Financial Crisis, Regulatory Changes and Bank Profit

This paper attempts to identify empirically the profitability determinants of Korean banks over different regimes of regulations in the banking industry. Firstly, we examine whether the traditional determinants that have been suggested to be effective in explaining the determinants of non-financial firms’ profitability can also explain the profitability of Korean banks. Secondly and more importantly, we partition the full sample period into three sub-periods based on the degree of banking regulation’s strength and compare the explanatory power of the bank profitability determinants and examine how the changes in banking regulations affect the bank profitability. Overall, we found that the profitability of Korean banks is positively related to asset size and capital ratio, and negatively related to the fixed asset ratio and nonperforming loans ratio. However, from the results for the partitioned sample periods, we found that the positive relationship between asset size (capital ratio) and profitability became weaker (stronger) after banking regulations became tightened with structural reform after Asian countries’ financial crisis. The relationship between fixed asset ratio and profitability became more negative after banking regulations became tightened. Net interest margin was no longer a significant determinant of bank profitability under tightened banking regulations. These results could be understood as follows. Under tightened banking regulations, heavier regulatory costs would be imposed on the banks with riskier characteristics such as lower capital ratio, larger asset size, and higher loan ratio, etc. Thus, the profitability of these banks would be affected more adversely than the banks in safer characteristics.