B. Appendix 2 – Climate regulation timeline implementation
2. Literature review
2.1 Bank specific determinants .1 Asset structure
Banks tend to diversify their loan portfolio and increase liquidity to reduce risks, particularly in times of crisis [14]. Much of the literature [9, 10] agrees that this action, to other safer assets, should cause profitability to increase more quickly. These operations tend to increase operational maintenance costs, however, García-Herrero et al. [15] argue that profit should also increase.
It should be noted that the increase in the level of credit can cause a high liquidity risk, if the manager does not effectively reduce its liabilities or if it does not know how to properly finance the increase in assets [10, 11]. If these operations are carried out well, the increase in loans will increase the bank’s revenues, therefore it will also increase profit- ability [16]. Therefore, Saona [12] and Trujillo-Ponce [10] found a positive relationship between the relative percentage of loans in a bank’s assets and its profitability. Also, Tan et al. [16] confirmed that liquidity risk exerts a positive influence when considering
ROAA as a measure of bank profitability in Chinese banks, however, there is a negative relationship when considering ROAE. On the other hand, Trabelsi and Trad [17] empiri- cally showed that asset structure negatively influences ROAA and positively influences ROAE. Guru et al. [8] and Rumler and Waschiczek [9] emphasize that the asset structure negatively influences bank profitability.
Thus, it can be seen that there is no consensus regarding the sign and significance of this variable with profitability. On the one hand, more loan amounts mean higher turnover and, in principle, more results. However, more loans also translate into more processing costs, higher chances of credit losses, and the cost of maintaining required capital reserves.
Thus, according to the literature, we expose hypothesis one, with no pre-defined sign.
Hypothesis 1—There is a significant relationship between the composition of banks’assets and their profitability (with no defined sign).
2.1.2 Asset quality
According to Trabelsi and Trad [17], this variable indicates the economic and financial situation of banks, as it warns us of financial vulnerability, assessing their resilience to financial shocks.
In fact, in unfavorable times, there may be an increase in bad debt assets, causing banks to distribute a portion of their gross margin for provisions, to cover any loan losses [10]. These operations are associated with a credit risk that affects bank profit- ability [3]. Thus, with an increase in impairment losses on loans and accounts receiv- able, the quality of the assets of banking institutions may be negatively affected [10].
Mester [13] also showed that the increase in loan quality is associated with an increase in bank operating costs, which may have an opposite effect to that expected.
Empirical analyzes by Alshatti [18], Athanasoglou et al. [2], Trabelsi and Trad [17], and Trujillo-Ponce [10] found a negative association between the quality of bank assets and their profit. Similarly, Dietrich and Wanzenried [3] showed a negative influence of asset quality on bank profitability during the time of crisis (2007–2009).
Garcia and Guerreiro [19], on the other hand, were faced with a negative relationship when this variable was associated with ROAA, but when they use ROAE, this rela- tionship is positive.
In contrast, Saona [12] showed a positive relationship between asset quality and profitability of Latin American banks. The author argues that this sign is observed because Latin American banks charge their customers with paying higher prices for services provided to combat the costs associated with credit risk. He also claims that these transactions are possible because the interest of investors is not protected in those countries. Following this literature, we propose the following hypothesis:
Hypothesis2—There is a significant relationship between the quality of assets and their profitability (with no defined sign).
2.1.3 Capital
Capital refers to the amount of own funds available to support banking activity, exerting a safety net in case of hostile developments [14]. Banks with a high net worth on assets are seen as safer and less risky banks compared to institutions with lower capital, that is, well-capitalized banks are able to cope with times of crisis [3, 8]. In fact, according to Iannotta, Nocera, and Sironi [20], a better capitalization of banks
may reflect a higher quality of management. This association can help banks finance their assets with lower interest rates, as the risk of bankruptcy is reduced [3, 15], thus making increase your profitability.
However, Djalilov and Piesse [14] suggest that the increase in financing costs due to the high level of capital could negatively affect bank profitability. Thus, the authors found a positive relationship between capital and profitability in the countries that made the initial transaction, however, the countries of the former USSR did not show any relationship between capital and the profitability of their banks. Dietrich and Wanzenried [3] also showed that in the pre-crisis period, capital did not influence the profitability of the Swiss banking sector, but between 2007 and 2009 they had a significantly negative ROAA. On the other hand, Knezevic and Dobromirov [11] show that the profits of Serbian national banks are not influenced by capital, on the other hand, foreign banks are negatively influenced.
Trujillo-Ponce [10] showed that Spanish banks are positively influenced by capital when profitability is calculated using ROAA, however, when it is related to ROAE, they present a negative relationship. In contrast, the Portuguese banks analyzed by Garcia and Guerreiro [19] showed a negative association with ROAA, but insignificant with ROAE.
Other studies, such as Alshatti [18], Athanasoglou et al. [2], Rumler and
Waschiczek [9], Saona [12] and Trabelsi and Trad [17] show a positive relationship between return and equity on assets. While the studies by Guru et al. [8] and Shehzad, De Haan and Scholtens [21] have a negative sign.
According to the exposed literature, the following hypothesis is proposed:
Hypothesis 3—There is a significant relationship between the capital ratio of banks and their profitability (with no defined sign).
2.1.4 Operational efficiency
Beccalli et al. [22] argue that efficiency represents the minimization of inputs (that is, consuming fewer inputs for the same level of results) or the maximization of outputs (producing more outputs for the same amount of inputs). To this, authors such as Beccalli et al. [22] and García-Herrero et al. [15], call itX-efficiency (best practice indicator). According to some studies [2, 4], operational efficiency is one of the indicators that most influence bank profitability. Thus, for profitability to be high, the degree of efficiency of the financial institution’s management must also be high [2, 3], that is, the reduction of operating costs (administrative expenses, employees’ salaries, property expenses, among others) and, simultaneously, the increase in income, lead to a high level of bank profitability [11].
Traditionally, the operational efficiency of the banking sector is calculated using the cost-to-income (CIR) ratio, that is, expenses to income, with a high value
reflecting more inefficiency. Therefore, it is expected that expenses will be lower than revenues so that efficiency will positively influence banks’profitability.
Thus, some showed a negative association between bank efficiency and profit [3, 8, 10, 11, 19, 21].
For example, Ding et al. [4] concluded that the Chinese banking sector is more efficient than US banking institutions in times of crisis, however, after the crisis, the US overlaps China. Tan et al. [16] found that efficiency in Chinese banks negatively influences ROAA and positively ROAE.
According to the literature cited, the fourth hypothesis is presented:
Hypothesis 4—There is a positive relationship between operational efficiency and your bank profitability.
2.1.5 Revenue diversification
Banking activities can be divided into traditional activities and non-traditional activities, both of which are important for bank profitability. According to Trujillo- Ponce [10], non-traditional activities arise for diversification, trying, in this way, to generate new sources of income complementing traditional activities. In this sense, Stiroh and Rumble [23] follow in stating that financial institutions have to make more profitable sources that are generated by non-traditional activities so that they increase profitability levels and manage to survive the competition.
However, DeYoung and Rice [24] argue that one cannot put all the emphasis on non-traditional activities, due to the consequent increase in profitability, since, if they are not associated with traditional activities, they become an unsound strategy, thus putting, concerned the possible profit.
Even so, studies have concluded that revenue diversification has a positive impact on profitability above the spread [25]. While Saona [12] presented a negative sign for this relationship. Tan et al. [16] showed a positive relationship between non-
traditional activities and ROAA, but a negative one with ROAE. However, Elsas, Hackethal and Holzhäuser [26], Stiroh and Rumble [23], and Trujillo-Ponce [10] did not find significant differences to be able to state that diversity affects profitability.
As per the provisions, it appears that there is a relationship between the diversity of revenues and the profitability of the banking sector. Accordingly, the following hypothesis arises:
Hypothesis 5—There is a significant relationship between revenue diversity and bank profitability (with no defined sign).
2.1.6 Deposit growth
In general, deposits represent stable and cheaper resources than other types of financing, and, to this extent, they contribute to increasing bank profitability [15]. But the global financial crisis led banks to adopt aggressive policies, mortgaging their margins at the expense of paying higher rates, which contributed to the decrease in profitability [10].
Dietrich and Wanzenried [3] state that an increase in deposits also implies attend- ing to numerous factors, such as operational efficiency, as banks must be able to convert deposit liabilities into revenue-generating assets, taking into account good credit quality. However, high deposit growth rates also attract additional competitors, affecting the profitability of banking institutions.
Thus, Trujillo-Ponce [10] did not find any relationship between the growth rate of bank deposits and Spanish bank profitability. However, Garcia and Guerreiro [19]
found that the growth of deposits intervenes positively in ROAA, but that it has no statistical significance in ROAE. In contrast, Dietrich and Wanzenried [3] are faced with a negative influence on ROAA and a positive influence on ROAE.
In harmony with the exposed literature, the following hypothesis is put forward:
Hypothesis 6—There is a significant relationship between the growth rate of deposits and bank profitability (no defined sign).
2.1.7 Bank size
The size of banks is one of the characteristics that have traditionally been used to determine their levels of profitability because, in principle, the bigger the bank, the
greater the use of synergies and economies of scale, leading to a reduction in expenses and, consequently, an increase in results and profitability [14, 20]. Saona [12] claims that a large bank will incur in large operations, therefore, it will be associated with a higher risk, which, consequently, will cause the institution to charge higher margins, positively influencing profit.
However, a bank that is too large may incur diseconomies of scale as it will have an increase in variable costs, such as operating, bureaucratic and marketing expenses, negatively affecting bank profitability [2, 3]. According to García-Herrero et al. [15], the increase in size can make bank management difficult due to the occurrence of aggressive competitive strategies.
Therefore, empirical investigations [12, 16, 17] have found a positive and signifi- cant relationship between profitability and size.
Dietrich and Wanzenried [3] showed that in Switzerland the largest banks are the least profitable, following Berger and Mester [27] who had concluded the same.
In another sense, Ding et al. [4] showed that the large US banks after the crisis were the ones that were able to restructure the fastest and obtain higher levels of profitability. Once the authors had obtained a negative relationship during the crisis.
Also, Elsas et al. [26] and Knezevic & Dobromirov [11] found a negative and signifi- cant relationship between size and profitability. Other empirical research does not find any significant relationship between profitability and bank size [2, 9, 10, 18, 28].
Following the exposed literature, we proposed hypothesis 7:
Hypothesis 7—There is a significant relationship between the bank’s size and its profitability (with no defined sign).
2.2 Industry-specific determinants