Retained EBIT B.V of Total
Asset Liability Asset Earnings Equity Liability

2012 34835 17870 16965 133142 413 12038 9683 123458

2013 33461 14813 18648 144409 1191 14867 11887 132521

2014 42268 25952 16316 158748 1364 14099 12746 146002

2015 45960 27685 18275 176362 962 12492 13389 162974

2016 50244 34438 15806 202192 942 12201 14446 187746

2017 48103 44384 3719 229453 953 13175 15245 214208

2018 60576 50145 10431 273976 821 16353 16616 257360

Dutch-Bangla Bank Limited

Year Current Current CA-CL Total Retained EBIT B.V of Total

Asset Liability Asset Earnings Equity Liability

2012 49247 31577 17670 155919 2626 11732 10855 145064

2013 61506 40565 20941 185537 3438 10871 12642 172895

2014 72852 54337 18515 214499 3523 12820 14486 200013

2015 75000 62724 12276 236052 4115 16045 16747 219305

2016 81259 63724 17535 266166 5181 13050 17603 248563

2017 88397 77183 11214 308623 5610 10173 19245 289378

2018 96082 73697 22385 339356 8809 12851 22646 316710

Prime Bank Limited

Year Current Current CA-CL Total Retained EBIT B.V of Total
Asset Liability Asset Earnings Equity Liability

2012 63683 51477 12206 236833 2072 22745 20787 216046

2013 75454 32551 42903 243869 1341 21123 23030 220839

2014 91690 38199 53491 254912 1791 18854 24461 230451

2015 82572 41063 41509 252161 1836 17009 26415 225746

2016 73337 53512 19825 272224 2018 13021 25285 246939

2017 53395 59496 -6101 281275 1079 11684 24708 256567

2018 57091 69734 -12643 293901 1759 14679 26181 267720

Determinants of Intellectual Capital Disclosure: Evidence from.......Bangladesh 127

Al-Arafah Bank Limited

Year Current Current CA-CL Total Retained EBIT B.V of Total
Asset Liability Asset Earnings Equity Liability
2012 31496 18958 12538 146335 1215 8190 12426 133909
2013 34215 17919 16296 170936 1308 8674 14478 156458
2014 42482 25600 16882 206549 1508 10327 16598 189951
2015 41762 30494 11268 224464 1605 10676 17507 206957
2016 53251 47726 5525 267335 2175 13102 19586 247748
2017 63522 59819 3703 314597 2177 14151 20677 293920
2018 55587 47270 8317 333262 1783 12673 21589 311673

First Security Bank Limited

Year Current Current CA-CL Total Retained EBIT B.V of Total
Asset Liability Asset Earnings Equity Liability
2012 26227 13542 12685 129733 433 4532 5664 124069
2013 32923 12825 20098 161823 502 5209 6434 155389
2014 41308 10950 30358 204513 642 5737 8349 196164
2015 55534 12613 42921 255480 501 6723 9639 245841
2016 62106 18163 43943 301228 736 9731 10702 290527
2017 55326 31940 23386 343739 724 11053 11672 332068
2018 50188 42092 8096 371336 801 12205 13258 358078

Bank Al-Falah Limited

Year Current Current CA-CL Total Retained EBIT B.V of Total
Asset Liability Asset Earnings Equity Liability

2012 7519 611 6908 13418 125 225 4641 8776

2013 8176 2287 5889 15228 -45 -143 4407 10822

2014 8454 1928 6526 16554 182 541 4673 11881

2015 9896 2053 7843 18373 504 763 5185 13188

2016 9480 2232 7248 19654 872 918 5340 14314

2017 10814 3222 7592 21865 1109 801 5569 16296

2018 10254 2401 7853 21758 1085 1010 5556 16203

128 Journal of Banking & Financial Services

Commercial Bank of Ceylon, PLC

Year Current Current CA-CL Total Retained EBIT B.V of Total
Asset Liability Asset Earnings Equity Liability
2012 8586 4894 3692 26308 707 2107 4811 21497
2013 9964 5084 4880 28795 1097 2164 5656 23139
2014 13002 11321 1681 33643 2091 2373 6559 27084
2015 10901 10036 865 36507 2781 2388 7238 29269
2016 11721 12334 -613 40075 3272 2116 7828 32248
2017 13116 15449 -2333 49848 3889 2800 8742 41106
2018 16983 20321 -3338 60977 5037 4041 9832 51145

State Bank of India

Year Current Current CA-CL Total Retained EBIT B.V of Total
Asset Liability Asset Earnings Equity Liability
2012 9558 5371 4187 17420 2242 1120 6162 10197
2013 9667 5490 4177 18698 2137 1142 6776 11922
2014 10107 5813 4294 19460 773 1412 7278 12182
2015 11008 7836 3172 22251 809 1772 8100 14151
2016 12565 12147 418 25763 556 1538 7511 18251
2017 9050 13229 -4179 27593 1987 1942 8616 18977
2018 11600 16681 -5081 33780 1054 2484 9681 24098

Shahjalal Islami Bank Limited

Year Current Current CA-CL Total Retained EBIT Book Total
asset liability asset earnings value of liability
equity
2012 28537 24704 3833 132823 1121 7608 9646 123177
2013 28737 19538 9199 121963 836 5420 10951 111021
2014 27658 15530 12128 126758 761 3932 11698 115060
2015 25582 17219 8363 137870 965 5325 12254 125616
2016 27449 32441 -4992 167245 1106 6474 12857 154388
2017 31377 50397 -19020 207886 784 6520 13318 194569
2018 39149 48692 -9543 243660 851 8992 14789 228871
Volume 12, Number 1, June 2020

Determinants of Intellectual Capital Disclosure: Evidence

from Banking Sector of Bangladesh

Mohammad Salahuddin Chowdhury 1

Zannatun Nayeem Chowdhury 2

Abstract: In today’s world only basic factors of production do not ensure

the success of a company. Intellectual capital is considered as an important
value driver in today’s organizations as business and economy. Intellectual
capital (IC) is a source of competitive advantage and satisfying information
needs. Evidence shows that the drivers of value creation in modern
competitive environment lie in a firm’s IC rather than its physical and
financial capital. This study attempts to assess the extent of the disclosure
of Intellectual Capital (IC) and also to find out the determinants of
intellectual capital disclosure in Bangladeshi banking sector by examining
the relationship of intellectual capital disclosure (ICD) with nine
exogenous variables which are bank size, bank risks, efficiency, bank age,
human capital pressure, ownership pattern, leverage level, structural
complexity and board composition. A total of 22 banks out of the 30 listed
banks in Dhaka Stock Exchange have been considered as sample. The data
are taken from the annual reports of the banks for the years of 2015 to
2019. A disclosure index is calculated based on 43 items and linear
multiple regression model is applied to examine the relationship between
ICD and the exogenous variables. The study reveals that Banks in
Bangladesh disclose around 22 items on average of the total 43 items
considered in this research. And the ordinary least square model used in
this study explored that ICD is affected by efficiency, leverage, structural
complexity and size of bank while the rest of the variables have no
association with ICD. Finally, the study suggests that banks should
improve ICD practices to reduce information asymmetry between insiders
and other stakeholders and thus make capital market of Bangladesh
economy more efficient.
Keywords: Intellectual capital disclosure; Efficiency; Ownership pattern;
Structural complexities; Human capital; Banking

1. Introduction
A firm must have some competitive advantage to be successful. Intellectual
capital (IC) is the intangible assets that a company can use as a competitive

1
Corresponding Author: Assistant Professor, Department of Finance, University of
Dhaka, Dhaka-1000, Email: [email protected]
2
Assistant Manager, BRAC University, Email: [email protected]
130 Journal of Banking & Financial Services

advantage. In the current world, IC is considered as strategically important

and has been recognized as an organizational resource in boosting corporate
performance. It provides a true, sustainable advantage needed to compete
effectively in the present global economy. It also gives a deeper
understanding of a company’s capability which can be used for long term
value generation. In a “knowledge-based” economy, companies’ economic
value no longer depends on the production of material goods but on the
creation and enhancement of intellectual capital. Choong (2008) on his
research article published in the Journal of Intellectual Capital implies that
intellectual capital include expenditures on advertising (marketing), training,
start-up, research and development activities, human resource expenditures,
organizational structure and values that come from brand names, copyrights,
franchises, licenses, operating rights, patents, secret processes, trademarks and
trade names that provides competitive advantage to a company in the market.

Nowadays, intellectual capital became an essential part of every company.

Enormous intellectual capital offers more acceptability in general public.
Intellectual capital disclosure is important to reduce agency cost and
information asymmetry. This helps to better estimate the firm risk by the
stakeholders as these disclosures enable them to understand how effectively
and efficiently an entity is creating and enhancing its intellectual capital.
Moreover, the better assessment and belief of the company’s future wealth
creation capabilities might raise the company share price, and thus increase
the market capitalization. Intellectual capital disclosure can also help to
increase the value relevance of financial statements. Failures to provide
relevant information about intellectual capital may lead to a deterioration of a
company’s financial position and a loss of competitiveness in the long run. In
fact, investors have difficulties in accurately assessing firm value for resource
allocation with financial statements that do not report intellectual capital.
Likewise, managers may find it difficult to determine relevant intangible
investments needed for the company’s operations. Traditional accounting
provide more focus on physical capital and less focus on intellectual capital
that is intangible in nature which constrains intellectual capital disclosures
practice.

However, no specific framework or guidelines developed regarding the

measurement and reporting of intellectual capital disclosures. Moreover, the
difficulties of intellectual capital disclosures measurement make it complex
for intellectual capital to be incorporated into the existing accounting
framework. Therefore, intellectual capital disclosure in the reporting field is
Determinants of Intellectual Capital Disclosure: Evidence from Banking Sector 131

still in its infancy and provides an important area to explore to contribute to

the confirmation of intellectual capital disclosures as a discipline. As the
economy of Bangladesh is growing, the role of a sustainable and competitive
banking sector is becoming prominent. To ensure a sustainable and
competitive banking sector, banks operating in the economy of Bangladesh
need to focus on the creation and enhancement of intellectual capital and also
to provide adequate disclosures on intellectual capital for stakeholders.
Therefore, this paper focuses on the extent of the disclosure of Intellectual
Capital and the factors influencing the intellectual capital disclosures of the
Banking sector of Bangladesh. By identifying the different aspects or factors
which influence intellectual capital disclosures, this study will pave a new
way in the field of intellectual capital disclosure in the banking sector of
Bangladesh.

2. Literature Review
The idea of intellectual capital (IC) is getting rapid recognition where efforts
are directed toward building a knowledge-based model (Sumedrea, 2013).
Companies across the world continuously seek for different answers to the
obstacles and challenges they face and therefore very much willing to utilize
all available resources more efficiently. Intellectual capital is a crucial factor
for adding corporate value and boost up a competitive edge. Recently,
research on intellectual capital disclosures (ICD) has got popularity among
the researchers, particularly exploring the effect of ICD in a specific country.
Davey and Yi (2010) conducted ICD researches on China, Haniffa and Pike
(2008) focused on UK; and Guthrie and Abeysekera (2005) performed
research on Sri Lanka. Some researchers conducted industry based analysis of
ICD which include VT, Kavida and K (2018) focusing on Pharmaceutical
sector, Cohen, Vlismas and Naoum (2014) conducted research on the SME
sector, Tower, White and Lee (2007) focused on bio-technology sector. Most
of these researches revealed that the extent of intellectual capital disclosure by
the companies was low and in qualitative form. Studies on ICD practices for
the companies across different countries have also been undertaken. These
include research conducted by Abeysekera (2008) on Sri Lanka and
Singapore, Guthrie, Ricceri and Petty (2006) on Hong Kong and Australia;
and Vergauwen, Vandemaele and Smits (2005) on Netherlands, Sweden and
the UK. The findings of these studies benefited to gain understanding of the
ICD practices in the international context.
Researches on longitudinal horizon have also been undertaken by some
researchers focusing on ICD practices of a particular country or sector.
132 Journal of Banking & Financial Services

Examples include Rahman and Campbell (2010), Bruggen et al. (2009); and
Cuganesan and Petty (2005). The researchers investigated and analyzed the
annual report over a period of time and found that IC disclosure was
expanding. Some key determinants of ICD included type of industry, firm
size, status of listing with exchanges, profitability, leverage, ownership
structure, proportion of independent directors and type of auditor.

But most of the studies by different researchers regarding ICD emphasized

on the developed countries instead of developing nations (Singh and Kansal,
2011; Davey and Yi, 2010; Kamath, 2008; and Xiao, 2008). Many researches
reveal that IC is an important component that enhances corporate
performance. According to Teece (2000), intangible assets of the firm are the
key assets to gaining the sustainable competitive advantage and considered as
the drivers of the economic growth. Researchers like Mavridis (2004), Chan
(2009), Cheng et al. (2010), Komnenic & Pokrajcic (2012) etc. have found a
positive relationship between intellectual capital of the firms and their
respective financial performances. In the meantime, many researches have
been conducted in various countries to examine the extent of intangible assets
reporting in the corporate annual reports. Guthrie & Petty (2000) examined
the intellectual capital reporting practices of top 20 Australian companies (in
terms of size). They have employed content analysis of the published annual
reports using Sveiby (1997) developed IC framework to determine the extent
of IC disclosure. They found that the key components of IC are poorly
understood, inadequately identified, inefficiently managed, and inconsistently
reported in the Australian context. In another study, Oliveras et al. (2008)
have analyzed the annual reports of 14 listed companies over a time period
from 1998 to 2002 in Spain. Their results show decreasing trend in the hidden
value (differences between market value and book value) of Spanish
companies and the level of disclosure of intellectual capital items in the
annual reports is low. April et al. (2003) conducted an empirical analysis of
intellectual capital measurement, management, and reporting of South African
mining companies. They also employed ‘content analysis’ technique to
analyze the annual reports of 20 listed mining companies besides collecting
necessary data through interviews with senior officials. They used 24
intellectual capital indicators covering main three categories of human,
internal, and external capital for data analysis. The results show that South
African mining companies report low amount of intellectual capital
information in their annual reports and external intellectual components like
business collaborations, favorable contracts comprise the major part of IC
Determinants of Intellectual Capital Disclosure: Evidence from Banking Sector 133

disclosure. In another study by Guthrie et al. (2006) the reporting of

intellectual capital items by the listed companies in Australia and Hong Kong
was investigated. Their results reveal that voluntary IC disclosure is low and
qualitative rather than quantitative in both countries.

There have been several studies in different countries utilizing the same
methodology as Guthrie and Petty (Brennan, 2001; Bozzolan et al., 2003; Goh
and Lim, 2004; Abeysekera and Guthrie, 2005). Although these studies all
indicate the lack of a consistent IC reporting framework and the extensive
disclosure of external capital, some differences in terms of the extent of IC
disclosure can be found across companies. For example, in Brennan (2001),
IC related items in the sample of 11 knowledge-based Irish listed companies
are disclosed less frequently than those in Guthrie and Petty’s sample.
However, their sample is very small so that results must be considered with
caution. Likewise, different proportions of IC categories (human capital,
internal capital and external capital) are found in Sri Lanka compared to those
in Guthrie and Petty’s study. In essence, these studies use the same
framework, but the results are different, which may be due to differences in
time, sample sizes, country-specific regulations and culture.

Researches on identifying specific determinants of intellectual capital

disclosures are also seen. According to Morris (1987), agency theory is the
reason for which highly leveraged firms tend to disclose more so as to reduce
the cost of the agency. Hossain (2008) and Speigal and Yamori (2004) found
that structural complexity of a firm is an important factor that affects the
disclosure level. Some researchers found board independence as one of the
important determinants of ICD. Muttakin et al. (2015) found significant effect
of percentage of independent directors on ICD whereas Martins et al. (2018)
and Rahman et al. (2019) found an insignificant effect. According to Mohd
Ghazali and Weetman (2006), companies which have a substantial part of
their shares held by governmental bodies are compelled to have a high
disclosure level because of their accountability to the public. This was further
confirmed by Said, Zainuddin and Haron (2009) who have suggested that a
strong association exists between government owned firms and their
disclosures. Size has been identified as another determinant for ICD by many
researchers .In previous studies, many researchers (Bhatia and Dhamija, 2015;
El-Bannany, 2013; Kamath, 2008; White, Lee and Tower, 2007; and Guthrie,
Petty and Ricceri, 2006) have concluded that size of an organization
positively influenced the extent of IC disclosure. According to Ousama,
Fatima and Hafiz (2012), factors like fund requirement, cost of disclosure,
134 Journal of Banking & Financial Services

competition, and need for higher visibility motivate larger companies to make
more disclosures when compared to smaller companies. According to Hossain
(2008) and Jameel and Weerathunga (2013), banks with higher risk, i.e.,
higher Non-Performing Assets (NPAs) may be unwilling to have high
voluntary disclosure in their annual reports. Hossain (2008) argued that
disclosure by a bank of its high level of NPAs may lead to a negative
perception about the bank caused by its high risk. Efficiency as measured by
Net Interest Margin has been identified as important determinant for
intellectual capital by some researchers (Demirgüç-Kunt and Huizinga, 1998).
It is expected that efficient organizations are keen to disclose more
voluntarily.

ICD studies in developing countries like Bangladesh are inadequate,

particularly concerning corporate governance attributes (Muttakin et al,
2015). Abhayawansa and Azim (2014) and Rahman, Sobhan and Islam (2019)
investigated only the pharmaceutical industry. Rashid (2013) suggested that
IC disclosure practice is limited but has a growing trend. Abhayawansa and
Azim (2014) documented significant variation in IC and its subcategories
disclosure among Bangladeshi pharmaceutical firms and suggested a
consistent framework. Similarly, Nurunnabi et al. (2011) concluded that the
level of disclosures is very low thereby underscoring the need to develop a
compliance guideline that will increase the disclosure practice of intellectual
capital.

It can be seen that study on intellectual capital disclosures has been

conducted in case of corporates across developed and developing nations.
However, limited literature is available on intellectual capital disclosure by
banks in Bangladesh. This study helps in filling this gap as few previous study
examines the disclosure level of intellectual capital and relationship of
intellectual capital disclosure with various factors on commercial banks of
Bangladesh.

3. Objectives of the study

 To study the extent of Intellectual Capital Disclosure in the Banking

Sector of Bangladesh

 To identify the determinants of Intellectual Capital Disclosure in the

Banking Sector of Bangladesh
Determinants of Intellectual Capital Disclosure: Evidence from Banking Sector 135

4. Data and Methodology

4.1 Sample
As the study focuses on the banking sector of Bangladesh, a total of 22 banks
of the listed banks in Dhaka Stock Exchange are included in this study. The
only government owned listed commercial bank included in this study is
Rupali Bank while the rest of the banks are private sector banks listed with
DSE. The data for the years from 2015 to 2019 are used in this study which
are taken from the annual reports of the banks.
4.2 Construction of Index
According to Abrahamson (1983), various forms of communication can be
evaluated by use of Content analysis method. It is a technique which helps
draw inferences through systematic and objective identification of special
characteristics of the message (Holsti, 1968). It refers to the ability to
comprehend written texts or terms (Campbell & Rahman, 2010; Kılıç &
Kuzey, 2018). Stakeholder theory supports the use of content analysis for IC
disclosure (Guthrie et al., 2004). Content analysis method is applied on annual
reports of listed banks in Bangladesh. Data sources of the study are based on
the annual reports of the listed banks for the year 2015-2019. Annual reports
are mostly preferred because annual reports are believed to be a significant
and frequent source for information. Annual reports are also audited, accurate,
timely and consistent (Nurunnabi et al., 2011; Singh & Mitchell Van der
Zahn, 2008). In this research, annual reports are downloaded from the
respective company’s website.

A 43-item disclosure index for banking sector has been used in this study.
The disclosure list contains three major heads namely:
• Internal Capital with ten items;
• External capital with sixteen items; and
• Human capital with eighteen items.
These items are searched in the annual reports of each of the banks for
scoring the disclosure index. The ICD score is assessed on the basis of the
item being disclosed by the bank using a self-constructed measure. For
developing the disclosure index, each item disclosed in the annual report is
given a score of 1 and the item not disclosed is scored zero. Equal weighted
has been given to all the 43 items. The total items disclosed is divided by the
total number of items i.e. 43 to get the Disclosure index value.
136 Journal of Banking & Financial Services

Disclosure =

where,
s =1 if an item is disclosed and s=0 if it is not.
n=Number of items.

The ICD index is calculated by using the formula:

IC Disclosure Score, ICDS =

where, di indicates an item i and is given a value of 1 when there is
disclosure and a value of 0 when there is no disclosure. di is divided by 43
which is the total number of IC items.
4.3 Empirical Model
Researchers often use multiple regression model to identify determinants of a
specific variable. Many prior researches relating to determinants of
disclosures also used multiple regression model. Therefore, linear multiple
regression analysis is considered as an appropriate tool in this study. The
following model is developed to study the relationship between ICD and the
exogenous variables:
ICDS = α + β1µSIZE + β2µRISK + β 3µEFF + β4µAGE + β5µHCAP + β 6µOPAT +
β7µLEV + β8µSCOM + β9µBCOM + ε...............................................................Eqn. 1
The detailed description of the variables is given below:
Table 1: Description of Endogenous and Exogenous variables
Title Description
ICDS Intellectual Capital Disclosure score which is the ratio of IC
items disclosed by the bank to the total IC items
α Minimum value of ICDS which is not affected by any change in
the value of the other variables
µSIZE Size of the bank in terms of total assets.
µRISK Risk represented by the percentage of gross Non Performing
Assets.
µEFF Efficiency represented by the Net interest Margin in percentage
terms
µAGE Age of the bank since formation
Determinants of Intellectual Capital Disclosure: Evidence from Banking Sector 137

µHCAP Human Capital pressure represented by number of employees in

the bank
µOPAT Ownership pattern represented by dummy variable. Dummy
variable is taken as one if the bank is state owned commercial
bank listed with DSE and zero in case it is a private sector
commercial bank listed with DSE.
µLEV Leverage represented by the percentage of debt to total capital
µSCOM Structural Complexity represented by number of subsidiaries of
the bank
µBCOM Board Composition represented by the percentage of independent
directors to total directors on board

Bank size: Larger companies may have a more significant influence on IC

disclosure. Ousama, Fatima and Hafiz (2012) opined that factors like fund
requirement, cost of disclosure, competition, and need for higher visibility
motivate larger companies to make more disclosures when compared to
smaller companies.
Bank Risk: Banks with high non-performing loans usually provide less
disclosures. According to Jameel and Weerathunga (2013), banks with higher
risk, i.e., higher Non-Performing Assets (NPAs) may be unwilling to have
high voluntary disclosure in their annual reports.
Efficiency: It is expected that efficient organizations are keen to disclose more
voluntarily. The mechanism of earning of profit by a bank primarily depends
on the effectiveness in conducting their main function of lending and
borrowing (Hossain, 2008).
Bank Age: Companies set up much earlier might have a higher degree of
disclosure in the annual reports as compared to newer companies. This is done
in order to maintain their impression or goodwill in the society. Hamid (2004)
observed a positive relationship between IC disclosure and age of a firm.
Human Capital Pressure: Human capital is not only the individuals working
in a company but also include personal traits possessed by individuals i.e.
knowledge, skills and technical ability possessed by the workforce. Disclosure
of information about the human resources of the firm in its annual reports
indicates the importance given by the firm to its workforce. (Subbarao and
Zeghal, 1997).
Ownership Pattern: According to Ghazali and Weetman (2006), companies
which have a substantial part of their shares held by governmental bodies are
138 Journal of Banking & Financial Services

compelled to have a high disclosure level because of their accountability to

the public.
Leverage Level: High leverage firms need to attract creditors, and IC
Disclosure may be used for this purpose. High disclosure tends to reduce
information asymmetry and leads to a lower cost of borrowing. According to
Morris (1987), agency theory is the reason for which highly leveraged firms
tend to disclose more so as to reduce the cost of the agency.
Structural Complexity: Structural complexity of a firm is an important factor
that affects the disclosure level. An effective Management Information
System (MIS) is required for monitoring structurally complexed firms
(Ahmed and Courtis, 1999). Such a MIS helps in reduction of cost of
information availability and thereby leading to higher disclosure.
Board Composition: Independent directors in the board play a significant role
to reduce the risk of capital misappropriation and to bring an independent
view in the board’s decision. Independent directors protect the interest of
investors ensuring better corporate disclosure. Muttakin et al. (2015) found
significant effect of percentage of independent directors on ICD whereas
Martins et al. (2018) found an insignificant effect.
5. Analysis and Findings
5.1 Item wise disclosure of Intellectual Capital
Item wise disclosure of IC of banks is given in Table 9 of annexure.
Disclosure pattern of the items under three broad categories is provided in the
below Table 2. In the “Internal capital” category, the highest disclosed items
are “Leadership” and “Information Systems” and the lowest disclosed item is
“Patent”. In the “External capital” category, the highest disclosed item is
“Customer services” followed by “Goodwill” and the least disclosed item is
“Brand development”. “Number of staff” is the most disclosed item in
“Human capital” category and “Professional qualification” and “Academic
qualifications” are the least disclosed items.
Table 2: Disclosure pattern of the items
Category Most disclosed Least disclosed
Internal capital Leadership Patent
Information Systems (technology)
External capital Customer services Brand development
Human capital Number of staff Professional
qualification
Academic qualifications
Determinants of Intellectual Capital Disclosure: Evidence from Banking Sector 139

5.2 Percentage analysis of three broad categories

On average, around 43% of internal capital items have been disclosed, around
52% of External capital items have been disclosed and around 52% of the
Human capital items have been disclosed.
Table 3: IC Disclosure of 3 broad categories
Broad Categories of Disclosure Index Average Score (%)
Internal capital 42.73%
External capital 52.27%
Human capital 51.77%
5.3 Intellectual Capital Disclosure score
The intellectual capital disclosure score of the individual banks is given in
Table 4. The highest disclosure score is 28 by Prime Bank which reveals that
Prime Bank disclosed the most items among the other banks in the sample.
On the other hand, NCC Banks disclosed the least number of items with a
score of 11.
Table 4: IC Disclosure score of the banks
Sl. No. Name of the Bank ICD score
01 AB Bank 22
02 BRAC Bank 23
03 Bank Asia Limited 26
04 Dhaka Bank 24
05 City Bank 27
06 Dutch Bangla Bank 20
07 Eastern Bank 27
08 IFIC Bank 24
09 Jamuna Bank 21
10 Mutual Trust Bank 24
11 National Bank 17
12 NCC Bank 11
13 One Bank 18
14 Premier Bank 23
15 Prime Bank 28
16 Pubali Bank 19
17 Rupali Bank 21
18 Shahjalal Islami Bank 21
19 Southeast Bank 24
20 Trust Bank 20
21 United Commercial Bank 23
22 Uttara Bank 20
140 Journal of Banking & Financial Services

5.4 Descriptive statistics

The mean value of ICD is 21.955 as shown in Table 5 which suggest that
banks on average disclose around 22 items of the total 44 items, varying from
highest at 28 items to lowest at 11 items. Banks have an average size of
around Tk. 271,939 million with maximum size of about Tk. 463,290 million
and minimum size of about Tk. 154,580 million. The banks are 7.13% risky
on average and average efficiency of bank is around 2.9% where maximum
efficiency is around 6.95%. Age of bank varies from 18 to 60 years with mean
age of around 30 years. Banks have an average of around 3,348 employees
and around 4.55% of the sample is public sector banks. Banks borrow around
6% of the total capital on average and they have around 3 subsidiaries on
average. The Board of Directors contains around 23% independent directors
on average.
Table 5: Descriptive analysis of Dependent and Independent variables
Variables Mean Median Standard Sample Kurtosis Skewness Range Minimum Maximum
Deviation Variance
ICD 21.955 22.5 3.8232 14.617 1.9624 -0.907 17 11 28
Size 271938.94 269137 69998.7 4.9E+09 -0.2975 0.4125 308709 154580.45 463289.8
Risk 0.0713 0.054 0.0640 0.0041 13.78 3.58 0.3715 0.0235 0.395
Efficiency 0.029 0.027 0.014 0.0002 2.054 0.996 0.075 -0.0053 0.0695
Age 30.05 24 12.20 148.94 0.0336 1.005 42 18 60
Human 3347.74 2546 1804.513 3256268 0.434 1.236 6684 1511 8195
capital
Ownership 0.0455 0 0.2099 0.0441 18.51 4.4665 1 0 1
pattern
Leverage 0.060 0.056 0.026 0.000678 0.6685 0.846 0.112 0.0154 0.1273
Structural 2.652 2 1.554 2.415 1.054 0.938 7 0 7
complexity
Board 0.229 0.207 0.0789 0.006 -0.0420 0.757 0.344 0.1 0.444
composition

5.5 Correlation analysis

The correlation matrix presents association in the variables that is applied for
the empirical model to perform research. It shows the positive or negative
relation with other selected variable. ICD is positively related to efficiency
(0.270), leverage (0.325), structural complexity (0.205) and board
composition (0.052). However, there is a negative relationship between ICD
and the other variables i.e. size (-0.056), risk (-0.149), age (-0.206), human
capital (-0.148) and ownership pattern (-0.173).
Determinants of Intellectual Capital Disclosure: Evidence from Banking Sector 141

Table 6: Correlation Coefficient among variables

Human Own. Struc Board

ICD Size Risk Eff. Age Lev.
capital pattern complex. comp.

ICD 1.000

Size -0.056 1.000

Risk -0.149 0.302 1.000

Eff. 0.270 -0.134 -0.434 1.000

Age -0.206 0.398 0.237 -0.314 1.000

Human
-0.148 0.570 0.270 0.052 0.424 1.000
capital

Own. pattern -0.173 0.381 0.480 -0.364 0.324 0.223 1.000

Lev. 0.325 -0.142 -0.079 0.041 -0.142 -0.023 -0.279 1.000

Struc.
0.205 0.241 0.213 -0.219 -0.075 -0.069 -0.092 0.094 1.000
Complex.

Board comp. 0.052 -0.034 0.014 0.225 -0.251 0.175 -0.161 0.261 0.077 1.000

5.6 Linear multiple regression results and analysis

Table 7 and 8 provide the linear multiple regression results. From the table it
is revealed that the model is statistically significant at 5% significance level.
The R square for the OLS regression is 56.7%. The result of R square suggest
that 56.7% of the variation in the ICD is explained by the nine exogenous
variables included in the model. Another important measure applied in
empirical model is adjusted R square which adjusts all effect to the research
model. Adjusted R square is highly dependable to explain endogenous
variable of ICD with the change of exogenous variable. The adjusted R square
for the OLS model is 51.9% which infers that intellectual capital disclosures
measured by ICD will be influenced by 51.9% due to the change in selected
exogenous variables.
142 Journal of Banking & Financial Services

Table 7: Regression results

Standard
Coefficients t Stat P-value
Error

Size (Asset) in million 54.24 25.88 2.24 0.072***

Risk (NPA) in million -1.945 8.677 -0.224 0.823

Efficiency (NIM) 97.470 39.063 2.495 0.016**

Age -0.009 0.045 -0.201 0.842

Hcap -0.00032 0.00034 -0.921 0.361

Ownership pattern 1.840 2.725 0.675 0.502

Leverage 48.754 17.875 2.727 0.009*

Structural complexity
0.613 0.329 1.862 0.068***
(subsidiaries)

Board Composition -4.742 6.236 -0.760 0.450

* Significant at the 1% level, ** significant at the 5% level, *** significant at the 10% level

Table 8: Regression model summary

R Square 0.567

Adjusted R Square 0.519

Standard Error 3.472

F 2.27 (0.03)

The OLS results in the above table revealed that efficiency, leverage and
structural complexity have statistically significant relation with ICD at
different level of significance. Efficiency of the banks is statistically
significant at 5% level of significance. The results show that efficiency of a
bank positively affects ICD. Banks with more net interest margin tends to
disclose more IC items. In other words, efficient organizations are keen to
disclose more about intellectual capital voluntarily. Leverage is statistically
significant at 1% level of significance which reveals that leverage is positively
related to IC disclosure. The higher the leverage ratio, the more will be the
ICD. As discussed earlier, more leveraged firm will tend to disclose more
intellectual capital items to attract creditors. Agency theory is the reason for
which highly leveraged firms tend to disclose more so as to reduce the cost of
the agency. High leverage firms need to attract creditors, and IC disclosure
Determinants of Intellectual Capital Disclosure: Evidence from Banking Sector 143

may be used for this purpose. High disclosure tends to reduce information
asymmetry and leads to a lower cost of borrowing. The focus is on voluntarily
providing more of value-added information to existing stakeholders. This is
supported by the managerial stakeholder theory as well. The results also
reveal that structural complexity and ICD have statistically significant
positive association at 10% level of significance. This results also supports the
claim of Hossain (2008) and Speigal and Yamori (2004) that structural
complexity is an important factor that affects ICD. An effective Management
Information System (MIS) is required for monitoring structurally complexed
firms. Such a MIS helps in reduction of cost of information availability and
thereby leading to higher disclosure.

The finding of this study support the findings of Garcia-Meca et al. (2005)
and Bruggen et al. (2009) which revealed that size is one of the determinants
of IC disclosure. This implies that larger companies provide more disclosures
on intellectual capital. As big companies have more stakeholders and strive to
maintain their market shares, these companies provide more disclosures on
intellectual capital to increase value relevancy of financial statements for their
larger stakeholders to facilitate their decision making.

6. Conclusion
Although there are no specific guidelines or regulations concerning the
measurement and reporting of IC disclosures, banks operating in Bangladesh
are reporting a good number of disclosures relating to intellectual capital.
With a sample of 22 listed banks, content analysis carried out in this study
explored 43 items of intellectual capital disclosures from the annual report
along with the financial statements of the sampled banks. Banks in
Bangladesh disclose around 22 items on average of the total 43 items. The
highest number of disclosure by a bank is 28 and the lowest disclosure is 11.
The study also revealed the determinants that impact the IC disclosure of 22
listed banks of Bangladesh. Of the nine variables taken into consideration, the
four variables namely efficiency, leverage, structural complexity and size
have a positive association with IC disclosures. However, the study does not
support any significant association between ICD and risk, age, human capital,
ownership pattern and board composition.
Although banks operating in Bangladesh are providing a good number of
disclosures, the extent of disclosures couldn’t be concluded as satisfactory.
Banks are reporting 50% of intellectual capital disclosures items considered in
this study. It implies that there is scope for improvement in the intellectual
144 Journal of Banking & Financial Services

capital disclosures practice of the banking sector. The finding of this study has
policy implication in the context that regulators of capital market should
encourage companies to provide more disclosures on intellectual capital for
increasing the value relevancy of financial statements to the stakeholders and
also to reduce information asymmetry between insiders and other stakeholders
and thus make capital market of Bangladesh economy more efficient. Finally,
creation and enhancement of intellectual capital by banks and proper
disclosures would lead to a competitive and sustainable banking sector which
will accelerate the development of Bangladesh economy.

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148 Journal of Banking & Financial Services

Appendix

Table 9: Intellectual Capital Disclosure Item-Wise Percentage

Percentage of Banks
Intellectual Capital Items
Making Disclosure
Internal capital
1 Patent 4.55%
2 Corporate Culture 59.09%
3 Corporate Philosophy 59.09%
4 Leadership 100.00%
5 Information Systems (technology) 100.00%
6 Financial relations 27.27%
7 Innovation 45.45%
8 Research and development 31.82%
9 Trademarks 90%
External capital
1 Business collaboration 59.09%
2 Joint Ventures 63.64%
3 Favorable contracts 54.55%
4 Brands 40.91%
5 Brands recognition 27.27%
6 Brand development 18.18%
7 Goodwill 81.82%
8 Distribution channels 77.27%
9 Market share 72.73%

10 Information about customer (type/number) 63.64%

11 Customer services 100.00%

12 Customer loyalty 45.45%
13 Customer relation 36.36%
14 Customer satisfaction 36.36%
15 Customer feedback 36.36%
16 Customer knowledge 22.73%
Determinants of Intellectual Capital Disclosure: Evidence from Banking Sector 149

Human capital
1 Number of staff 100.00%
2 Employee education and training 95.45%
3 Employee know-how 50.00%
4 Work related knowledge 63.64%
5 Expertise 72.73%
6 Professional qualification 0.00%
7 Academic qualifications 0.00%
8 Age and gender 77.27%
9 Geographical distribution 45.45%
10 Safety and health at work 81.82%
11 Employee succession path training 27.27%
12 Knowledge sharing 13.64%
13 Employee retention 45.45%
14 Employee engagement 86.36%
15 Motivation 86.36%
16 Employee Satisfaction survey 9.09%
17 Employee communication 31.82%
18 Entrepreneur spirit 45.45%
150 Journal of Banking & Financial Services
Volume 12, Number 1, June 2020

Do Capital Inflows Contribute to Economic Growth of

the Least Developed Countries? Lesson from Bangladesh

Abdullah Al Mahmud1
Shibli Rubayat Ul Islam2

Abstract: The present study attempts to examine the causal relationship

between foreign capital inflows and economic growth in Least Developed
Countries. Using the autoregressive distributive lag approach and panel
data during the period 2000–2018, the results of the study show that the
domestic capital stock and foreign aid have positive and significant impact
on economic growth in the short run, while the foreign direct investment
on economic growth is significantly negative in the long run. A plausible
argument attributable to the fact that least developed countries do not have
the capacity to utilize foreign investments for a longer time period owing
to inefficient labor force and institutional structure. Besides, In Bangladesh
Foreign Direct Investment (FDI) has great impact. Country like
Bangladesh which is lagging behind to attract FDI are generating new
policies.FDI has the important contribution to improve the garments and
weaving, IT, banking and medicine industries of Bangladesh. In this report
the role of FDI in economic growth is analyzed to find out relationship
between FDI and economic growth in Bangladesh.
Keywords: LDCs; GDP; FDI

1. Introduction

The purpose of this paper is to capture the impact of foreign capital inflows
(which include foreign aid and foreign direct investment) on economic growth
in Less Developed Countries (LDCs). In the development literature, it is
widely accepted that foreign capital inflows simulated growth in LDCs and
make it possible for host countries to achieve capital formation that are higher
than their own levels of domestic savings. Moreover, capital inflows are a
major source of financing opportunity for LDCs which facilitate the transfer
of advanced technology to LDCs, thus accelerate the economic growth of

1
Corresponding Author: Associate Professor, Department of Banking and Insurance,
University of Dhaka, Dhaka – 1000, Bangladesh; Email: [email protected]
2
Professor, Department of Banking and Insurance University of Dhaka, Dhaka-1000,
Bangladesh; Email: [email protected]
152 Journal of Banking & Financial Services

LDCs. On the other hand, capital inflow and economic growth vary from
country to country, and sometimes it adversely affects the economic growth
(Borensztein et al. 1998; DeMello 1999; Lipsey 2000).

Capital inflows not only facilitate the adoption of new technologies and
innovations but also facilitate the domestic sources of finance that affect
majority of macroeconomic variables such domestic capital stock, job
creation, the acquisition of knowhow by the workforce as well as facilitate the
efficiency of the business environment of the less developed countries. There
are several forms of capital inflows of which the most important are foreign
direct investment and foreign aid.

2. An Overview of Growth, Foreign Aid and FDI Inflows to LDCs

2.1 Changes in Real GDP

Figure 1 summarizes the real GDP growth of Less Developed Countries from
the period of 2000 to 2018. It is evident that the growth of GDP is decreasing
from 2001 to 2002. There is sharp increase in growth of GDP from 2002 to
2005. It remains steady until 2007 and started falling until 2009 which may be
explained as the effect of global economic crisis. Again from 2009 it started
rising.

Source: Author’s computations based on data from World Development Indicators of

the World Bank

2.2 FDI Inflows and Foreign Aid into LDCs

FDI inflows into Less Developed Countries are mostly in the form of direct
investment. Figure 2 summarizes the FDI and Official Development
Assistance flows to Less Developed Countries. FDI and Foreign Aid both are
moving in similar pattern although FDI inflows dominate the Foreign aid.
There is slight downturn in 2008 in foreign aid but it started rising again 2009.
Do Capital Inflows Contribute to Economic Growth of the Least Developed 153

Source: Author’s computations based on data from World Development Indicators of

the World Bank

Figure 3 summarizes the FDI and Gross domestic savings in LDCs from
the period of 2000 to 2018. Here it is evident that gross domestic savings as a
percentage of GDP is decreasing in response to decrease in FDI during 2008
to 2009 although FDI started falling from 2007. This is because investment
creates return and thus savings. As foreign direct investment declines so does
gross domestic savings.

Source: Author’s computations based on data from World Development Indicators of

the World Bank

Source: Author’s computations based on data from World Development Indicators of

the World Bank
154 Journal of Banking & Financial Services

Figure 4 summarizes the foreign aid and gross domestic savings of the
LDCs from the period of 2000 to 2011. Foreign aid is rising steadily from
2000 to 2018 whereas gross domestic savings is decreasing from 2007 to
2008 and started rising again in 2009.

3. Literature Review

There have been large number empirical and theoretical studies in the recent
years on capital inflows and their impact on macroeconomic variables.
Recently, Alfaro et al. (2005) examine the empirical role of different
explanations for the lack of flows of capital from rich to poor countries the
“Lucas Paradox”. The results indicate that foreign direct investment might be
a channel that can foster economic growth. The effect of FDI on economic
growth is dependent on the level of human capital available in the host
economy. There is a strong positive interaction between FDI and the level of
educational attainment (E. Borensztein et al., 1998). Foreign direct investment
and portfolio equity inflows stimulate long-term economic growth of
developing countries (Helmet Reisen and Marcelo Soto, 2001). Blomstrom et
al. (1992) conclude that per capita income growth in developing countries has
a positive relationship with the average FDI inflows to GDP ratio.

According to Morrissey (2001), foreign aid may contribute to economic

growth by increasing investment in physical and human capital, as well as in
the capacity of the country to import capital goods and technology. A
substantial increase in investment financed largely by foreign loans and grants
has led to rapid growth of GNP followed by a steady decline in the
dependence on external financing (Hollis B. Chenery and Alan M. Strout,
1966). The study by McGillivray (2005) shows that the foreign aid granted to
African countries not only increases economic growth, but also reduces
poverty. Levy (1988), Gomanee et al. (2005), Ekanayake and Chatrnas (2010)
also present some evidence according to which foreign aid has contributed
positively to economic growth in SSA countries by financing public
investment.

Hsiao and Shen found a feedback association between FDI and GDP in
their time series analysis of the data from China. Using data on 80 countries
for the period 1971–95. Choe detects two-way causation between FDI and
growth, but the effects are more apparent from growth to FDI. Kafi, Uddin &
Islam showed the problems and prospects of FDI in Bangladesh and they have
identified some key factors to increase FDI in Bangladesh. In addition,
Stimulate. Investigates the direction of causal link between FDI and economic
Do Capital Inflows Contribute to Economic Growth of the Least Developed 155

growth measured by GDP in nineteen developing countries of South East Asia

and Latin America using co-integration technique. The relationship between
growing FDI stock and economic growth has motivated a voluminous
empirical literature in developed and developing countries. Aitken et. al.
confirmed the existence of a positive and significant relationship between FDI
and the economic growth in the United States.
Borensztein, De Gregorio, & Lee, (1998)found in a cross-country
regression framework for 69 less-developed countries in the period 1970-89,
that inward FDI has positive effects on growth through its interaction with
human capital. And FDI contributed more to growth than domestic investment
and it also had the effect of increasing domestic investment. According to
them, it should be noted that growth equations are extremely sensitive to
proxies of human capital. In a panel data framework for a sample of 18 Latin
American countries for the period 1970-99, Bengoa & Sanchez-Robles,
(2003) stated that in order for a positive effect from FDI to be achieved, the
country must have an adequate level of economic stability, and liberalized
capital markets, as well as human capital. Li & Liu, (2005) in a panel data
analysis for 84countries over the period 1970-99 found that FDI affects
growth directly and also indirectly through its interaction with human capital.
Regarding the complementarily between domestic and foreign investment,
(Kentor, 1998) calculated foreign capital dependence and showed that
countries with a relatively high dependence on foreign capital exhibit slower
economic growth than less-dependent countries for the years 1940-1990,
which also supports the earlier findings of (Dixon & Boswell, 1996). They
argued that foreign investment has an initial positive effect on growth but in
the long run the dependence on foreign investment exerts a negative effect on
growth, because the infrastructure and institutions that develop with foreign
investment support further foreign investment; and negative externalities such
as unemployment, over-urbanization, and income inequality perpetuate the
problem. (Kentor & Boswell, 2003) selected a different measure -foreign
investment concentration - the percentage of total foreign direct investment
stocks accounted for by the top investing country, still illustrated a long term
negative effect on growth. De Mello, 1999utilizing a sample of OECD and
non-OECD countries over the period 1970-90, concludes that the long-term
growth in host countries is determined by the spill over’s of technology and
knowledge from the investing countries to host countries, and its extent is
determined by the complementary and substitution between FDI and domestic
investment. In the non-OECD sample, he demonstrated no causation from
FDI to growth based on fixed effects regressions and a negative short run
156 Journal of Banking & Financial Services

impact of FDI on GDP, indicating that growth benefits may be restricted to

higher income countries. Along this same theme, (Blomstrom, Lipsey, &
Zejan, 1994)in across-country analysis of 78 developing countries also found
that FDI had positive effect on growth rates for higher income developing
countries, but not for lower income ones. Finally, the trade regime also plays
a role in the transmission of positive growth effects from FDI.
Balasubramanyam, Salisu, & Sapsford, 1996 using an annual cross-sectional
data for 46 developing countries in a fixed effects model supported that the
growth effect of FDI is positive in the export promoting countries but
negative in the import substituting ones. Similarly, (Zhang, 2001), using
cointegration and error correction techniques, found FDI enhances economic
growth in Hong Kong, Indonesia, Singapore, Taiwan, and Mexico from 11
selected countries in the study; and for the other six countries without
cointegration links, unidirectional causal effects were disclosed in five
countries.

Agbloyor, Gyeke-Dako, Kuipo, & Abor, (2016) showeda direct and

positive relationship between FDI and economic growth. They also found a
direct relationship between institutions and economic growth. But Alvarado,
R., Iniguez, M., & Ponce, P. (2017) found robust empirical evidence that
suggests that the effect of FDI on economic growth is not statistically
significant in aggregated form. Mohamed, Singh & Liew, (2017) used vector
error correction modeling (VECM) to 1970-2008 data to analyze the long-run
causal relationship between foreign direct investment (FDI), domestic
investment (DI) and economic growth in Malaysia. Their results suggest a
long-run bilateral causality between economic growth and DI but there is no
evidence of causality between FDI and economic growth. On the other hand,
the results suggest a short-run crowding-in effect between FDI and DI.
Sunde(2017) indicated that both foreign direct investment and exports spur
economic growth. The study also confirmed that the government could
stimulate FDI through incentives to investors, creation of a good
macroeconomic environment and a careful utilization of loose monetary
policy to grow the economy.

4. Methodology and Data

4.1 The Analytical Framework and Econometric Procedure

To examine the impact of capital flows (Foreign Direct Investment and

Foreign Aid) on economic growth in less developed countries, I use an
aggregate production function ( which incorporates FDI, FA and other
Do Capital Inflows Contribute to Economic Growth of the Least Developed 157

relevant variables in the model. The model is based on endogenous growth

model which uses the Cobb-Douglas production function as the aggregate
production function of the economy, is given by the following formula:
...................................................................................Eqn. 1

Where is the output of the economy and represents real GDP at time t:
are respectively the productive factor, the capital stock and the
labor stock at time t1, is the disturbance term and is a base of natural logs.
According to Samuel (2013), the impacts of FA and FDI are captured
through the component of ( ). Since the objective of the study is to
capture the impacts of FA and FDI inflows on economic growth through the
changes in , we therefore assume that is a function of FDI and FA.
Therefore,

........................................................Eqn. 2

By combining equation 1 and 2,

.......................................................................Eqn. 3

Taking natural logs of equation (3),

.........................Eqn. 4

More formally,

..................Eqn. 5

Here a is the constant and is the error term.

Pesaran and Shin (1995) showed that the estimators of the long-term
coefficients, which are based on the ARDL procedure, are super-consistent,
and that inferences about the long-term parameters can be made by using
standard asymptotic theory. To apply the ARDL approach, Equation (5) may
be specified as a conditional ARDL-error correction model as follows:

...Eqn. 6

1
Contrary to Solow’s neoclassical growth models, changes in the rate of investment and in
government policies in endogenous growth models may impact on the short- and long-term
growth rates of the economy.
158 Journal of Banking & Financial Services

Where j denotes country and is drift component; white noise error

term, ln Y , the natural log of real GDP; ln FDI, the natural log of foreign
direct investment; (FA), the natural log of official development assistance;
ln(Cap), the natural log of the gross capital stock; ln(LAB), the natural log of
the labour force; p, the optimal lag length; and the first difference operator;
, the short run effects in the model, while
represents the long run elasticities.

To check the robustness of our result we also the following to present the
empirical relationship between FDI and GDP. This model is also used to show
a co-integration analysis between FDI and GDP.

Model Specification: ............................Eqn. 7

Where, is the Gross Local Product (Millions USD), is the Foreign
Direct Investment (Million USD), represents regression coefficients for
the independent variable.

Hypothesis
H0 = There is no relationship between FDI and GDP (β1=0)

H1= There is a relationship between FDI and GDP (β1≠0)

The regression shows an affirmative correlation between FDI and GDP,

that reveals the participation of FDI in the economic growth of Bangladesh.

4.2 Data

The data used in this paper come from the World Development Indicators of
the World Bank, covering the period 2000 to 2011. Data format is panel data
for each low income country (Appendix A) consisting of real GDP, foreign
direct investment in current US dollars, foreign aid in current US dollars, the
labor force, and the gross capital stock as a proxy for investment.

5. Empirical Results

Table 1 summarizes the results of the empirical framework. Column (I) used
log_gdp as a dependent variable. In this short-term effect, the coefficient of
FDI is significant and has a positive sign indicating that FDI has a positive
impact on economic growth, since FDI inflows into developing countries not
only act as a complement to domestic credit, but they also help to introduce
new technologies and innovations in host countries while providing them with
better job opportunities. In addition, the capital stock also has a positive and
Do Capital Inflows Contribute to Economic Growth of the Least Developed 159

significant impact on economic growth. The impact of foreign aid and labor
force on economic growth are also positive and significant.

Table 1: Autoregressive distributed lag estimates (ARDL) based on

Schwarz Bayesian criterion
(I) (II)
Regressors D.log_gdp D.log_GNI
Short Run Effects
log_FDI 0.050*** 0.040**
(0.016) (0.016)
log_FA 0.063 0.060
(0.055) (0.055)
log_Cap 0.349*** 0.373***
(0.074) (0.075)
log_LAB 0.890*** 0.914***
(0.050) (0.050)
Long Run Effects
log_gdp (-1) -0.871*** -0.902***
(0.074) (0.075)
log_FDI (-1) 0.018 0.016
(0.021) (0.022)
log_FA(-1) 0.277*** 0.298***
(0.077) (0.078)
log_Cap (-1) 0.423*** 0.402***
(0.116) (0.117)
log_LAB (-1) 0.673*** 0.717***
(0.089) (0.090)
Constant 2.073** 1.710*
(1.006) (1.016)
Observations 204 204
R-squared 0.927 0.928
Adjusted R-squared 0.924 0.924
A: Hetero. 0.970 0.640
(0.323) 0.423
B: RESET (1) 7.380 6.840
(0.000) 0.002

Notes: Following Pesaran and Shin (1997), lag order of the ARDL model was
selected using the Schwarz Bayesian Criteria (SBC), and the LM tests for testing
residual correlation. ∆ denotes the first difference of each variable. FDI denotes
Foreign Direct investment, FA denotes Foreign Aid, Cap Gross Capital stock
formation, LAB denotes Gross Labor force. The probabilities of 2 χ for the diagnostic
160 Journal of Banking & Financial Services

tests are represented in square brackets. A: Lagrange multiplier based on the Breusch-
Pagan test for residual serial correlation; B: Ramsey's RESET test using the square of
the fitted values; Standard errors in parentheses *** p<0.01, ** p<0.05, * p<0.10.

In the long run effect, the coefficient of FDI is significant and has a
negative sign indicating that FDI has a negative impact on economic growth,
since FDI inflows into developing countries but may as a result of inefficient
use of this FDI it creates a negative impact on economic growth in the long
run. All the others variable appears to be same as short run effect. The
robustness of the result is also checked in column (II) by taking log_GNI as
a dependent variable and the results appears to be same as the previous
empirical results.

5.1 FDI Inflow in Bangladesh

There is no regular trend in the flow of FDI. FDI inbound in Bangladesh

occasionally. Not every time, every day, every week. After so many steps FDI
initiated in Bangladesh. The flow of FDI increased at a staggering rate of
64.45, 47.16 and 182.86 percent in FY 1997-98, FY 2000-01 and FY 2004-05
respectively than that of FY 1996-97, FY 1999-00 and FY 2003-04. The flow
of FDI totals at USD 600.12 million, USD 400.42 million and USD 803.11
million in FY 1997-98, FY 2001-02 and FY 2004-05 respectively. After FY
2004-05, the flow of FDI declined in the next year. Year on year basis, total
FDI inflows (net) accomplished to US$ 1526.7 million during CY 2014 which
was decreased by US$ 72.46 million or 4.53% compared to FDI inflows (net)
during CY 2013 (US$ 1599.16 million). While in CY 2013 FDI inflows (net)
was increased by US$ 306.6 million or 23.72% compared to CY 2012 and an
increase of US$ 156.18 million or 13.74% during the CY 2012 compared to
CY 2011.

Figure 5: FDI Inflows (in million USD) in Bangladesh, 2014-15

Source: Statistics Department of Bangladesh Bank, Survey report 2014-2015

Do Capital Inflows Contribute to Economic Growth of the Least Developed 161

5.2 FDI Inflows by Sectors

Sector-wise analysis of FDI reveals the fact that a shift has been made by the
foreign investors in their investment in Bangladesh. Sectoral contribution in
Bangladesh economy is to be very carefully analyzed. The content shows the
trend of FDI towards power and energy, manufacturing and
telecommunications, whereas the neglected sectors were agricultural, services
and trade and commerce. In 2015, the main focus of investment was in the
power sector. The success in textiles through the ready-made garments
(RMG) industry was a important part of this investment. The RMG brings
foreign money for the economy. The pie chart shows the shift of FDI in the
sectors of Bangladesh. The pie chart draws a clear picture how the dimensions
of FDI inflows have changed in recent years.
Figure 6: FDI Inflows (in million USD) by sectors in Bangladesh (Panel
A: 2011-15 & Panel B 1996-2014)

Other Power Gas &

7% 11% petrole
Teleco um
mmunic 18%
ation Textile
21% &
wearing
14%

Banking
MfgFertilize
12%
Cement (other) r
9% 3% 5%

Source: Statistics Department of Bangladesh Bank, Survey report 2015

162 Journal of Banking & Financial Services

In the above 2 figures, it is clearly shown that the percentage of investment in

different sectors has changed quite a lot. The percentage of investment in
telecommunication sector was 21% in 1996-2000 & 43% in 2006-2010. On
the other hand, the portion of investment in the gas & petroleum sector has
declined gradually during the year of 1996 to 2010. It was 28% in 1996-2000,
18% in 2001-2005 and only 13% in 2006-2010. It is also a matter of great
concern that the investment in energy sector has decreased from 11% to only
3%, which is very alarming. Energy sector is very important sector for
Bangladesh economy. The development index depends the enrichment of
energy sector. If a country is enriched with energy sector that country is
developed. Development of the economic stability of a country flourishes by
so many ways. Energy consuming, energy dependence, energy production,
distribution, generation, reservation all the finds should have to maintain
properly. The government should take a close look in this matter and take
necessary steps to identify the causing factors and to rectify those to improve
our present energy sector conditions.
5.3 Foreign Direct Investment and Portfolio Investment

Portfolio investment is a very sensible topic for FDI. Now a days the Chinese
group started a new venture with DSE for the new hope in Bangladesh.
Chinese participation in the capital market makes the investors hopeful. In the
others sectoral investment has raised in the last few decades.FDI inflow in
FY2015 has yet to pick up after facing a downturn in the last quarter of 2013.
During July-October 2014, FDI inflow was about USD 463 million which is
5.6 per cent higher compared to the same period of the last year. This rise
took place over the negative growth examined in the same period of FY2014
(-16.6 per cent). Unlike FDI, foreign portfolio investment has registered a
significant rise over the same comparable periods (53.4 per cent). Due to
weak institutional structure and poor governance in the capital market,
movements in major indices in the stock exchanges often failed to reflect
actual economic scenario. As a result, foreign investment in the capital market
often takes place based on weak market information. Concerns have been
raised in some of the other countries regarding ‘round-tripping’ nature of FDI
whereby capital outflow returns to home country as ‘foreign investment’.
Time has come to look at this issue in Bangladesh as well. In fact, India has
recently identified that about 10 per cent of its FDI are ‘round tripped’ which
ranged between 1 per cent in IT and ITES sector to as high as 38 per cent in
infrastructure sector. A part of FDI during July-November 2014 was directed
to different EPZs which was to the amount of USD 142 million. This FDI has
Do Capital Inflows Contribute to Economic Growth of the Least Developed 163

been concentrated mainly in Chittagong, Karnaphully and Dhaka EPZs

because of the relative benefits in terms of location, infrastructure and
logistics. However, existing EPZs are increasingly facing constraints to
accommodate new investment due to lack of adequate land and other
infrastructural facilities. In view of this, foreign investors have started to take
interest in other EPZs such as Mongla, Adamjee, Ishwardi and Uttara EPZs.
But infrastructure, logistics, housing for workers and other facilities need to
be much improved in these EPZs to attract and accommodate more FDI.

Figure 7 summarizes the FDI and portfolio investment from the year 2000
to 2018. It is evident that there is a steady growth in foreign direct investment
and there is a fluctuation in portfolio investment over times. But it also has
been steadily growing since 2015.

5.4 Impact of Economic Factors on Foreign Direct Investment

There are so many impacts of FDI in any country. Bangladesh is an emerging

economy. It is astonishing for the other country that did not believed in. After
the great liberation war in 1971 Bangladesh were faced with several problems
such as fragile economy, huge damage, no food, no cloths, no medicine etc.
On the other hand, a huge population in our country was starving, mass
people were died without proper treatment. The infrastructures were
destroyed by the brutal force of Pakistan. A newborn nation just started its
journey with a sky limit problem. The newborn nation with a huge number of
populations. The country was expecting foreign aid from different countries.
At the earlier stage of independence many countries didn't acknowledged
Bangladesh as a sovereign nation which was a major obstacle for getting
foreign direct investment. But the scenario has changed in recent times which
was evident from rapid GDP growth and export scenario (See figure 8&9).
164 Journal of Banking & Financial Services

Source: Author’s computations based on data from World Development Indicators of

the World Bank

Source: Author’s computations based on data from World Development Indicators of

the World Bank

If a country’s inflation rate increases relative to the countries with which it

invests, its capital account would be expected to decrease, other things being
equal. Consumer and corporations in that country will most likely purchase
more goods or invest more in overseas (due to high local inflation), while the
country’s exports to other countries &flow of investment from foreign will
decline. However, the inflation is at stable level with the rapid growth of GDP
and investment (see figure 10).

Source: Author’s computations based on data from World Development Indicators of

the World Bank
Do Capital Inflows Contribute to Economic Growth of the Least Developed 165

5.5 FDI Inflows by Components

Figure 11: FDI Inflow by Components, 1996 and 2014

Source: Statistics Department of Bangladesh Bank, Survey report 1996 and 2014

FDI in Bangladesh consists of three components: Equity capital, Reinvested

Earnings and Intra-company loans. These components have fluctuated
considerably in the last two decades. The shifting of component wise FDI
inflow in Bangladesh is clearly visible in the above two figures. In recent
years, the major portion of FDI inflow in Bangladesh come in equity capital
form. In 1996 the share of equity capital in total FDI was 30 percent which
increases to 57 percent in 2010. In 1996 share of reinvested earnings was 53
percent which decreased to 40 percent in 2010. On the other hand, share of
intra-company loan was 17 percent which then decreased to 3 percent in 2010.
166 Journal of Banking & Financial Services

This shows that the net transfer of resources from abroad into Bangladesh is
fairly negligible.

5.7 Foreign Direct Investment and economic growth of Bangladesh

The data of FDI can explain 83.18% growth of GDP. Therefore, the FDI has a
strong role for the economic development of Bangladesh. So the FDI can have
positive contribution in the development of Bangladesh Economy, especially
different sector like Garments, Banking, Telecommunication, Fertilizer and
other manufacturing sectors.

Table 3: Descriptive Statistics, Regression Statistics and ANOVA

GDP FDI

Mean 45399.90625 Mean 314.3325

Standard Error 4543.11788 Standard Error 64.66950952
Median 40548 Median 161.955
Standard Deviation 25699.75568 Standard Deviation 365.8259897
Sample Variance 660477442.2 Sample Variance 133828.6548
Kurtosis 0.893726729 Kurtosis -0.544297816
Skewness 1.207893595 Skewness 0.833771101
Range 95624 Range 1143.06

Regression Statistics

Multiple R 0.912025013
R Square 0.831789625
Adjusted R Square 0.826182612
Standard Error 10714.59116
Observations 32

The data reveals there is very significant impact among two variables as
the Significance F is much less than 0.05 and the Sum of Squares and Mean
Squares are very high. Here F-statistics is greater than upper bound so the null
hypothesis is clearly rejected.
Do Capital Inflows Contribute to Economic Growth of the Least Developed 167

ANOVA

df SS MS F Significance F
Regression 1 1.7E+10 1.7E+10 148.3481 3.84451E-13
Residual 30 3.4E+09 1.15E+08
Total 31 2E+10

The coefficient of intercept is 25260.3286 and FDI is 64.0709 so it is clear

that if FDI changes by 1 unit then the GDP will definitely change by 64.0709.
As p-value is much less than 0.05 therefore null hypothesis will be rejected.
So, it is clear that there is a strong impact of FDI in the growth or GDP of
Bangladesh.

Standard Upper
Coefficients Error t Stat P-value Lower 95% 95%

Intercept 25260.32322 2514.3 10.04666 0.0000 20125.43704 30395.21

FDI 64.07095362 5.26042 12.17982 0.0000 53.32774817 74.81416

From the above analysis we can conclude that there is a high degree of
correlation (0.912024962) between FDI and GDP. If the FDI increases then
the GDP will obviously increase, consequently it will improve the economic
growth, employment, per capita income and also lower inflation of the
country. So, the government should promote the foreign investors to invest in
different prospective sectors like Agriculture, Service such as transportation,
railway and airline, electricity and power, fertilizer and cement.

GDP FDI

GDP 1

FDI 0.91 1

In Bangladesh FDI plays a very crucial role in achieving expected

economic growth. FDI flows have been successful in increasing GDP. At the
same time, FDI has also made a significant contribution in improving the
income level of Bangladesh. However, this increase in FDI can fully ensure
Bangladesh to realize higher growth by having the capabilities of using the
resources. There is an increasing trend in foreign investment due to positive
effect of the incentives provided and changes in our economic policies. FDI
has positive correlation with GDP, export and private investment.
168 Journal of Banking & Financial Services

6. Conclusion and Recommendation

The purpose of this study was to examine empirically the relationship

between foreign direct investment, foreign aid, and economic growth in Less
Developed Countries. More specifically the study aimed to test for the
efficiency of external factors through their impact on economic growth in
Less Developed Countries during the period 2000-2011. To explain the
changes which occurred in real GDP over the study period, the model retained
as independent variables, the labor force, the capital stock (domestic factors),
and external factors such as official development assistance and foreign direct
investment. The results of the econometric analysis of this study have shown
that the share of investment, which is proxied by the capital stock formulation
in GDP, and foreign direct investment (FDI) have positive and significant
impacts on growth. In addition, foreign aid also was found to have a positive
but insignificant impact on growth.

From the perspective of Bangladesh, good governance is a cure for FDI.

Good governance denotes a desirable state of affairs and so is the key to
success of all the reforms. Political and bureaucratic accountability are the
two principal components of good governance, and without ensuring them,
good governance is not possible. Accountability is more important for
economic development. The more accountability the more governance will
sustain in Bangladesh. Accountability and transparency continue to remain
the twin elusive prerequisites for the overall development of the country.
Investing in private sector and inflow of FDI occasionally administrative
barriers that arise out of a lack of transparency and accountability, which
logically leads to inefficiency and corruption. Competence and efficiency,
which are both appallingly, lacking in the bureaucracy, will both become
achievable goals with the infusion of transparency in decision-making and
governance. This will also greatly reduce what is commonly known as “red-
tapism” or "bureaucratic wrangling" since the tiers of the decision-making
process are bound to become fluent and responsible if they are held
accountable for their job. Co-ordination among state agencies is an important
matter for investment. Co-ordination among state agencies will make
effective each other. Confirming enough co-ordination among ministries,
departments, regulatory bodies and prompt decision making in the
implementation procedure will enlarge the flow of investment. The legal
authority, implementation body, supplier etc. should work among each other.
FDI will radically change for proper co-ordination. Regulatory authority
should be more strengthen. Strengthening the regulatory authority is much
Do Capital Inflows Contribute to Economic Growth of the Least Developed 169

needed. Government agencies responsible for facilitating investment need to

be more active. In this regard, full freedom to the agencies like the central
bank, investment promotion agencies, telecom regulatory body, energy
regulatory commission, Securities and Exchange Commission’s etc. is a
prerequisite. The state organs should be in proper settlement. Proper size of
state organ and makes balancing of that is very important if not that will be
more hazardous. The size of the state organs is quite large and thus mostly
inefficient, unproductive and hazardous. So, rightsizing the government is
important. The different organs inter link should be the smooth and entrusted.
Shape should be sufficient consists of expert, technically sound people and
that should not be the overpopulated. If that could be confirmed by reducing
the number of executives in the decision-making process in different state
organs, transparency and accountability of bureaucracy can be established.
Offering a reasonable compensation package to the officials retained is also
one of the major determiners in ensuring transparency and accountability.
Judicial reformation is very important. For good governance sound
governance is important. A sound judicial system, which is a must for good
governance, is possible when the judiciary can exercise its authority
independently. Judicial system should be uninterruptable. It should be free of
consent. Judicial separation from executive body is helpful for the people. In
this regard, separation of the judiciary from executive branch of the
government is essential as influence of the executive on the lower judiciary
continues to be exercised. In present days the executive body exercises their
power and completes their job efficiently. It will make entrusted to the
investors and will be beneficiary for FDI. Ensuring the capacity building is
important. The cases could be disposal faster for the time being trade laws
should be properly updated. This is the demand of time. There is need for
capacity building in the judicial system in order to ensure speedy disposal of
cases. Archaic laws, especially those related with trade and investment should
be updated in line with the needs of the day. Corruption should be abolished.
Unfair means should let not be practiced. Corruption should be stopped
immediately. In banking sector should be corruption free. Tackling corruption
in banking, power, other state-owned enterprises and tax administration ought
to be an urgent priority. A comprehensive mandate of the corruption problem
in financial institutions, energy and other state-owned enterprises will require
privatization along with independent regulatory bodies functioning in the
public sector. Gradually allowing the policy challenges is to define the
practically of public sector. Fiscal policy may have to be easier. Regarding tax
administration, reform option includes establishing an autonomous tax
170 Journal of Banking & Financial Services

institution with proper incentive and accountability. Countries of the region

can learn from the foreign experience of a number of countries including the
Internal Revenue Service of the USA. There is, however, a need for further
deregulation of authority. It is also necessary to establish a coordinating
mechanism to take decisive and continuous steps in resolving problems
identified in relation to project implementation. Infrastructure is vital element
for all kind of investment. The main policy challenge is to redefine the role of
public sector in infrastructure development by gradually allowing the private
sector to play a bigger role. Public sector’s role should be restricted to
regulatory functions only. Mention may be made here that, Bangladesh’s
existing Industrial Policy includes infrastructure as a thrust sector
acknowledging a lead role of the private sector supported by special
incentives and the Finance Minister of Bangladesh, in his 2002 budget speech,
stressed the need for more private sector participation in infrastructure
development of the country. The Infrastructure Investment Facilitation Center
(IIFC) of Bangladesh has been interacting with the private sector to attract
private investment in this sector. Other countries of the region could take
lesson from Bangladesh in this regard.

Bangladesh offers a well-educated, highly adaptive and industrious

workforce with the lowest wages and salaries in the region. It is contributing
in the economy by delivering qualified, educated, technically sound
workforce. In a report says that 57.3% of the population is fewer than 25,
providing a youthful group for recruitment. The country has consistently
developed a skilled workforce catering to investor needs. English is widely
spoken, making communication easy. Bangladesh is strategically located next
to India, China and ASEAN markets. As the South Asian Free Trade Area
(SAFTA) comes into force, investors in Bangladesh will enjoy duty-free
access to India and other member countries. Bangladesh has proved to be an
attractive investment location with its 146.6 million populations and
consistent economic growth leading to strong and growing local demand.
Energy prices are the most competitive in Bangladesh. Transportation on
green compressed natural gas is less than 20% of the diesel price. Bangladesh
enjoys tariff-free access to the European Union, Canada, Australia and Japan.
In Europe, Bangladesh enjoys 60% of the market share and is the top
manufacturing exporter amongst 50 least developed countries. Bangladesh
offers the most liberal FDI regime in South Asia, allowing 100% foreign
equity with unrestricted exit policy, easy remittance of royalty, and
repatriation of profits and incomes. Bangladesh offers export-oriented
industrial enclaves with infrastructural facilities and logistical support for
Do Capital Inflows Contribute to Economic Growth of the Least Developed 171

foreign investors. The country is also developing its core infrastructures,

including roads, highways, surface transport and port facilities for a better
business environment. All the government should take care of it.
Foreign Direct Investment in Bangladesh has increased in 2017 by 1706
million USD. FDI investment averages 958.13 million USD from 2002 In the
year of 2017 GDP is 149.7 billion of Bangladesh. That is amazing.
Bangladeshis economically benefitted by FDI. The life expectation index rise
up, living standard has been changed for the Bangladeshi people. FDI may be
a good sign for the Bangladesh economy, not only Bangladesh for all over the
world. After the great liberation war in 1971 Bangladesh faced a very big
challenge for the economic viability. The fragile, broken, war destroyed
economy for the 7.5 core population was a big challenge. The political
stabilization was another concern for the economy. The large population but
not enough jobs for mass group were to be worried for the newborn country.
In the years of eighty some investment started launched in Bangladesh. That
was the opening of FDI in Bangladesh. Now a day’s almost 44countries are
doing business as well as investment. Bangladesh has so far received 53
developed and developing countries across the globe.
In FY 2010-2011 Bangladesh received total 779.04 million USD as FDI
from 44countries. UK is the heights investors by144.6 million USD. In the
sane fiscal year major source of FDI from Netherland 71.41 million USD,
Hong Kong 93.58 USD, 94.18 million from USA.As well as from China,
Japan, UAE, KSA, Korea republic, India. After all if the investment can
function properly the economic conditions will definitely be changed.

FDI benefits for host country. For host country FDI brings some prospects
in many ways. Foreign Direct Investment has some specific benefits for
Bangladesh especially for the Bangladesh economy i.e. people, Industries,
hospitals, infrastructures, roads, bridges, vehicles, technology, employment
effects, sustainability, balance of payments International trade, effects of
competition.

Inaugurating new technology makes the process smooth and convenient. In

Bangladesh economy infrastructural development has changed since last two
decades. Roads and bridges, ports, railways expand. Economic contribution of
FDI is to be determined by evaluating different index for last few years. In
Bangladesh our GDP was 3 or 4 in the early 1990 but it is almost 7.5%
(estimated) in the year of 2018. Per capita income raised almost 1751 U.S.D
GDP growth rate is 7.86%. Living standard has been changed.
172 Journal of Banking & Financial Services

In Bangladesh FDI plays a very important role in achieving expected

economic growth. FD flows have been successful in increasing GDP. At the
same time, FDI has also made a contribution in improving the income level of
Bangladesh. FDI can ensure Bangladesh to realize higher growth by having
the capabilities of using all the resources to the fullest potential. There is an
increasing trend in foreign investment due to positive effect of the incentives
provided and changes in our economic policies. FDI has positive correlation
with GDP, export and private investment.

It is important for a developing country like Bangladesh to modernize the

laws relating to business and investment. It should be done focusing on
foreign practices. The development of new industrial parks can play a very
important role in attracting foreign investment in Bangladesh. The
government may consider setting up new EPZs to encourage export-oriented
investors. Necessary steps should be taken to improve the image of the
country abroad. An investment promotion agency needs to provide functions
such as investment generation and policy advocacy. Bangladesh needs to
strengthen economic and commercial diplomacy in attracting FDI in by rapid
globalization and increasing competition. Bilateral relations with potential
investor countries should be improved. Fast growing GDP is 286.27 billion
nominal and 758.17 billion PPP. The huge population is an advantage for the
economy if they are well trained. Foreign Direct Investment makes the
economy stable of BOP, BOT. Relations among other countries is a hand of
co-operation by FDI as well as profit in the shade of investment.

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174 Journal of Banking & Financial Services

Appendix A

List Less Developed Countries (LDCs)

Afghanistan Kyrgyz Republic

Bangladesh Liberia

Benin Madagascar

Burkina Faso Malawi

Burundi Mali

Cambodia Mozambique

Central African Republic Myanmar

Chad Nepal

Comoros Niger

Congo, Dem. Rep. Rwanda

Eritrea Sierra Leone

Ethiopia Somalia

Gambia, The South Sudan

Guinea Tajikistan

Guinea-Bissau Tanzania

Haiti Togo

Kenya Uganda

Korea, Dem. Rep. Zimbabwe

Volume 12, Number 1, June 2020

Financial Literacy Among University Students in

Bangladesh

Dr. Naheed Rabbani 1

Abstract: Financial literacy is an important means to make better

economic and financial decision. Although there have been several studies
examining financial literacy of the people across the world, there is a lack
of study on young people. Financial literacy is important for the young
people because they often take borrowing and investment decisions.
Wrong financial decisions at the early stage of life could have serious
consequences on financial wellbeing at the later stage of life. This study
examines financial literacy among university students in Bangladesh.
Using data from a survey conducted on the students of the Faculty of
Business Studies of the University of Dhaka, this study provides evidence
that financial literacy is not quite high among the current students of
business programs in the leading university in Bangladesh. The level of
advanced financial literacy is found to be lower than that of basic financial
literacy. The results further show that financial literacy of male students is
significantly higher than that of female students. Moreover, father’s
education, being unmarried, the current level of financial satisfaction and
anxiety about life in the old age positively contributes to the attainment of
financial literacy among students.
Keywords: Financial literacy; Business students; Socio-economic factors;
Bangladesh

1. Introduction
Financial literacy has received immense attention from the academia and
policy makers for its ability to enhance peoples’ decision-making ability.
Financial literacy indicates the ability to understand and apply financial
knowledge in personal financial decisions. In today’s complex financial
markets, people need specialized knowledge to make successful financial and
investment decisions. Lusardi and Mitchell (2011a) found that financial
market has become more global and the characteristics of financial products
have become more complicated than ever before. Generally, a financially
literate person has knowledge relating to money, interest rates, inflation, risk

1
Associate Professor, Department of Banking and Insurance, University of Dhaka,
Dhaka-1000, E-mail: [email protected]
176 Journal of Banking & Financial Services

diversification, and personal finance. Although financial literacy directly

affects savings and investment decisions, it has far reaching influence on
other issues such as retirement planning, financial satisfaction, reducing
anxiety about life in the old age and others (Lusardi and Mitchell, 2007;
Kadoya and Khan, 2018). Financial literacy bears an important implication
for young people as well since they are likely to make borrowing decisions
such as credit card loan, student loan and others. These financial decisions
could have serious implications on future financial conditions of the young
people. Lack of financial knowledge often leads to over borrowing of student
loans or credit card loans at a very young age. Such wrong decisions could
have serious consequences for wealth accumulation (Lusardi, Mitchell and
Curto, 2010). Lusardi and Tufano (2009) found that low financial literacy
could lead to carry high cost debt and to have problems with debt. It is often
found that many people reach retirement age with little or no savings for life
after retirement. Financially literate people save more for life after retirement
and thus can avoid the anxiety about life after retirement (Behrman et al.
2012; Lusardi and Mitchell, 2011b).
Despite the importance of financial literacy in making sound economic and
financial decisions, the overall financial literacy level across the world is low.
Lusardi and Mitchell (2011a) provided evidence of widespread financial
illiteracy in the USA, Germany, the Netherlands, Sweden, Japan, Italy, and
New Zealand even when their financial markets are well developed.
Moreover, Lusardi and Mitchell (2013) analyzed the financial literacy level of
US and across seven other countries and found that financial literacy
remained low regardless of the stage of development of the country and
financial markets. Several other studies provided evidence for low level of
financial literacy in the United Kingdom (Disney and Gathergood, 2012),
Japan (Sekita, 2011, 2013; Kadoya and Khan, 2020), China (Niu, Zhou and
Gan, 2020) and India (Kiliyanni and Sivaraman, 2016). There have been
several studies on the financial literacy level of the college and university
students. Artavanis and Karra (2020) studied the level of financial literacy
among students of a public university in Massachusetts, USA and found low
financial literacy particularly among female, minority and first-generation
students. However, the level of financial literacy is particularly higher for the
university students who have completed finance related courses. Barreto and
Gamble (2020) studied the financial literacy level among undergraduate
university students in the United States. The sample students were selected
both from the finance and non-finance classes. Their results show that a
higher proportion of students correctly answered all the questions testing
Financial Literacy Among University Students in Bangladesh 177

financial literacy. There was divergence of performance among the students

from business backgrounds and others.
The profound importance of financial literacy in making sound economic
and financial decisions and the overall low level of financial literacy across
the world necessitate understanding how financial literacy is determined and
why it is heterogeneously distributed among people. However, despite several
attempt to investigate the issue, what determines the acquisition of financial
literacy is still an inconclusive issue. There have been many studies
explaining financial literacy from different viewpoints. Social learning theory
and consumer socialization theory are two dominant theories explaining how
people acquire knowledge (Ward, 1974; Bandura and Walters, 1977). These
theories could be applied to explain the determinants of financial literacy as
well. According to these theories, people learn from society and from their
experiences. Previous studies relate the acquisition of financial literacy with
social learning and consumer socialization theories. People who are exposed
to outside world and have experience in the commercial and business sectors
are more likely to acquire financial knowledge than other people. Kadoya and
Khan (2018) found that those who work in finance or insurance sectors have
high financial literacy because of the experience of dealing with financial
matters. A number of studies, rather than associating financial literacy with
theories, adapted more practical way to study determinants of financial
literacy by associating financial literacy with acquirers’ demographic, socio-
economic and psychological backgrounds. Although most of the studies in the
field of financial literacy provide some evidence on demographic and socio-
economic determinants, studies providing credible evidence on the
relationship between financial literacy and psychological factors are still
scarce. A group of studies emphasized the need for formal financial education
at the early stage of life for the acquisition of financial literacy. These studies
consider that implementation of financial education programs at the high
school could be a viable option. However, previous studies found that
financial education in the high school curriculum is still very low even in the
developed country contributing to the low level of financial literacy (Beal and
Delpachitra, 2010). Tennyson and Nguyen (2001) provided evidence that
financial literacy improved when students attended compulsory financial
courses.
The study of financial literacy is particularly important for Bangladesh
because of its linkage with better economic and financial decisions.
Consumers and investors in Bangladesh are often found to take irrational and
uninformed decisions, which can be reverted by financial literacy. The young
178 Journal of Banking & Financial Services

generation of Bangladesh has been increasingly using credit cards, mobile and
online financial tools and online financial commercial transaction platforms.
Moreover, a large number of young people have investment in the stock
markets. Following the trend of the developed and developing countries,
financial literacy is believed to be low in Bangladesh as well. However, there
is a lack of empirical studies that provide evidence on the level of financial
literacy of the young generation in Bangladesh. This study examines the level
and determinants of financial literacy among university students in
Bangladesh. This study makes significant contribution to the existing
literature in at least two ways. First, this is the first study, to the best of my
knowledge that examines the level and determinants of financial literacy
among university students in Bangladesh. Second, this study empirically
examines the validity of the social learning and consumer socialization
theories in explaining the acquisition of financial literacy.
The rest of the paper is organized as follows. Section 2 provides literature
review, section 3 describes the data and the methodology, section 4 presents
empirical findings and discussion, and section 5 concludes.
2. Literature Review
Financial literacy is a heavily studied area in empirical finance particularly in
the developed countries. Financial literacy is the ability to make personal
savings and investment decisions (Lusardi, 2008a). Mandell (2007) defined
financial literacy as the ability to evaluate the new and complex financial
instruments and make informed judgments in both choice of instruments and
extent of use that would be in their own best long-run interests. Financially
literate individual possess knowledge about basic financial concepts, such as
the working of interest compounding, the difference between nominal and real
values, and the basics of risk diversification (Lusardi, 2008a, 2008b).
Behrman et al. (2012) defined financial literacy as the ability to process
economic information and make informed decisions about household
finances, wealth accumulation and pension contributions.
Previous studies provide empirical evidence on the association of financial
literacy with economic and financial decisions such as savings, wealth
accumulation, retirement planning, debt management, investment and others.
Empirical studies show that financial literacy has a positive impact on wealth
accumulation. Lusardi (2003) found that financially literate people
accumulated more wealth before retirement and they were more likely to
invest in stock market. In another study conducted on older Americans,
Financial Literacy Among University Students in Bangladesh 179

Lusardi and Mitchell (2007) found that financially literate people were more
prepared for life after retirement. They made proper savings and investment
decisions and as a result accumulated more wealth. They further found that
majority of respondents did not have knowledge about basic financial
concepts and faced difficulties to answer questions relating to money, interest
rates, inflation and personal finance. In line with their findings Behrman et al.
(2012) found that financially literate people contributed more in pension
savings and, thus, generate more wealth. This was particularly concerning for
women, as they were less financially literate than men and were expected to
live longer than their male counterparts. Lusardi and Mitchell (2008) found
that financial illiteracy was widespread among older American women. Since
most of the women were financially illiterate, they could not make proper
savings and investment decisions. This is of particular concern, as women
tend to live more than men and had lower income. Klapper, Lusardi and
Panos (2012) found that the most financially literate were significantly less
likely to report diminished spending capacity and had more saving. Similar
evidence is found in other countries as well. Financial literacy reduced
anxiety about life in old age by making people financially sound (Kadoya and
Khan, 2018; Kadoya et al. 2018). Lusardi and Mitchell (2011b) provided
evidence that financial knowledge had substantial impact on savings for
retirement.

Several studies examined how financial literacy influence debt and

investment behavior. Previous studies show that poor borrowing behavior
primarily emanates from the ignorance about financial concepts (Lusardi,
2008a). Lusardi and Tufano (2009) confirmed that the least financially savvy
incurred high transaction costs, paid higher fees and faced high-cost
borrowing. In their study, the less knowledgeable also reported excessive debt
loads and that they were unable to judge their debt positions. Besides debt,
financial literacy has consequences for investment in stocks. Lusardi (2008)
found that financially illiterate people hardly invested in the stock market.
Moreover, when they invested, excessive trading behavior was observed,
which reduced their return from investing. Previous studies provided special
emphasize on the financial literacy among young people and its economic
consequences. Young people make many financial decisions which have
serious implications on their future wealth accumulations. For example, lack
of financial knowledge often leads to over borrowing of student loans or
credit card loans at a very young age. Such wrong decisions create obstacles
in wealth accumulation. Lusardi, Mitchell and Curto (2010) conducted a study
on young people using data from the 1997 National Longitudinal Survey of
180 Journal of Banking & Financial Services

US Youth. They found that financial literacy level of young people was very
low. Only 27% of the respondents possessed basic knowledge about inflation,
interest rates and risk diversification. Artavanis and Karra (2020) studied the
level of financial literacy among students of a public university in
Massachusetts, USA and found low financial literacy particularly among
female, minority and first-generation students. Beal and Delpachitra, (2003)
examined the financial literacy level of the students of a regional Australian
university. While the students scored fairly well in basic concepts, decision
making skills and knowledge of insurance were very low. Lusardi, de Bassa
Scheresberg, and Oggero (2016) found that millennials had poor
understanding about their students loan. Pults (2019) argued that financial
literacy could be a means to solve student loan problem.

What determines financial literacy has emerged as an important issue

because of the economic consequences of financial literacy. Several studies
investigated demographic and socio-economic factors explaining financial
literacy. Previous studies provided evidence that financial illiteracy was more
concentrated among older people, females, black, and Hispanic (Lusardi and
Mitchell, 2007; Lusardi, Mitchell and Curto, 2010; Kadoya and Khan, 2018;
Sekita 2011, 2013). Moreover, literacy level was found to increase with the
level of educational attainment and income (Lusardi and Mitchell, 2007;
Sekita 2011, 2013). Absence of financial education in High School could
contribute to low level of financial literacy as well. Tennyson and Nguyen
(2001) reported that when students were mandated to take a financial
education course, they performed much better than students in states with no
personal finance mandates. Lusardi and Mitchell (2007) showed that those
who studied economics at school, are more likely to display higher levels of
financial literacy later in life. Moreover, financial literacy was found to be
improved with work experience (Beal and Delpachitra, 2003). Bernheim and
Garrett (2003) found that employees who attended a retirement seminar were
more likely to contribute to pension accounts. Bedsides, psychological factors
such as future orientation and the current level of financial satisfaction also
played a major role in determining financial literacy (Kadoya and Khan,
2020).
3. Variables, Data and mMethodology
3.1 Definition and measurement of variables
Dependent variable: The dependent variable of the study is the financial
literacy. Previous literature did not provide a definite way to measure
Financial Literacy Among University Students in Bangladesh 181

financial literacy. Different authors have measured financial literacy using

different methods. Lusardi and Mitchell (2007, 2008) measured financial
literacy using three questions, Van Rooij, Lusardi and Alessie (2011) used
five questions, and Stango and Zinman (2009) used only one question. This
study generally follows the methodology used by Lusardi and Mitchel (2007)
and Van Rooij, Lusardi and Alessie (2011) to measure financial literacy. A set
of questions is used to measure the basic financial literacy and advanced
financial literacy of the students. This study measured basic literacy by using
four questions on basic financial calculation, concept of inflation and risks of
securities. The questions are as follows:
1. Suppose you had Tk100 in a savings account and the interest rate was 2%
per year. After 5 years, how much do you think you would have in the
account if you left the money to grow?
2. Imagine that the interest rate on your savings account was 1% per year
and inflation was 2% per year. After 1 year, how much would you be able
to buy with the money in this account?
3. Stocks are normally riskier than bonds. True or false?
4. Buying a company stock usually provides a safer return than a stock
mutual fund. True or false?
Furthermore, this study measured advanced literacy by using eight
questions time value of money, risk diversification, risk and return behavior
of securities and functions of a stock market. The questions are as follows:
1. Assume a friend inherits Tk. 10,000 today and his sibling inherits
Tk10,000, 3 years from now. Who is richer because of the inheritance?
2. Which statement describes the main function of the stock market? The
stock market helps to predict stock earnings/ The stock market results in
an increase in the price of stocks/ The stock market brings people who
want to buy stocks together with those who want to sell stocks/ None of
the above/ Do not know.
3. Which of the following statements is correct? Once one invests in a
mutual fund, one cannot withdraw the money in the first year / Mutual
funds can invest in several assets, for example invest in both stocks and
bonds/ Mutual funds pay a guaranteed rate of return which depends on
their past performance/ None of the above/ Do not know.
4. Considering a long time period (for example 10 or 20 years), which asset
normally gives the highest return: savings accounts, bonds or stocks?
182 Journal of Banking & Financial Services

5. Normally, which asset displays the highest fluctuations over time: savings
accounts, bonds, stocks?
6. When an investor spreads his money among different assets, does the risk
of losing money increase, decrease or stay the same?
7. If you buy a 10-year bond, it means you cannot sell it after 5 years
without incurring a major penalty. True or false?
8. If interest rate falls (rises), what should happen to bond prices? Rise/ fall/
stay the same/ none of the above?
We measured basic and advanced financial literacy scores of students by
counting total points from correct answers. Since students answered four
questions in basic financial literacy, each correct question was assigned 0.25
points. Similarly, 0.125 points was assigned for each correct answer of eight
advanced financial literacy questions.
Independent variables: We used several demographic, socio-economic and
psychological factors to examine the determinants of financial literacy among
students. Demographic variables used in this study included gender, age,
marital status, education of the respondents and their parents. Several studies
have found that financial literacy is significantly related to gender and age
(Lusardi and Mitchell, 2008; Sekita, 2011; Van Rooij, Lusardi and Alessie,
2011; Atkinson and Messy, 2012; Kadoya, Khan and Rabbani, 2017).
According to the social learning theory, people learn from observing the
behaviors and actions of others in the society (Bandura and Walters, 1977).
Thus, women are expected to be less financially literate than men, as women
have less opportunity to learn from society and experience. Young people are
expected to be more financially literate than old. Consumer socialization
theory argues that children learn the consumption-related knowledge from
parents, schools, the mass media, and peers (Ward, 1974; Moschis and
Churchill, 1978).
Socio-economic variables used in this study include income, assets,
employment status and occupation. Previous studies provided evidence that
income capacity and balance of assets were related to financial literacy (Guiso
and Jappelli, 2008; Lusardi and Tufano, 2009). The social learning theory and
the consumer socialization theory support the inclusion of employment status
and occupation as independent variables. Since several respondents of this
study were from the evening MBA program which were designed for
employed people, the consideration of employment status and occupation
became important. Economic and financial theories based on psychology and
Financial Literacy Among University Students in Bangladesh 183

behavior emphasize that behavioral patterns affect financial decisions

(Kahneman and Tversky, 1979). Empirical evidence shows that confidence,
trust, financial satisfaction, future orientation, anxiety about life in the future,
and other factors shape the acquisition of financial knowledge (Murphy, 2013;
Kadoya and Khan, 2018; Kadoya et al., 2018). As a result, psychological
factors such as future orientation, the current level of financial satisfaction,
and anxiety were included as independent variables in this study. Table 1
shows the definitions and measurements of variables used in this study.
Table 1: Definitions and measurement of variables
Variable Definition
Dependent variable
Financial literacy Financial literacy is measured by using four questions
(fliteracy) related to basic financial calculations, inflation and
financial instruments.
Advanced financial Advanced financial literacy is measured by using eight
literacy (advfliteracy) questions related to time value of money, risk
diversification, risk and return behavior of securities and
functions of a stock market.
Independent Variables
Gender (gender) 0= male, 1 = female
Age (age) Respondents’ age
Education (edu) Years of education
Father’s education Years of education of respondents’ father
(fedu)
Mother’s education Years of education of respondents’ mother
(medu)
Marital status 1= married, 0= otherwise
Employment status 1= currently employed 0 = otherwise
(emplstatus)
Occupation 1= working in finance and insurance 0 = all other
(occupation) occupations
Household assets
(hasset) Balance of assets (savings, stocks, bonds, insurance, etc.)
of the entire household
Household income Household income
(hincome)
Future orientation 1=respondents who consider the future uncertain, 0 =
otherwise
Financial satisfaction Level of current satisfaction with the family’s financial
(finsatisfaction) situation.
Anxiety (anxiety) Level of anxiety about life during old age on a five-point
scale
184 Journal of Banking & Financial Services

3.2 Data

The data was collected from a survey conducted in the Faculty of Business
Studies of the University of Dhaka. Students from the Bachelor of Business
Administration (BBA) and Master of Business Administration programs
(MBA) in the Department of Banking and Insurance participated in the
survey. Although most of the students participated in this survey were from
the regular BBA and MBA program, several students were from the evening
MBA programs. As a result, the sample ensures representation of respondents
from different demographic, socio-economic and psychological backgrounds.
Students were informed about the objective of the survey and all students
agreed to participate in the survey. Students were given a questionnaire,
which included questions to measure financial literacy and information
regarding demographic, socio-economic and psychological characteristics.
The sample size of this study is 167.

Table 2 shows the descriptive statistics of the main variable of this study.
Results show a moderate financial literacy among the students in Bangladesh.
Average financial literacy score of the respondents were 0.66 out of 1 while
average advanced financial literacy score was 0.59. The average financial
literacy scores indicate that most of the respondents could not answer three
basic financial literacy questions and five advanced financial literacy
questions. The performance seems to be dismal since respondents were the
students of the business programs of the leading university in Bangladesh.
Results further show that 46.71% of the respondents are male and 53.29% of
the respondents are female. Average age of respondents was 25 years and
21.56% were married. On average respondents completed 16.30 years of
education when respondents’ father and mother completed 14.02 and 10.54
years of education, respectively. Descriptive statistics of the socio-economic
factors show that respondents had an average household income Tk.71000
and balance of assets of Tk.2532,000. Moreover, 39.52% of the respondents
are employed and 93.41% of the employed respondents had their job in the
financial sector. Psychological profile of the respondents show that
respondents have mediocre orientation towards future (mean = 2.28 on a five-
point scale), financial satisfaction (mean = 2.38 on a five-point scale) and
anxiety about life in the old age (mean = 2.52 on a five-point scale).
Financial Literacy Among University Students in Bangladesh 185

Table 2: Descriptive statistics

Variable Mean Std. Dev. Min Max Obs
Fliteracy 0.6602 0.2706 0 1 167
Advfliteracy 0.5943 0.2334 0 1 167
Gender 0.5329 0.5004 0 1 167
Age 1.1925 0.4110 1 3 161
Marital status 0.2156 0.4125 0 1 167
Edu 16.2956 1.0527 14 20 159
Fedu 14.0154 4.9258 0 25 130
Medu 10.5424 5.1235 0 20 118
Hincome 2.1018 1.1752 1 5 167
Hassets 2.5329 1.5784 1 5 167
Emplstatus 0.3952 0.6205 0 2 167
Occupation 0.9341 0.2488 0 1 167
Future orientation 2.2754 1.1957 1 5 167
Finsatisfaction 2.3832 0.9801 1 5 167
Anxiety 2.5210 1.0287 1 5 167

3.3 Methodology

We used the linear regression model to examine the determinants of financial

literacy among university students in Bangladesh. Since we examined the
determinants of both basic and advanced financial literacy, we used two linear
regression models. In both the regression models, financial literacy (and
advanced financial literacy) is used as the dependent variable and 13 other
independent variables are used as to represent demographic, socio-economic
and psychological attributes of the respondents. We checked multicollinearity
and autocorrelation issues to confirm that regression coefficients were
unbiased. The regression equations are as follows:

(1)
186 Journal of Banking & Financial Services

(2)
4. Empirical Findings
4.1 Item-wise responses to basic financial literacy and advanced financial
literacy questions

Table 3 reports results from the four questions that measured respondents’
level of basic financial literacy. We used four questions to measure basic
financial literacy. These questions relate to the respondent’s ability to
understand the working of interest rate, effect of inflation, characteristics of
financial instruments and concept of risk diversification. Results from the
survey display high level of financial literacy among Business students in
Bangladesh. More than 80% of respondents could answer first question
correctly and more than two-third of the respondents were able to answer
second and third questions correctly. This reveals respondents have higher
levels of basic economic concepts and financial numeracy. The fourth
question was the most challenging question to answer as fewer than half of
the respondents know buying a stock mutual fund usually provide safer return
than a company stock. Majority of the respondents are not familiar with the
concept of risk diversification.

To understand the depth of financial knowledge of respondents a different

set of questions were used to measure advanced financial literacy. Table 4
shows the responses to advanced financial literacy questions. Majority of
questions are answered correctly by more than 70% of the respondents. The
respondents have a good grasp of time value of money, stock market,
fluctuations of assets and pattern of asset return. They are found to be more
knowledgeable about time value of money, functions of a stock market, and
risk and returns behavior of stocks than functions of a mutual fund and pricing
and features of bonds. More than 50% of the respondents did not know about
the relationship between interest rate and bond price, meaning that
respondents were not aware of how bonds were priced. While a large majority
of respondents could answer correctly to some of the most advanced
questions, only about one-third of the sample knows if a long-term bond could
Financial Literacy Among University Students in Bangladesh 187

be sold before maturity without incurring any penalty. Advanced literacy is

not widespread as only 2.99% could answer all questions correctly. Our
results are consistent with the findings of Lusardi and Mitchell (2007), which
reported that most of the respondents were uninformed about mutual fund and
they knew little about the relationship between interest rates and bond prices.
Table 3: Distribution of responses to basic financial literacy questions

Correct Incorrect Do not

know
1. Suppose you had Tk100 in a savings account 83.44% 11.65% 4.91%
and the interest rate was 2% per year. After 5
years, how much do you think you would have in
the account if you left the money to grow?
2. Imagine that the interest rate on your savings 68.15% 19.11% 12.74%
account was 1% per year and inflation was 2%
per year. After 1 year, how much would you be
able to buy with the money in this account?
3. Stocks are normally riskier than bonds, True or 76.54% 19.14% 4.32%
false?
4. Buying a company stock usually provides a 46.00% 27.75% 26.25%
safer return than a stock mutual fund. True or
false?

Table 4: Distribution of responses to advanced financial literacy

questions

Correct Incorrect Do not

know
1. Assume a friend inherits Tk10,000 today and 71.60% 20.38% 8.02%
his sibling inherits Tk10,000 3 years from now.
Who is richer because of the inheritance?
2. Which statement describes the main function 74.69% 21.00% 4.31%
of the stock market? The stock market helps to
predict stock earnings/ The stock market results
in an increase in the price of stocks/ The stock
market brings people who want to buy stocks
together with those who want to sell stocks/
None of the above/ Do not know.
188 Journal of Banking & Financial Services

3. Which of the following statements is correct? 45.00% 32.64% 22.36%

Once one invests in a mutual fund, one cannot
withdraw the money in the first year / Mutual
funds can invest in several assets, for example
invest in both stocks and bonds/ Mutual funds
pay a guaranteed rate of return which depends
on their past performance/ None of the above/
Do not know.
4. Considering a long time period (for example 63.19% 36.20% 0.61%
10 or 20 years), which asset normally gives the
highest return: savings accounts, bonds or
stocks?
5. Normally, which asset displays the highest 74.53% 24.85% 0.62%
fluctuations over time: savings accounts, bonds,
stocks?
6. When an investor spreads his money among 76.07% 18.41% 5.52%
different assets, does the risk of losing money
increase, decrease or stay the same
7. If you buy a 10-year bond, it means you 35.58% 53.38% 11.04%
cannot sell it after 5 years without incurring a
major penalty, True or false?
8. If the interest rate falls/rises, what should 49.69% 45.96% 4.35%
happen to bond prices: rise/fall/stay the
same/none of the above?

4.2 Regression results

We used two linear regression models to examine the determinants of
financial literacy among university students in Bangladesh. Model 1 shows
the regression coefficients of the basic financial literacy and Model 2 shows
the regression coefficients of the advanced financial literacy. Results of
Model 1 show that gender has significantly negative relationship with
financial literacy, meaning that males are more financially literate than
females. Other demographic factors such as age, marital status, and education
do not have significant relationships with financial literacy. Results further
show that no socio-economic factor has any relationship with financial
literacy. Among psychological factors, respondents’ current state of financial
satisfaction and anxiety about life in the old age have significantly positive
relationships with financial literacy meaning that respondents who are
currently satisfied with their financial condition and those who are anxious
Financial Literacy Among University Students in Bangladesh 189

about life in the old age are more financially literate than their counterparts.
However, respondents’ future orientation does not have relationship with
financial literacy. Model 2 shows the determinants of the advanced financial
literacy. Advanced financial literacy measures the ability of the respondents to
understand functions of a stock market and the behavior of pricing and risks
of financial securities. Results show that gender has significantly negative
relationship with financial literacy meaning that males are more financially
literate than females. Moreover, marital status has a significantly negative
relationship with advanced financial literacy meaning that unmarried
respondents have more advanced financial literacy than married respondents.
Other demographic factors such as age and education are not related with
financial literacy. Results further show that no socio-economic and
psychological factor has any relationship with financial literacy.
The findings of this study need explanation in the context of previous
studies and scenario of Bangladesh. This study finds that gender is the most
significant and consistent predictor of financial literacy of students in
Bangladesh. Males are found to be substantially more financially literate than
their female counterparts. This finding is consistent with the study of Lusardi
(2008), which found that males are more financially literate than females.
Moreover, Lusardi, Mitchell and Curto (2010) found that males performed
significantly better than females in financial literacy. This finding is also
consistent with socialization theory, which posits that people learn from the
society. Since males get more opportunity to learn from others, they are more
financially literate. Moreover, this study provides evidence that father’s
education significantly contributes to the attainment of financial literacy.
Family characteristics is an important determinant of financial literacy.
Consumer socialization theory also suggests that father’s education
contributes to the acquisition of knowledge of children. Lusardi, Mitchell and
Curto (2010) found a strong association between education and financial
literacy. The evidence that unmarried respondents tend to have more
advanced financial literacy could be due to the time and scope available to
acquire knowledge because they are less engaged in family life. This study
provides evidence on the roles of psychological factors such as the current
state of financial satisfaction and anxiety about life in the old age. Financially
satisfied people are found to contribute to the acquisition of financial literacy,
which is consistent with the previous studies (Kadoya and Khan, 2020).
Moreover, people who are concerned about life in the old age acquires more
financial literacy. I argue that when people become concerned about their
future, they tend to acquire more knowledge to secure their future.
190 Journal of Banking & Financial Services

Table 5: Regression coefficients

Model 1 Model 2
fliteracy Coef. advfliteracy Coef.
Gender -0.1403 (-2.84)*** Gender -0.1063 (-2.27)***
Age -0.0217 (-0.32) Age -0.0417 (-0.64)
Marital status -0.0738 (-1.07) Marital status -0.1391 (-2.13)**
Edu -0.0180 (-0.80) Edu 0.0126 (0.59)
**
Fedu 0.0141 (2.29) Fedu 0.0023 (0.39)
Medu -0.0091 (-1.61) Medu -0.0041 (-0.77)
Hincome 0.0209 (0.84) Hincome -0.0065 (-0.28)
Hassets 0.0147 (0.93) Hassets 0.0078 (0.52)
Emplstatus 0.0464 (1.06) Emplstatus -0.0565 (-1.36)
Occupation 0.1333 (1.40) Occupation 0.0193 (0.21)
Future orientation 0.0211 (1.10) Future orientation -0.0023 (-0.13)
**
Finsatisfaction 0.0502 (2.06) Finsatisfaction 0.0360 (1.56)
**
Anxiety 0.0483 (2.10) Anxiety 0.0010 (0.05)
Cons 0.4748 (1.29) Cons 0.4593 (1.32)
***
F 3.01 F 1.90**
Adj. R2 0.1865 Adj. R2 0.0935
Obs. 115 Obs. 115

Note: z values in parentheses. ***, **, and * represent significance at the 1%, 5%,
and 10% levels, respectively.

5. Conclusion
Financial literacy has been recognized as an important means to make better
economic and financial decision. Although there are serious consequences of
wrong financial decisions, there is a lack of study on the financial literacy
among young people. This study examines financial literacy among university
students in Bangladesh. A survey conducted on the students of the Faculty of
Business Studies of the University of Dhaka provided data for this study.
Linear regression models are used to determine what affect financial literacy
among the students in Bangladesh. This study provides evidence of a
moderate level of financial literacy among the current students of business
Financial Literacy Among University Students in Bangladesh 191

programs in the leading university in Bangladesh. The level of advanced

financial literacy is lower than that of basic financial literacy. The results
further show that financial literacy of male students is significantly higher
than that of female students. Moreover, father’s education, being unmarried,
the current level of financial satisfaction and anxiety about life in the old age
positively contributes to the attainment of financial literacy among students.
However, unlike previous studies, this study finds no association of age,
mother’s education, household income and assets, employment status,
occupation, and future orientation. The moderate level of financial literacy
among the business students is indicative of a low financial knowledge among
the young people of Bangladesh. The concerned authorities should seriously
take this issue into account so that prospective borrowers and investors do not
fall prey to wrong economic and financial decisions.

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194 Journal of Banking & Financial Services
Volume 12, Number 1, June 2020

Impact of Innovation Culture on Organizational

Citizenship Behavior: A Study on Fin-tech Industry
of Bangladesh

Shahrin Ashraf1

Abstract: Innovation is appraised as key to sustainability in the long run

for organizations. In the hyper competitive business climate, successful
organizations tend to embrace innovation in their shared culture and lead
industries with a vantage point. The purpose of this study was to
investigate the effect of innovation culture on the citizenship behavior of
organizational employees. The study worked with two formative constructs
and was tested empirically by structural equation modelling (SEM). The
validity of the measures was ensured by administering confirmatory factor
analysis. The finding suggested significant relationship between two major
constructs, namely innovation culture and organizational citizenship
behavior. The study proposed a conceptual model and the model validation
came from measuring convergent and discriminant validity. The result
implied a substantial impact of innovation culture on the citizenship
behavior of the employees in the viewpoint of fin-tech industry of
Bangladesh.
Keywords: Innovation culture; Organizational culture; Organizational
citizenship behavior; Fin-Tech; SEM

1. Introduction
Innovation has always been the front runner in the turbulent business climate.
Organizations have tried to stay competitive by inventing new offerings and
newer methods to lure both internal and external customers. Here,
organizational culture is key to instilling innovativeness among the employees
(Amabile et al. 1998). It is also suggested that the proper work environment
will facilitate creativity and newness among the employees (Subramanium,
1996). Drawing from the marketing literature, it can be suggested that culture
in any organization plays the pivotal part in instilling belief and effectiveness
among the staff. The culture, when promotes implementing radical new ideas
to the internal customers leads the way for the whole organization to be
innovative.

1
Lecturer, Department of Marketing, University of Dhaka, Dhaka-1000
E-mail: [email protected]
196 Journal of Banking & Financial Services

Organizational behavior is being studied for multiple decades by the

researchers and academicians as suggested by the vast literature. However,
the organizational citizenship behavior (OCB) is one of the core parts in
studying organizational behavior. This OCB was first introduced by Organ
(1988) and it was defined as something that is not included in the payroll
description or for any employee and which is voluntary to any employee.
Organizational citizenship behavior is also known as good soldier syndrome
(Organ 1988) as the soldiers who keep trying and keep putting their effort
which is not asked but required to do their job at hand efficiently. The
definition of OCB also covers the area that the employees who don’t expect
any such reward for such beyond job performance. The concept can be widely
found in the management of flexible organizations where every employee
feels their task as important and as necessary to excel at every level. From the
literature, it is suggested that organizational citizenship behavior enhances the
performances of employees in turn the organization.
This study aims to find the possible effect of the tenets of innovation
culture on the organization citizenship behavior in the context of Bangladeshi
Fin-tech firms. Moreover, this study aims to specify which dimensions of
innovation culture impact significantly on this particular employee behavior.
There are three dimensions indicated by the study whose impact can be
empirically tested and they are: intention for innovation, infrastructure for
innovation and learning orientation. There were other dimensions: innovation
and flexibility, risk willingness, market orientation. These dimensions didn’t
have much impact on the fin-tech cases. The first three dimensions had
significantly led the way for organizational citizenship behavior.
The wide literature on innovation, innovation culture and organizational
behavior have provided an opening for this study. There are extant of research
on how innovation can enhance performance for the organization but there is
no indication as to how innovation culture does so. Moreover, the particular
behavior of organizational citizenship and its relationship with innovation
culture hasn’t been tested on any Bangladeshi context beforehand. This gap in
the literature was being enquired and empirically tested through this study.
Prior researchers have studied the innovation and organizational citizenship
behavior separately. In this study, the relationship between these two
constructs is tested and empirically validated.
The study enquires after the footprint of innovation culture on
organizational citizenship behavior and seeks to answer the following
questions such as: what’s the impact of innovation culture on organizational
Impact of Innovation Culture on Organizational Citizenship Behavior: 197

citizenship behavior? To what measure of significance does innovation

culture dimensions have on organization’s citizenship behavior? To what
extent are these innovation culture and citizenship behavior applicable in the
context of fin-tech firms? Therefore, the research intends to propose a way out
for answering these major research questions. The result of the study
indicated a substantial impact of innovation culture on organizational
citizenship behavior from the standpoint of fin-tech industry of Bangladesh.
The study is outlined as follows: the next section consists of the theoretical
background of the study followed by methodology and sample design. The
analysis of data and empirical findings are set on the next chapter. Finally, the
theoretical and managerial implications are placed with the right concluding
remark.
2. Theoretical Background
The term innovation has been so widely used that the reference became
generic by no means. However, the intention to innovation has always paved
the way in hyper competitive world. The study follows through this
innovation and its impact toward the organizational citizenship behavior
among the employees. The study analyzed through the vast literature of
innovation definition and the strong link between organization citizenship
behavior and innovation and set its own course.
2.1 Organizational Citizenship Behavior
The work environment of any organization has their impact on the internal
and external dynamics. To what extent this environment is significant can be
seen in terms of organizational culture. Organizational culture is the shared
set of belief and value system which germinates a string of norms, mores,
rituals, activities, performance unique to the particular organization. The
definition of organization culture is somehow nonoperational to be precise.
One of the major subsets of organizational culture is organizational
citizenship behavior (Koberg 1987; Organ 1988; Amabile 1996; Hwang
2017). Organizational citizenship behavior is first introduced in theory by
Organ (1988) where he stated this behavior as beyond the employees’ job
related duties or job descriptions. He also noted organizational citizenship
behavior as the good soldier syndrome where the solders i.e. the employees of
any organization considers their effort as non-compensatory and as voluntary
sacrifice to the development of the organization. Here, the employees don’t
even expect any sort of monetary or non-monetary reward for their
extraordinary performances. Prior researchers of organizational behavior have
198 Journal of Banking & Financial Services

also stated that this sort of idiosyncratic behavior is the root reason for
achieving and in maintaining success for any firm. The literature suggests
organization citizen are those who have this idiosyncratic view of their job
and are willing to take on any risk or responsibility which is a far from their
job requirement. They have this vibe of good soldiers who feel empowered to
take on any decision for the fulfillment and improvement of their job
performance, in turn organization performance (Organ 1988; Damanpour
1991; Hwang 2017).
The organizational citizens are the ones who make the utmost difference
for any firm, irrespective of the industry they are in. The extent of literature
on organizational culture suggest likewise. The variables of this OCB
construct are accumulated from the prior literature and they are:
Interfunctional coordination of the internal and external employees, job
satisfaction among the employees, identification of the employees with their
relevant job position and conscientiousness among the employees. The
variables have been chosen from the previous work of Farh (1997); Auh
(2005); Farzad (2008) and Dobni (2006; 2008). They have been tested
empirically and the stimulus and effect were significant enough to continue
this study.
2.1.1 Interfunctional Coordination
Interfunctional coordination can be defined through four Cs’ and they are
coordination, cooperation, cohesiveness and communication (Auh, 2005).
Interfunctional coordination can be stated as the integration and coalition of
various department to achieve one common goal for the organization. This
coherence leads to increased performance by every other employee as well as
every other department. This coordination sets out to accommodate all
different views and inertia and envy among the different functional areas of
an organization and create a sync in the work and flow of activities and
information. It also helps mitigating any sort of unresolved issues, putting out
conflicts and general adoption of strategy throughout the organization. (Auh,
2005). The leadership plays a strong role in coordinating and managing any
new innovation across the organization. By putting aside own interest of
every other department, the organization will succeed if lead as one entity.
The inherent culture will help facilitating common goal for the organization as
a whole. This synergy among all segments is considered as an internal capital
to the organization. Moreover, the greater the communication, the greater the
association will be among the members of the organization, thus fostering a
strong relationship in the process of achieving goals.
Impact of Innovation Culture on Organizational Citizenship Behavior: 199

2.1.2 Job Satisfaction

Job satisfaction is widely studied on any of the business climate. Here, job
satisfaction is considered more of as an antecedent to organizational
citizenship behavior (Moorman, 1993). The relationship between Job
satisfaction and organizational citizenship behavior leads to the fairness
perception among employees (Moorman, 1993). When employees are
contented with their employer along with the firm culture, the citizenship
behavior tends to develop spontaneously. The internal and external job
atmospheres additionally play a significant role in attaining the satisfaction.
Job satisfaction is required to have measures such as clean working
environment of the organization, the interior and exterior must be state of the
art, updated services available to internal employees and external customers,
large number of branches of the organization, cooperation and contribution
toward social welfare activities, secure premise and secure services and lower
bureaucracy in the organization (Farzad 2008). In the process of creating
customer oriented mindset, organization can motivate the employees through
transparent and unambiguous work environment. Job satisfaction and
organizational culture, organizational commitment and presently
organizational citizenship behavior is most interpersonally connected.
2.1.3 Identification with the Organization
Identification with company refers to the belongings of the employee. It is
suggested that employees who stand to up to protect the goodwill of the
company truly accepts the organizations as their family. The identification
with the entity is strongly related to organizational psychology. The
identification comes from the feeling of unanimity among the employees
(Farh, 1997). This feeling of togetherness will lead to a oneness in attaining
the common goal of organization and may as well reduce confusion and
conflicts. The dedication and citizenship behavior among employees may
come from the harmony prevailing in the organization. This particular
variable can be measured by whether employees are willing to defend the
reputation of the company name and fame, willing to take measures to share
positive news with the outsiders, willing to make constructive suggestions to
rectify any mistakes here and there, willing to participate in every other
company meeting without any excuse for breaks. (Farh, 1997).
2.1.4 Conscientiousness
Conscientiousness is one of the major desired characteristics from the
employees’ end. Conscientiousness is defined to be a discretionary behavior
200 Journal of Banking & Financial Services

by an employee where he outperforms the job requirements in obeying rules

and orders, works harder than other fellow employees, takes on newer
challenge, complies with tough responsibility even without management’s
presence, works to improve oneself to improve the work output, takes one’s
work serious enough and respect others to help resolve their problems. (Farh,
1997). This intrinsic responsible behavior is imperative to ingrain the
citizenship behavior among the staff. When employees pick up the tendency
to be diligent, detailed, purposeful to be ensuring the work-in-hand, it’s easier
for the managers to lead them to success. It’s especially true for the
innovative firms whose ideals are aligned with inventions. Investment in
training and motivating conscientiousness will help building these super
personality traits which in turn, will lead to expected organizational
citizenship behavior. These characteristics prove to be vital in the success of
any organization and also play as the intellectual asset to the company.
2.2 Innovation Culture
The definitions of innovation are multi-contextual as supported by the
literature. Innovation can be defined in terms of the process oriented activities
of the organization, the intention to introduce new offerings, behavior of the
employees, the infrastructural support provided by the organization, the
culture instilled among the vertical and horizontal relationship among
employees (West & Farr 1990; Hamel 1999; Dobny 2008; Hwang 2017).
Hamel prescribed innovation to be remarkable in nature; whereas West & Farr
suggested innovation to be disruptive and something that brought change
(Hamel & Prahalad, 1994; Hamel 1999; West & Farr 1990). From the meta-
analysis of Innovation and organizational adoptive behavior of
innovativeness, he suggested that innovation must be considered as more than
just the behavior and performances by the organizational employees. His
study found a strong relationship between organizational innovation and its
determinants of change attitudes of management, process specialization,
knowledge resources and smooth communication among internal and external
staff (Damanpour, 1991-1998).
An innovation culture has the power to support any radical ideas and thus
bring about disruptive changes. Innovation supportive culture can enhance the
performance by driving toward changes while leading the employees accept
that change and promote this shared values with everyone (Hwang 2017).
Innovation culture requires every employee to move forward, to take risk as
deemed necessary, to take financial challenges, to learn new things to self-
Impact of Innovation Culture on Organizational Citizenship Behavior: 201

improvement and to accept failure as normalcy. If these venturesome attitudes

can be implanted across the organization, innovation culture will support any
sort of mind bending, disruptive change. The variables used to measure
innovation culture have been amassed from prior literary work of Hurley &
Hult (1998); Dobni (2006, 2008) and Hult et al. (2007).
2.2.1 Intention for Innovation
The propensity for innovation must be starting at the core. It takes new
approaches and continuous initiatives to learn something new, to bring about
change, to invent newer process and to accept failure. Enthusiasm is key to
new learning as well as innovative thinking. The organization must be
opportunity oriented rather process oriented as old processes must be rectified
on the basis of trial and error. The management must think as a diverse team
and bring along the employees to think outside the box. This string of
coherence into design thinking will be the kernel of intention for innovation.
If properly executed, innovation can be ingrained as culture to all (Dobni
2008). Throughout the organization, the management must envision
innovation oriented goals and objectives to set them apart from the
competition. To channel such innovativeness, management must also cascade
the employees with innovative ideas. On top of everything, innovation must
be strongly instilled as underlying value in the system structure of the
organization.
2.2.2 Infrastructure for Innovation
The system must be pumped with innovativeness to make it worthwhile. The
support for innovation and innovative culture must be higher from the top to
bottom level to achieve total innovation culture. Every employee in the
organization must be encouraged in continuous learning. To implant, training
facilities and post training counselling must be available for the employees.
Mentorship is another variable which is considerably significant to summon
up for effectiveness (Dobni 2008). The manager must undertake appropriate
measures to smooth out the information flow so to detect major changes in the
industry before the counterparts. The employees must be empowered to take
quick decision in order to act on market information, rather wait on red tape.
To create a proper infrastructural support, the organization must consider
knowledge as a strategic asset and in turn knowledge creates a competitive
advantage in the business climate. Most importantly, there needs to be an
expectation to learn new skill and to adapt to new changes in the marketplace.
202 Journal of Banking & Financial Services

2.2.3 Learning Orientation

Learning, if considered as an investment rather an expense will make an
organization sustainable. This penchant for learning new things and newer
methods must be appreciated from the top to bottom workflow. The
willingness to learn and to implement newer process will be key to
organizational performance (Hurley & Hult, 1998; Hult et. al. 2007). Learning
is considered to be the key ingredient in knowledge development for the
organization (Hult et. al. 2007). The inquisitiveness, if ingrained in the
culture, will help expedite growth for the firm. The inventive organization
must ensure the zeal of learning among the employees. This orientation for
new insight as well as design thinking supports the quintessential requirement
for static, constant improvement for any organization. When the work flow
stops as in the learning discontinues, it will lead the doom for any
organization however large it might be. The growth only comes when the firm
is continuously learning and adapting itself to the changes in environment.
The diversity of thinking in a team will reap its benefits both financially and
intellectually. The learning inclination paves the way for sustainable success
in the midst of competitiveness. Old techniques will wear out as new
innovation will easily replace and bring simplicity in doing business. The
tendency to implement radical ideas is to be shared and expected by the top
management as an antecedent to build up this culture of innovation. This
cultural shift toward newness will be at the disposal of the organization.
Hypothesis H0 : Innovation culture doesn’t have an impact on organizational
citizenship behavior.
Hypothesis H1 : Innovation culture has an impact on organizational citizenship
behavior.
Figure 1: The proposed hypothesis of innovation culture and organizational
citizenship behavior
Intention for
Innovation

H1
Infrastructure Innovation
Culture OCB
for Innovation

IV DV
Learning
Orientation

Source: Author’s Construction

Impact of Innovation Culture on Organizational Citizenship Behavior: 203

3. Methodology
This study comported an empirical analysis to examine the effect of
innovation culture’s dimension on organizational citizenship behavior. With
the aim of testing the relationship among variables and the two major
constructs, this study followed a quantitative research approach to measure
the items empirically. Here, the construct organizational citizenship behavior
acts as the criterion variable whereas, innovation culture acts as the predictor
variable.
3.1 Measures for Criterion and Predictor Variables
The measures used for this study were adopted from prior literature. The
construct organizational citizenship behavior was adopted mostly from the
work of Farh (1997) and Farzad (2008). The sub-dimensions for this OCB
construct came from the work of Farh (1997); Auh (2005) and Farzad (2008).
The construct innovation culture was adopted from Hurley and Hult (1998),
Dobni (2006, 2008) and Hult et al. (2007). The sub dimensions were adopted
from Dobni (2008) and Hult et. al. (2007)
3.1.1 The Measurement Items for Organizational Citizenship Behavior
The first variable, without dropping any item, interfunctional coordination
was measured by synchronized flow of information among the employees and
adoption of strategy by the employees. The second variable, job satisfaction
was measured by clean work environment of the firm, updated services
available for the staff, cooperation in the social welfare activities. The items:
great number of branch, lower bureaucracy, secure services were dropped due
to low factor loading. Identification with the company variable, the third
variable, was measured by the willingness to protect the goodwill of the
company and the willingness to make constructive suggestion for the
betterment of the company. The items: sharing good news with outsiders,
participation in meetings and events were dropped due to low factor loadings.
The final variable, conscientiousness, was measured by the compliance with
the company rules, seriousness of effort on the job and self-improving effort
to improve the work output. The items: accepting new challenges and
compliance without management’s presence were dropped due to lower factor
loading.
3.1.2 The Measurement Items for Innovation Culture
Intention for innovation, the first variable, was measured by innovation as
underlying culture, diversity in management’s thinking and coherent set of
innovation goals and objectives implanted in the organization. Items:
204 Journal of Banking & Financial Services

innovation as core value, the concept of opportunity orientation rather process

orientation, innovation vision were dropped. The second variable,
infrastructure for innovation was measured by every employee’s involvement
in the learning process, an expectation to develop new capabilities and skills
across the firm and mentorship and post training facilities. Items: continued
organizational learning and empowered to apply new ideas were dropped.
Finally, the learning orientation was measured by the willingness to learn new
skills and employee learning to be considered as investment rather an
expense. Items: discontinuation of learning will result in endangerment to
future and learning is required for static improvement were dropped.

3.2 Data Collection

Prior to data collection, pretesting was done with the help of six executives
and ten managers of financial institutions. There was also a focus group
discussion with three academicians on the effectiveness of this study’s
research design. Moreover, two of the industry experts were interviewed for
their opinion on the subject. These measures resulted in some modifications in
the questionnaires and the research approach. The modifications were made to
make the survey questions easier to the respondents. The questionnaire’s
response measures had 5-point Likert scale (where 1 denotes strongly
disagree to 5 denotes strongly agree). The questionnaire was also designed so
to secure anonymity of the respondents.
The study was conducted in the context of fin-tech firms of Bangladesh so
the target population consisted of the six major fin-tech firms. The sampling
frame consisted of 267 professionals working at the major financial
institutions. These individuals have been working for no less than 3 years with
the company and were very uptight about the company policy. The financial
institutions had good intranet system placed in their infrastructure. The survey
questionnaire was sent through, using electronic medium to those
professionals where the response rates were 177. Some of the professionals
didn’t take part in the survey due to their fear for non-disclosure agreement
with the company. The responses were taken from directors, mid-level
managers and operational employees. The response which were received had
some missing information and thus the study removed 59 missing response
and continued with some 118 usable responses.

The study used purposive sampling technique which is a nonprobability

sampling tool. This particular technique was chosen based on the researcher’s
professional judgment. This purposive technique helps in selecting sample
Impact of Innovation Culture on Organizational Citizenship Behavior: 205

based on the subject and the context of the study. The sampling was decided
so to ensure consistency and coherency of the relationship between variables
and constructs. The sampling was conducted in the time frame of December
to February, 2020. The SPSS and the AMOS statistical softwares’ were used
to conduct the study.
Table 1: A snippet of the methods used in the study

Items Description
1 Research Design Quantitative Research Approach
2 Target Population 5 Major Fin-tech Institutions of Bangladesh
(bKash, Shurjo Pay, DBBL’s Mobile Banking,
Sure Cash and Smart Kompare; minimum 10
years of experience)
3 Sampling Frame The professionals who’ve had 3 or more years of
experience with the firm. (Directors, Mid
managers, Operation Managers)
4 Sampling Technique Purposive Sampling(Non-probability Sampling
Technique)
5 Scaling Technique 5 point Likert Scale
6 Sample Size 118 (Questionnaire sent: 267; Respondents: 177;
Usable Response: 118)
7 Sampling Time December 2019 to February 2020
8 Statistical Analysis SPSS 20.0 and AMOS 22.0
Tools

4. Analysis and Findings

4.1 Assessments of the Measures Validity
The purpose of the study was to find the effect of predictor construct i.e.
innovation culture, on the criterion construct i.e. organizational citizenship
behavior. The predictor construct was measured using three variables whereas
the criterion construct was measured by using four variables. The structural
relationship between these two formative constructs was examined by
Structural Equation Modeling (SEM). As these variables were accumulated
from the prior literature, checking for reliability of the measures were
redundant for this study. Therefore, conducting exploratory factor analysis
was not required for this study. The confirmatory factor analysis was
conducted to check for validation of the measures as well as the validation of
the proposed model.
206 Journal of Banking & Financial Services

This study subjected all the measures to be assessed by structural equation

modeling (SEM) through AMOS statistical software. An advantage of SEM is
its capability to calculate relationship among formative or reflective
constructs. SEM requires multiple test statistics to fit the hypothesized model
with the data for authentic representation of the relationship between
constructs (Hair, 2006). In this study, both the measurement model and
structural model were examined to confirm that results were coherent with the
proposed conceptual model. Here, the Confirmatory Factor Analysis was
administered to check for the construct validity so all the measures were
loaded on its intended factors (Gerbing and Anderson, 1988). All factor
loadings were satisfactory. The measurement model suggested an acceptable
fit of the data (as shown in Table 2) where Chi Square ϰ 2= 284.800, degrees
of freedom= 144; ϰ2/df= 1.97< 3 where p value=.000<.05 (Hair, 2006). So the
null hypothesis was rejected and the study found significant impact of
innovation culture on organizational citizenship behavior.
Table 2: The Summary of Goodness of Fit and Badness of Fit Indices
Result (Level of
Name of Fit Categories Name of Index
Acceptance)
Chi Square p=.000 <.05
Absolute Fit Indices GFI .831
RMSEA .089
AGFI .755
Incremental Fit Indices CFI .880
TLI .840
NFI .786
Parsimonious Fit PGFI .674
Indices

4.2 Fit Indicators

The CFA resulted in the goodness of fit index and badness of fit index for all
the measures to examine the model fit for the study. The Chi Square, GFI and
RMSEA are part of the absolute fit index, where the Chi square requires p
value<.05, GFI requires >0.90 and RMSEA requires <0.80. (Gerbing and
Anderson, 1988 and Hair, 2006). The study has Goodness of fit of (GFI) .831
which is satisfactory and Root Mean Square of Approximation (RMSEA) of
.089 which is also at satisfactory level.
Impact of Innovation Culture on Organizational Citizenship Behavior: 207

The AGFI, CFI, TLI and NFI fit indices measured the incremental fit of
the study (Hair, 2006). Therefore, the study has AGFI= .755 which is at
moderate level, CFI= .880 which is satisfactory, TLI= .840 which is
satisfactory and NFI= .786 which is at satisfactory level. So, the incremental
fit looks reasonable for this study. The parsimonious fit was measured by
Parsimonious Goodness of Fit Index (PGFI) which stood at .674 which is at
moderate level. Apparently, all the measures were at par with satisfactory
level of goodness of fit indices. So the findings suggested the model fit
indices secured an acceptable level and therefore helped explain the
hypothesized relationship.

Figure 2: The Results of Structural Equation Modeling

The fit indices projected the measures at satisfactory levels. From Table 3,
the composite reliability was found at moderate level. The reason for this can
be associated to the number of sample size (Hair, 2006). The composite
reliability projected a moderate level of convergent validity. Moreover, the
discriminant validity was checked by assessing both the unconstrained model
and the constrained model which had no cross loading among variables.
208 Journal of Banking & Financial Services

Table 3: Structural Model Coefficients

Dimensions of Innovation Second Order Loading Estimates T-values
Culture
Int3 (Innovation Goal) .794 -
Int2 (Innovation Diversity) .819 9.377
Int1 (Innovation Culture) .876 9.954
Infra3 (Mentorship) .723 -
Infra2 (Develop New Skill) .884 7.323
Infra1 (Learning Involvement) .631 6.221
LO3 (Accept Financial Risk) .630 -
LO2 (Learning is Investment) .747 5.979
LO1 (Willingness to Learn) .652 5.493
Dimensions of OCB Second Order Loading Estimates T-values
IFC1 (Synchronized .844 -
Information)
IFC2 (Adaption of Strategy) .683 5.246
JS1 (Cleanliness) .737 -
JS2 (Updated Services) .678 6.314
JS3 (Cooperation in Social .527 5.025
Welfare)
ID1 (Protect Reputation) .838 -
ID2 (Constructive Suggestion) .776 6.305
CS1 (Comply with Company .860 -
Rules)
CS2 (Take Job Seriously) .792 8.557
CS3 (Self Study to Improve .643 6.967
Output)
Relationship of Measures Standardized Estimates T-values
Learning  Innovation Culture .897 5.103
InfrastructureInnovation .630 4.580
Culture
Intention  Innovation Culture .781 5.675
Coordination OCB .670 4.601
Job Satisfaction OCB .913 5.185
Identification  OCB .676 4.664
Conscientiousness  OCB .722 5.019
Relationship of Exogenous Standardized T-values p-value Comment
and Endogenous Constructs Estimates
OCB Innovation Culture .888 4.735 *** Significant

Source: Author’s Projection of Results

Impact of Innovation Culture on Organizational Citizenship Behavior: 209

Analyzing the overall results, the validity of the proposed model was ensured
at satisfactory level and the hypothesis was accepted. Innovation culture has a
strong, positive impact on the organizational citizenship behavior among
employees.
5. Discussion and Practical Implications
Innovation, if properly utilized, has always been the differential advantage in
sustaining a firm. The term Innovation became generic because of its wide
global acceptability, even then its importance hasn’t been reduced to any less.
The quintessential task for the organizations would be to accept innovation as
an operational term and accommodate this disruptive idea into the system
flow of organizations. To do so, the organization culture will be off immense
help. The shared culture of the organization, if embraces the concept of
innovativeness and principally lives on it, will have the potentials to fully reap
the benefits. The study, based on its analysis of the results, suggested a
substantial relationship between innovation culture and citizenship behavior
of organizational employees. As the findings imply, citizenship behavior
comes from within the employees, who with or without the presence of
management will comply with firm rules and work hard for the betterment of
the organization. Innovation culture works as the independent variable and
citizenship behavior acts as the variable dependent on this cause.

The study attempted to answer three salient research questions- First, how
impactful the culture of innovativeness is on the citizenship behavior of any
organization? The findings of the study suggest that innovation culture will
enhance the overall performance of the organization by elevating the
citizenship behavior among employees. The citizenship behavior is the
beyond job performance by the employees who portrays a good soldier
syndrome and work beyond their payroll description. The innovation culture
substantially encourages its employees to have disruptive views and thought
patterns, which additionally empowers the employees to act on extra job
performance unasked by the organization.
Secondly, to what measure of significance does innovation culture
dimensions have on the citizenship behavior? The fundamental effect of this
disruptive culture will bring about contentment among the employees, will
awake them morally and avoid unlawful task and will lead the way for further
advancement, both for the employees and for the firm. The findings suggested
that employees felt positive and enthusiastic about the creative culture when
the dimensions of innovation culture were practiced throughout the
210 Journal of Banking & Financial Services

organization. The three primary tenets of innovation culture are: i) Intention

for innovation where innovation is at the bedrock of culture, management
promotes diversity across the firm and the firm is led by coherent set of
innovative goals; ii) Infrastructure for innovation where the employees are
supported by training & post training facilities and where employees are
expected to learn new skills to uplift their performance; iii) Learning
orientation where new knowledge is regarded as an investment rather an
expense. The study implied that these major dimensions do have profound
impact on the citizenship behavior of organizational employees.

Finally, to what extent are these innovation culture and citizenship

behavior applicable in the context of fin-tech firms of Bangladesh? The
analysis of the conceptual model indicates the acceptability of innovation
culture and its positive effect on the minds of the employees who are then
influenced to do better for the organizations. The study was conducted over
five major fin-tech firms of Bangladesh and they were: bKash, Shurjo Pay,
DBBL’s Mobile Banking, Sure Cash and Smart Kompare. These fin-tech
firms are providing the customer with financial solutions for around ten years.
They already have an innovation vision in the company culture so
consequently they were chosen based on the researcher’s professional
judgement. The directors, mid-level managers and operational managers were
interviewed during the field work and their collective opinion was infused in
the research. As suggested by the previous literature, it can be stated that the
concept of citizenship behavior is off significance for many a country and
their implementation has been beneficiary for the organizations, irrespective
of country or industry. In Bangladesh, this concept is neither familiar, nor
popular. The probable reason can be that the Bangladeshi employees already
feel they are overworked and underpaid by their employers. Their overwork is
believed to be unaccounted for thus they feel underappreciated. If the
underlying value of these both concepts: innovation culture and organizational
citizenship behavior can be injected and executed properly in the system flow
of firms, it will certainly reap benefits in future for both the advancement of
employees and firms alike.
6. Conclusion
The extant literature on innovative culture and citizenship behavior has
provided the study with an opening to the research gap. These widely
accepted concepts of innovation and citizenship behavior are rarely tested in
the context of Bangladesh. The first limitation was this study could only focus
on fin-tech industry to avoid cross-industry data. If not specific, the study
Impact of Innovation Culture on Organizational Citizenship Behavior: 211

might have lost its primary focus. The relationship between innovation culture
and citizenship behavior of organizational employees was found to be
substantial as the predictor variable had significant influence on the predicted
variable. The second limitation was the sample size. The questionnaire
remained unanswered by the respondents due to non-disclosure agreement.
Solving this issue in further research will bring more generalized data.
Nevertheless, in the proposed model, all the statistical relationships were
significant (p=.000<.05) and there were not a single negative association
among any of the measures. Moreover, the null hypothesis was rejected and
the study found a profound impact of innovative culture on the escalating the
citizenship behavior among employees. Therefore, the intention for
innovation, the infrastructural support and the learning orientation will be
preparing the employees to perform beyond their job requirement and will be
instilling coordination, coherence, contentment, belongingness and
conscientiousness among the employees which in turn, enhances the overall
performance of the organizations. In the viewpoint of fin-tech firms and
financial institution, operating in Bangladesh, they have already found success
by investing in an innovation culture and hoped to implant citizenship
behavior for the betterment of employees and organizations nonetheless.

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214 Journal of Banking & Financial Services
Volume 12, Number 1, June 2020

The Moderating Role of University Environment in

Boosting Students’ Entrepreneurial Action Behavior

Kazi Md Jamshed1
Muhammad Intisar Alam2

Abstract: Entrepreneurship is being considered as the social phenomenon

and driver of the global dynamics over the time as it has multiplier positive
effects on the economies. Intention is the prerequisite for creating
entrepreneurial ventures. The aim of this study is to extend the current
literature on entrepreneurial intentions by emphasizing the role
psychological traits centered conceptualized by Azen (1991) in the Theory
of Planned Behavior. We apply convenient sampling method with 205
respondents from the University of Dhaka and data has been collected
through self-administered survey. Structural equation modeling has been
applied and partial least square (Smart PLS 3.0) method) is the tool for
analysis. The regression analysis shows the significant relationship
between independent variables (entrepreneurial attitude, perceived
behavioral control) and dependent variable except subjective norm with
entrepreneurial intentions. This study tries to identify the moderating
effects of university entrepreneurial environment that translates
entrepreneurial intentions into entrepreneurial actions. University
authorities and government can get insights from this paper to develop
entrepreneurial climate in transition economy like Bangladesh.
Keywords: Entrepreneurial intentions; Entrepreneurial attitude; Perceived
behavioral control; Subjective norm; Theory of planned behavior

1. Introduction
Entrepreneurship, one of the major catalysts, is the process of creating new
enterprises that stimulate economic development of the countries (Baumol
and Strom, 2007, Global Entrepreneurship Monitor, 2008, Miller and Acs,
2017, Al-Jubari, 2019). We state that innovation and entrepreneurship are the
prerequisite for the economic progress of a nation. The field of
entrepreneurship has gained the attention among individuals, governments,
policy makers, cities and corporations in that they perceive an opportunity in
it (Shapero, 1985). The academicians both form emerging and developing
1
Corresponding Author: Lecturer, Department of International Business, University of
Dhaka, Dhaka-1000, E-mail: [email protected]
2
Associate Professor, Department of Marketing, University of Dhaka, Dhaka-1000,
E-mail: [email protected]
216 Journal of Banking & Financial Services

economies emphasize on the understanding of the entrepreneurship behavior

among the students and non-students in different environmental contexts
(Haynie and Shepherd 2009; Urban, 2012a, 2012b, Al-Jubari et al., 2019,
Breznitz and Zhang, 2019). Developed countries have already created
entrepreneurial ecosystem to make innovation driven economies (Naudé,
2011). Emerging and developing economies are contemplating on these issues
for tackling unemployment through including their national agenda. The level
of unemployment among graduates in Bangladesh is a national concerning
issue (Uddin and Bose, 2012).
Again we state that entrepreneurship can be a remedy for reducing huge
unemployment and eliminating poverty for the developing economies like
Bangladesh. Every year a larger number of graduates from public and private
higher educational institutions are adding the number to the unemployment
list. On the other hand, private sector’s job opening is not increasing that
pace. Entrepreneurship backs development of an economy by creating new
markets, new industries, new technologies, new jobs and leads to the net
increase in real productivity (Behave, 1994). There is immense opportunity of
developing entrepreneurship in Bangladesh as a good number of young
graduates are passing every year (Center for research and Information, 2014).
But it is argued that the general tendency of our country’s people is to run for
job not for job creation. We argue that the antidote to this blight is for
university graduates to widen their career scope by considering
entrepreneurship as a career choice and entrepreneurial spirits or intentions
will increase entrepreneurial activities.
In Bangladesh, entrepreneurs are not well recognized and most of the
people think job is the only solution of employment. The intentions are
required to be entrepreneurs first. We argue that a nation can promote
entrepreneurship through collaborating the academic institutions, industries
and policy makers. Bangladesh government and different public institutions
have taken various impactful initiatives and policies to encourage
entrepreneurship, mostly focusing on MSME (Micro, Small and Medium
Enterprises) (Asheq, 2018). There are scanty of initiatives observed to create
enthusiasm among the students at the university level. Besides, industry
attachment is really a rare subject of consideration. We also argue that the
indifference and negligence are observed while setting collaborative
initiatives by the academic level and policy maker’s level. Institutional
environments have significant influence on entrepreneurial institution (EI)
among the students.
In this study, Bangladesh is being considered as the context for several
reasons. We are experiencing the consistent growth of GDP for last 8 years
The Moderating Role of University Environment in Boosting Students’ 217

but the question arises about the sustainability. Mass entrepreneurship can
give us the hope of the sustainability. Besides, it is mandatory as we are
having world’s one of the densely populated countries. According to
University Grants commission (2019) there are 45 public universities and 103
private universities. Entrepreneurial process starts from the motivation of
pursuing and exploitation of perceived opportunities to create new venture
(Cavallo et al., 2019). Predicting entrepreneurial behavior by modeling
personality or demographic characteristics has resulted in small explanatory
power (Izquierdo & Buelens, 2008). They also added that individuals who
have similar characteristics to a typical entrepreneur would behave
entrepreneurially. Intention models have been advocated as a better
alternative to foresee entrepreneurial activity (Krueger & Carsrud, 1993).
Intentions are perceived as immediate antecedents of actual behavior (Ajzen,
1991). Measuring entrepreneurial intentions or entrepreneurial spirit among
the students, who are the potential source of entrepreneurship, has got plenty
of attention among the researchers in recent years. Although the theoretical
basis of entrepreneurial intention is strong and resourceful, there is still a
scope to examine the diverse and interrelated factors that jointly lead to the
formation of entrepreneurial spirits and actions or behaviors mostly among
the graduates.
There are many previous research works mainly on university students in
different countries (Nieuwenhuizen, 2016 in South Africa and Poland,
Popescu et al., 2016 in Romania; Karabulut, 2016 in Turkey; Kabir & Sarwar,
2017 in Bangladesh; Taha et al., 2017, Al-Jubari et al., 2018 in Malaysia,
Galvao et al., 2018 in Portugal, Israr and Saleem, 2018 in Italy). Some
Bangladeshi researchers also have studied some factors as drivers of
entrepreneurial behavior among the university students (Chowdhury, 2018,
Kabir & Sarwar, 2017, Uddin & Bose, 2012). There are some studies
analyzing the moderating effect of university entrepreneurial environment on
entrepreneurial action by the students in the developed and developing
country contexts. Our study can fill up contextual gap in Bangladesh. Ajzen’s
theory of planned behavior (TPB) has been well validated in various studies
of intention and behavior development, of which entrepreneurship studies are
inclusive (Ajzen, 2001; Autio et al., 2001). As this model demonstrates the
psychological paths by which entrepreneurial spirit, personal attitudes,
subjective norms and perceived behavioral control co-exist in determining
entrepreneurial intentions. Since world is becoming competitive day by day,
there is no alternative of entrepreneurs to abate unemployment rates. As
Bangladesh is still a developing country, it is important to motivate young
generation to come forward to reduce the unemployment rate throughout the
country.
218 Journal of Banking & Financial Services

2. Research Objectives

The major aim of this study is to understand the entrepreneurial action

behavior and its antecedents of the university students. There are some other
objectives shown below:

1. To identify the relationship of the intentional factors posited in the theory

of planned behavior in our country context.

2. To identify the relationship between intention and its linkage with action
behavior.

3. To analyze the moderating effects of university entrepreneurial

environment relative to action behavior through intention to start new
venture.

3. Literature Review

New venture creation is the driver of innovation and the major factor of
economic growth. It is stated that entrepreneurship has emerged as the most
crucial economic force that world has ever experienced over the past three
decades. Dutta & Crossan (2005) demonstrate that entrepreneurs act as an
engine of the economy. Definitions of entrepreneurship emphasize a broad
range of activities including the creation of organizations (Gartner, 1988), the
carrying out of new combinations (Schumpeter, 1934), the exploration of
opportunities (Kirzner, 1973), the bearing of uncertainty (Knight 1921). It is a
process of fundamental transformation: from an innovative idea to an
enterprise, as well as from an enterprise to the creation of value (Kauffman,
2007). It is argued that one thing is catalyst to be an entrepreneur is his or her
entrepreneurial intentions that help to a person to find the opportunity and
explore the venture. In the broadest sense, an entrepreneur may be described
as a person who has the ability to explore the environment, identify
opportunities for improvement, mobilize resources and implement actions to
capitalize on those opportunities.

Intention drives person to do his or her own way. It can be described as the
cognitive demonstration of the will of a person to exercise behavior.
Entrepreneurial intentions are currently analyzed on at least two important
directions. Ajzen (1991) described in the Theory of Planned Behaviour (TPB)
that entrepreneurial intentions were the result of the subjective norms and the
perception of behavioral control. Popescu et al. (2016) state both models
highlight a number of traits and perceptions of individuals that lead them to
The Moderating Role of University Environment in Boosting Students’ 219

make certain decisions helpful to entrepreneurship. Bird (1998) links intention

with entrepreneurial behavior in a way that it is the state of mind which leads
intentions and actions of a person towards creating entrepreneurial venture.
Karabulut (2016) states entrepreneurial intentions are the combination of
visions, dreams and feelings of entrepreneurs. However, it can be stated that
the intention to have an entrepreneurial career before actually establishing a
business is the focus of entrepreneurship because of its importance as a
starting point of new venture creation. Entrepreneurs can come from variety
of education backgrounds, family situations and work experience. And so it is
argued that their feelings about entrepreneurial aptitude can also be different.
Many studies have done for identifying the determinants of entrepreneurial
intentions. Some of them emphasize on the environmental factors, such as
family, school and society. Some of them focus on personal factors. Karimi et
al., (2015) state psychological traits and contextual factors drive
entrepreneurial intentions through attitudes and perceived behavioral control.
Goethner et al. (2012) outlines social capital and human capital are the drivers
of entrepreneurial intentions. Besides, other researchers have also found the
relationship between psychological traits (locus of control, need for
achievement, risk taking propensity, entrepreneurial alertness, individual’s
creative mindset) and entrepreneurial intentions (Ertuna and Gurel, 2011;
Uddin and Bose, 2012; karabulut, 2016; Israr and Saleem, 2018, Al-Zubari et
al., 2019). Hisrich et al. (2008) states individual entrepreneur has different
extent of feelings about locus of control, feelings about independence, and
risk taking propensity. This study has tried to explore the association between
psychological traits and entrepreneurial intentions among the university
students.

The determining factors of Entrepreneurial Intention are changing over the

time. The Theory of Planned Behavior (TPB) advocates that the salient
beliefs, behavioral beliefs and normative beliefs will convert the intention to
action (Ajzen 1991) and the Entrepreneurial Event (SEE) individual’s
perceived desirability, feasibility, and propensity are the most crucial factors
influencing a person’s intention to new venture creation (Shapero & Sokol,
1982). While the Ajzen’s Theory of Planned Behavior model is general and
can be used to analyze any human action, Shapero and Sokol’s method is
specific for the entrepreneurship analysis. According to Krueger et al. (2000),
both models, Theory of Planned Behavior and Entrepreneurial Event model,
are largely similar one to another and both provide us the concept of
understanding the entrepreneur’s behavior. According to the integrated model,
220 Journal of Banking & Financial Services

intentions are motivated by individuals’ perceptions that venture creation is

perceived as personally desirable, supported by social norms and feasible
(Krueger and Brazeal, 1994; Krueger, 2000).
Attitude is the degree that an individual perceived the allurement of
specific behavior (Al-Zubari et al., 2019). The entrepreneurial attitude is,
therefore, the extent of one’s positive valuation of inventing and starting a
new business (Linan et al., 2015). Attitudes are found to have a strong
significant relationship with entrepreneurial intentions (Botha et al., 2017).
Hypothesis 1: Attitude has a good relationship with entrepreneurial intentions
among the students.
Perceived behavioral control is referred to as a person's apparent ease or
difficulty in performing a given behavior (Ajzen, 1991). An individual is
likely to involve into a specified behavior once he believes such behavior is
attainable (Bandura, 1997; Krueger et al., 2000). Perceived behavioral control
has a significant influence on entrepreneurial intentions (Linan et al., 2015;
Malebana, 2014).
Hypothesis 2: Perceived Behavioral Control has a good relationship with
entrepreneurial intentions among the students.
Subjective norm is the professed social force to perform a precise behavior
or otherwise (Ajzen, 1991). It is the approbation of important members of the
family, associates or colleagues in entrepreneurship decision (Linan et al.,
2013). Subjective norm also denotes the perception of an individual about the
endorsement or discontentment of friends and important members of the
family on the decision to create a business. The extent to which a person’s
social network is occupied by people who approve the decision for
entrepreneurship the higher the expectation that such person will engage in
entrepreneurship activity (Autio et al., 2001). Subjective norms are
significantly influential on entrepreneurial intentions (Malebana 2014;
Souitaris, Zerbinati, & Al-Laham, 2007).
Hypothesis 3: Subjective norm has a good relationship with entrepreneurial
intention among the students.
Similar to the theory of reasoned action (Ajzen & Fishbein, 1980; Fishbein
& Ajzen, 1975), the theory of planned behavior postulates that intention
provides a cognitive link between the three antecedents and subsequent
behavior (Kautonen et al., 2013). The strength of intention captures
motivational factors influencing people's behavior, and reflects the amounts of
effort people are willing to invest (Bird, 1988; Gielnik et al., 2014).
The Moderating Role of University Environment in Boosting Students’ 221

Hypothesis 4: Entrepreneurial intention has a good relationship with action

behavior among the students.
University context can provide a pool of resources for students, and can
influence students’ entrepreneurial behavior and help them to develop viable
new ventures. Student entrepreneurs have a chance to benefit from utilizing
resources offered by their universities. The provision of entrepreneurial
courses, which increase students' knowledge and skills, the access to business
contacts, and networks and financial resources, are critical to the ability to
recognize opportunities (Shane, 2000; Zhao et al., 2005) and realize them
effectively (Robinson & Sexton, 1994). According to an emerging stream of
literature, there is relationship between university context and intended
entrepreneurial action unfolded by students (Shirokova et. al., 2015; Cavallo
et al., 2019). Examples of such promotion activities may include offering
entrepreneurship education to enhance entrepreneurial intentions among
students Al-Jubari et al., 2019), providing incubators facilities (Breznitz and
Zhang, 2019), and mentoring programs and networks platforms (Nielsen &
Lassen, 2012, Miller and Acs, 2017).
Hypothesis 5: There is a significant relationship between university
environment and action behavior.
Hypothesis 6: The relationship between entrepreneurial intentions and the
action behavior will be positively moderated by the favorable university
entrepreneurial environment.
This study is being tested analyzing the Ajzen (1991) theory of planned
behavior. The proposed theoretical framework is presented for conceptual
underpinning.
Figure 1: Theoretical framework of this research

Attitude
University
Entrepreneurial
Environment

Subjective Entrepreneurial
norm Intention
Action-
Behavior
Perceived
Behavior
control
a
Adapted from Ajzen’s Theory of Planned Behavior (1991)
222 Journal of Banking & Financial Services

The above figure demonstrates the research work and contribution we are
going to add in the academic insight.

4. Methodology

4.1 Research Design

The aim of this study is to investigate the factors that influence university
students to become entrepreneur and to find out the significant differences of
entrepreneurial intentions between public and private university students.
Prior literature has demonstrated that university students are ideally suitable
for the study of entrepreneurial intention (Al-Jubari et al., 2019; Krueger et
al., 2000). This research in its nature is a quantitative one and with regard to
the issue of control over the variables is of non-experimental type which has
an applied modality. The constructs and items of the study were selected
based on the exploratory research methods such as secondary data analysis
and literature reviews. This was a contextual analysis to identify factors
affecting entrepreneurial intention on Bangladesh perspective.

4.2 Population and Sample

This study was conducted among the students of the University of Dhaka. As
the purpose of this study was accomplished by measuring the attitude of youth
generation, university students mainly in 3rd and 4th year students of
Business Faculty were the target population. This group of students was
selected because they are in stage of completing their graduation where they
are facing important career decisions. Entrepreneur could be one of their
career paths and so they were best suitable for this study to understanding
entrepreneurial behavior. The sample size is 205. According to Sekaran et al.
(2003) refers to gathering of information from the participants of a population
who are conveniently available to accept it. So, respondents were obtained
using convenience sampling method.

4.3 Data collection and measurement

The data collection process was designed by structured questionnaires which

were concerned about respondent’s viewpoint on entrepreneurial intention
and it’s affecting factors. The questionnaires contained with four independent
variables which are attitude, subjective norm, perceived behavior control,
university entrepreneurial environment also as a moderator variable and two
dependent variables which are entrepreneurial intention and entrepreneurial
action behavior. A five-point Likert scale was used to measure the
The Moderating Role of University Environment in Boosting Students’ 223

independent variables where strongly disagree was considered as 1 and

strongly agree was considered as 5. Study personnel briefly described the
purpose of this study to potential participants during their classes.
Participation in the present study was entirely voluntary. Students who were
interested were invited to participate and they completed a consent form
before they participated in this study.

4.4 Data Analysis Techniques

The partial least squares approach to structural equation modeling (PLS-SEM)

using Smart PLS 3.0 (Ringle et al., 2015). In most business management
studies, SEM has been the most-preferred method (Sarstedt et al., 2017).
According to Hair et al. (2016) there are two SEM based methods: one is
covariance-based (CB-SEM) and the other one is PLS-SEM. We preferred
PLS over covariance-based approaches due to the flexibility to handle more
complex models in which moderating and mediating relations are tested
(Lowry and Gaskin 2014; Hair et al. 2016). Moreover, it relaxes some binding
assumptions such as normal distribution which is rarely met by social sciences
data (Sarstedt et al. 2017). Cronbach’s α coefficient, rho_A, composite
reliability, and Averance variance explained (AVE) are measured to
understand the construct reliability and validity of the proposed model. For
regression analysis, we applied bootstrapping using 200 sub-samples to
explore the relationship between independent variables and dependent
variable. We also applied bootstrapping to get the results of the mediation
analysis and to explain specific indirect and total indirect effects.

5. Results and Discussion

5.1 Measurement Model

We used structural equation modeling to test the suggested hypotheses. PLS is

preferred over covariance-based model due to better handling of small sample
size (Chin 1998; Haenlein and Kaplan 2004; Hair et al. 2016; Sarstedt et al.
2017). The five independent constructs (attitude, subjective norm, perceived
behavioral control, perceived desirability and perceived feasibility) and one
dependent construct (Entrepreneurial Intention) with all latent variables
including multi-items are first tested using PLS-algorithm for reliability and
validity. The reliability of all reflective measures was measured using
Cronbach’s α value, and composite reliability (CR) and convergent validity
were computed using average variance extracted (AVE) were satisfactory.
224 Journal of Banking & Financial Services

Table 1: Construct Reliability and Validity

Cronbach’s Composite Average Variance

Alpha Reliability Extracted (AVE)
Attitude (ATD) 0.711 0.783 0.512
Entrepreneurial Action 0.723 0.811 0.567
Behavior (EAB)
Entrepreneurial Intention (EI) 0.829 0.898 0.746

Perceived Behavioral Control 0.788 0.850 0.534

(PBC)
Perceived Social Norm (PSN) 0.712 0.836 0.630
University Entrepreneurial 0.705 0.763 0.602
Environment (UEE)
Source: Derived from researcher’s own study

The Cronbach’s α value was ranged from 0.711 to 0.829, composite reliability
was ranged from 0.763 to 0.900 which were above the threshold above 0.70
(Hair, Hult, Ringle, & Sarstedt, 2016) and also divergent validity was
established which was ranged from 0.512 to 0.746 also above the threshold
level 0.50 (Hair et al., 2016). We also tested the discriminant validity for
confirmation of our data. We measured Heterotrait-monotrait (HTMT) ratio
of correlation as it can detect better collinearity problems among the latent
constructs than Fornell and larcker Criterion (Hamid, 2017).

Table 2: Heterotrait-Monotrait Ratio (HTMT)

ATD EAB EI PBC PSN UEE

ATD .723
EAB 0.672 0.628
EI 0.578 0.656 0.814

PBC 0.642 0.768 0.745 0.662

PSN 0.755 0.560 0.612 0.613 0.745
UEE 0.372 0.299 0.286 0.399 0.714 0.736

Source: Derived from researcher’s own study

The Moderating Role of University Environment in Boosting Students’ 225

HTMT values close to 0.90 indicates a lack of discriminant validity (Gold and
Malhotra, 2001) and the lowest HTMT ratio is 0.628 and the highest ratio is
.814 which shows there is no multi-collinearity problems in the model.
5.2 Regression analysis

We analyzed the hypothesis testing through bootstrapping and found there is

positive relationship between interdependent variables except subjective norm
with dependent variables.
Y(EAB) = b0 + b1AT + b2PBC + b3SN+ b4EI .....................................Eqn. 1

Where, EAB= Entrepreneurial action behavior, EI= entrepreneurial

intention, AT= Attitude, PBC= Perceived Behavioral Control, PSN=
Perceived Subjective Norm, UEE= University Entrepreneurial Environment
ei= Error
Table 3 : Total Effects with Path Coeffecients
Path T Statistics P Values Significant
Coefficients (|O/STDEV|)
ATD -> EI 0.190 3.841 0.000 Supported
PBC -> EI 0.346 7.672 0.000 Supported
PSN -> EI 0.413 0.680 Not
0.013
Supported
EI -> EAB 0.380 3.996 0.000 Supported
UEE -> EAB 1.378 0.053 Not
0.067
Supported
Moderating effect of 2.976 0.002 Supported
UEE between EI and 0.453
EAB
a
n=705, and b * p < .05
Source: Derived from researcher’s own study

Hypothesis 1 and 2 represent that significant relationship between attitude

and entrepreneurial intentions and also between perceived behavioral control
perceived behavioral control and entrepreneurial intentions (T-statistics =
3.841 and respectively T-statistics = 7.762, p = 0.000, p < 0.05) . Hypothesis
3 relates to the relationship between subjective norm and entrepreneurial
intentions and was found to be no significant effect (T-statistics = 0.413, p =
0.000, p < 0.05). Hypothesis 4 shows the significant relationship between
entrepreneurial intentions and entrepreneurial action behavior (T-statistics =
226 Journal of Banking & Financial Services

3.996, p = 8.378, p < 0.05). Hypothesis 5 is not supported as there is no

significant relationship between university entrepreneurial environment and
entrepreneurial action behavior. Hypothesis 6 represents significant
moderating effects of university entrepreneurial environment between
intentions and action behavior (Effect size = 0.234, T-statistics = 2.976, p =
0.002, p < 0.05). Effect size has derived by predictive relevance analysis in
the structural equation modeling.

5.3 Discussion

Entrepreneurial ecosystem has become a matter of great importance, as cities,

regions, and nations grapple with the entrepreneurial economy (Miller and
Acs, 2017). Audretsch (2014) argues that the role of universities is to provide
leadership necessary to advance the entrepreneurial society. Thus, only by
realizing this leadership role, manifested through the creation of
entrepreneurial thinking, actions, institutions, and entrepreneurial capital, can
universities fulfill their economic and social potential. After analyzing the
data, using PLS algorithm, our study has construct reliability and validity.
And also there is no multi-collinearity problem in the dataset. After doing
Bootstrapping for regression analysis, it has found that there is a significant
relationship between independent variables with dependent variables except
the perceived subjective norm. In case of the relationship between university
environment and action behavior we have found that there is no significant
effect. But as a moderator, the impact of entrepreneurial intentions on action
behavior of the students tends to increase while prevalence a favorable
university entrepreneurial environment. Our result also supports the previous
literature (Saeed et al., 2015, and Shirokova et al., 2015, Miller and Acs,
2017, Breznitz and Zhang, 2019). With a process in place, strong support, and
connections off campus, and a clear student focus, university can develop
many entrepreneurship resources for it students. Besides, high-growth firms
and university leaders should support the students by offering experiential
learning and extensive engagement with the off campus world, regardless of
their field of study or chosen industry. With a broad pool of students from the
business school and elsewhere, expanding assets and programs in innovation
and entrepreneurship (Miller and Acs, 2017). This way students can feel
enthusiasm to test themselves for entrepreneurial journey. This study has tried
to posit entrepreneurial behavior is volitional, driven by cognitive
mechanisms (Al-Jubari et al., 2019) explained by the Theory of Planned
Behavior. In line with this view, the starting point of entrepreneurial actions is
the formation of entrepreneurial intentions (Krueger et al., 2000). Considering
The Moderating Role of University Environment in Boosting Students’ 227

the individual entrepreneurial actions thorough the intentionality lens allows

their rigorous structural analysis, as “intentionality brings order to the
perception of behavior in that it allows the perceiver to detect structure e
intentions and actions in humans' complex stream of movement” (Malle et al.,
2001:1).

6. Conclusion and Limitation

Entrepreneurship is known as an influential source of economic development.

So, entrepreneurship is recognized as a growing field of interest and various
factors, including high unemployment rates have contributed to increase
interest in this field. In order to predict entrepreneurial spirits of university
students, Ajzen (1991) theory of planned behavior was conducted. The results
showed that the independent variables create positive effect over the
dependent variable. Subjective norm was found to be insignificant influence
on entrepreneurial intention. Besides, intention of the students to start
entrepreneurial ventures influencing the transformation of the actual behavior.
Data also indicated that the resulting model was an adequate fit to the
observed relationships among the factors. The recommendations of our study
are to improve university environment of both public and private for
developing entrepreneurial ecosystem and government should promote
entrepreneurship through different initiatives.

This study implies the collaborative initiative among the university,

industry and policy makers. The present study has both theoretical and
practical implications. To generalize the findings regarding entrepreneurial
intention, different studies should be done in different countries and fields of
study. So, at the theoretical level, the findings add to the existing literature on
students’ entrepreneurial intensions, especially university students, and also
contribute to a better understanding of factors influencing students’
entrepreneurial intensions. Students to be proficient entrepreneurs not only
have to obtain knowledge and skill on the field of study, but also need to
obtain skills such as goal setting, marketing, and so on. Universities should
invite successful entrepreneurs from alumni to provide lectures to students.
Students can pay special attention to the factors that showed a positive
association with entrepreneurship. The findings have also policy implications.
Policy-makers should give priority to develop potential entrepreneurs even
while they are students. So, the findings can be helpful to policy-makers in the
academy sector to find the right way to foster entrepreneurship at universities.
228 Journal of Banking & Financial Services

As with any research, this study suffers from a number of limitations.

Firstly, the sample is made up of university students in one single country
(Bangladesh). Given that intention is related to the internal and social contexts
other than university environment, cultural characteristics are also probably
relevant in this process. In this sense, future research should replicate this
study in different countries or, even better, in several countries and different
other dimensions simultaneously. Nevertheless, our results confirm that, for a
given cultural context (Bangladesh) and sample (university students), the
model is meaningful and the results are satisfactory. Secondly, the study is
cross-sectional. As a first consequence, we cannot claim causality in any of
the relationships. For this reason, we have stressed that the results support our
hypotheses, but we cannot be sure that the causal relationship is as proposed
until a longitudinal study is carried out. Besides, this study only focuses on
public university students and so future research should include private
university students. The authors plan to follow the students surveyed in the
future to assess the influence of basic psychological needs throughout the
entrepreneurial process. Overall, much more research is needed to confirm the
results obtained here. In this sense, we call for researchers to replicate and
expand the present study. In particular, we request longitudinal research to
fully test the model and confirm its potential implications.

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232 Journal of Banking & Financial Services
 Call for Contribution of Research Papers

Journal of Banking & Financial Services is a half-yearly journal of the

Department of Banking and Insurance, University of Dhaka, published in
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with special emphasis on Banking, Insurance and other financial services.

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in December 2020.

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