Analysis: Determinants of Profitability in UK Commercial Banks

This report provides a comprehensive literature review on the determinants of profitability for commercial banks in the United Kingdom. It categorizes factors affecting bank profitability into internal and external categories, discussing the influence of management decisions, employee qualifications, and expense control as internal factors. The report highlights the impact of external factors such as inflation, market structure, and economic conditions. It examines the traditional structure-conduct-performance (SCP) hypothesis and the efficient-structure (EFS) hypothesis, exploring how market power and efficiency influence bank profits. Additionally, the report considers the role of regulations, ownership, and demand factors like population and income on bank profitability. The conclusion emphasizes the importance of management policies in navigating both internal and external challenges to maintain and improve bank performance.

Determinants of profitability of
commercial banks in the United
Kingdom

TABLE OF CONTENTS
introduction......................................................................................................................................3
literature review...............................................................................................................................3
conclusion........................................................................................................................................5
refrences...........................................................................................................................................6

INTRODUCTION
A literature review is a significant part of research study as it shows viewpoints of previous
research scholars on the current topic. The present study is based on the factors which affect the
profitability of commercial banks in the United Kingdom by considering bank’s earning capacity
and various aspects of banks operating performance. Several studies of research scholars are
evaluated to know the factors that change the profits of commercial banks.
LITERATURE REVIEW
According to the study of Saeed (2014) factors that affect the profitability of banks can be
categorized into two parts which are internal and external. The first one i.e. internal factor refers
to the organization objectives, policies and decision which are in control of management. It is
one of the reasons which create a difference in the profitability of different banks. In this aspect,
Boria and co-authors (2017) had stated that Banks performance largely depends on the
management efforts, qualification and experience of employees which include a decision
regarding loan portfolio concentration. Efforts, awareness and control over the decision of senior
officials of banks are required for good bank performance.
Study of Alessandri and Nelson (2015) control over the expenses is considering the main
factor of bank’s profitability. Through proper analysis of the expense management can increase
the chances for improvement in the profitability department. This fact is supported by the study
of Culpepper and Reinke (2014) which states that behind the success of every big organization
whether it is banks or other businesses is man power. The senior officer, management and labour
give their best to their work. If management can manage the staff expenses, then they can reduce
the cost. There is no problem to give staff good salary if banks performance is continuously
growing.
Gibson and Thirlwall (2016) believes that there are some external factors which are
beyond the control of management decisions and policies but have significant influence over the
profitability of banks. It is included in the performance report which helps to identify the reasons
behind performance separately. To support this statement, the study of Saghi-Zedek and Tarazi
(2015) shows the relationship between market structure and profitability. Bank’s performance is

measured by the traditional structure conduct performance (SCP) hypothesis and the efficiency
structure (EFS) hypothesis. Some economist using several free variables which are linked to the
feature of both external and internal factors for explaining bank’s profitability.
The traditional structure conduct performance (SCP) says that bank can increase their
profit margin by lowering their deposits interest rate and increasing their loan interest rates, but
relative market power hypothesis (RMP) says that only those firms who have different product
and have big market capital can earn super normal profit (Apergis, 2014). If performance –
structure relation is characterized by dichotomous relationship then monopoly profits can be
earned by the bank that operates above the critical level of concentration while competitive
profits can be earned by the banks that operate below the breakeven point.
According to Campiglio (2016), the second approach of efficient structure (EFS)
hypothesis is challenging traditional structure conduct performance (SCP) hypothesis. In this
approach, some firms in the industry have superior efficiency, so market concentration depends
on them. EFS hypothesis refers to the big firms which generate huge profits which result increase
in market concentration (De Jonghe and Öztekin, 2015). Many researchers want to differentiate
between these two hypotheses, so they take market share as an independent variable with a
positive coefficient which supports EFS hypothesis.
There are some other variables in banking sectors like the scale of regulation. After
giving permission to state wide banking operating cost and not performing asset is reduced
which lead bank to grow faster as a comparison to their rivals. Many researchers say that
ownership may influence the profitability of banks. In this aspect, Hall and Co-authors (2016)
had stated that the solvency and stability of the financial institution are affected by inflation.
Inflation can change the profitability of banks according to the level of inflation. The effect of
inflation can be clearly seen on the customers of financial institutions because of change in
demands. Inflation can lead to increase in nonperforming assets because there are difficulties in
cash flow. Factors which affect profitability can be considered as demand factor. Study of
Fredriksson and Moro (2014) shows that it is generally believed that change in population and
income is an important demand factor. Per capita income is not directly affecting the earning
capacity of banks. For example oil crisis and commercial real estate crashes. If there is a
downward slope in real estate, then it can affect banks earning but did not effect on per capita

income. Some of the researchers say that profitability of banks is not affected by the locations of
banks, on the other hand, some of the researchers say that location can have a big impact on
banks earning (Cohen and Scatigna, 2016).
CONCLUSION
On the basis of this part of the study, the conclusion can be drawn that profitability of the banks
can be primarily affected by management policies and decisions. It can be controlled because it
is an internal factor, but there are some external factors which are not in the control of
management such as inflation, market economic condition. To maintain the performance,
management must check or modify their policies according to outside environment.

REFERENCES
Alessandri, P. and Nelson, B.D., 2015. Simple banking: profitability and the yield curve. Journal
of Money, Credit and Banking, 47(1), pp.143-175.
Apergis, N., 2014. The long-term role of non-traditional banking in profitability and risk
profiles: Evidence from a panel of US banking institutions. Journal of International Money and
Finance, 45, pp.61-73.
Borio, C., Gambacorta, L. and Hofmann, B., 2017. The influence of monetary policy on bank
profitability. International Finance, 20(1), pp.48-63.
Campiglio, E., 2016. Beyond carbon pricing: The role of banking and monetary policy in
financing the transition to a low-carbon economy. Ecological Economics, 121, pp.220-230.
Cohen, B.H. and Scatigna, M., 2016. Banks and capital requirements: channels of
adjustment. Journal of Banking & Finance, 69, pp.S56-S69.
Culpepper, P.D. and Reinke, R., 2014. Structural power and bank bailouts in the United
Kingdom and the United States. Politics & Society, 42(4), pp.427-454.
De Jonghe, O. and Öztekin, Ö., 2015. Bank capital management: International evidence. Journal
of Financial Intermediation, 24(2), pp.154-177.
Fredriksson, A. and Moro, A., 2014. Bank–SMEs relationships and banks’ risk-adjusted
profitability. Journal of Banking & Finance, 41, pp.67-77.
Gibson, H.D. and Thirlwall, A.P., 2016. Balance-of-payments theory and the United Kingdom
experience. Springer.
Hall, S., Foxon, T.J. and Bolton, R., 2016. Financing the civic energy sector: How financial
institutions affect ownership models in Germany and the United Kingdom. Energy Research &
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Saeed, M.S., 2014. Bank-related, industry-related and macroeconomic factors affecting bank
profitability: a case of the United Kingdom. Research journal of finance and accounting, 5(2),
pp.42-50.
Saghi-Zedek, N. and Tarazi, A., 2015. Excess control rights, financial crisis and bank
profitability and risk. Journal of Banking & Finance, 55, pp.361-379.