Saint mary’s university

Control variables

The researcher used two major control variables in both regression models namely; bank specific factors and macroeconomic factors. Bank specific factors proxies were size, credit risk, and efficiency and the Macroeconomic factors were proxy with inflation and GDP.

• Operating efficiency

Operating efficiency proxy of management quality is taken as a ratio expense to asset. The ratio of operating expenses to total asset is expected to be negatively associated with profitability. The coefficient estimates of-0.098683 andthepvaluewas0.0574 whichwashighlysignificantat10% significance level. Holding other factors constant, an increase a100% in the increase in ratio of operating expense to total asset decreases the profitability of banks by decreased 9.87% (see table 4.5).

Bank equity and profitability

Some theories (Berger, 1995 and others) suggest that well-capitalized banks are subject to less expected bankruptcy costs and hence lower cost of capital. Accordingly our result shows a positive and statistically significant relationship. Holding other factors constant, an increase a100% in the increase in ratio of operating expense to total asset decreases the profitability of banks increased by 10.3%.

• Bank size

This variable is set to be equal to the logarithm of total bank assets in millions of Birr. Size might be an important determinant of bank performance if there are increasing returns to scale in banking. In the regression result shown above in table, (table 4.5) Confirms this hypothesis big banks enjoy a high profit in Ethiopia. It is significant at 1% level of

significance if a banks increases there size by 100% on average there profit will increase by 139.5%.

Macroeconomic Indicators

Among the macroeconomic indicators inflation and financial sector development proxy by M2 to GDP ratio are found to be significant in explain the profitability of private banks in Ethiopia at a significance level of 1%. However log of GDP a proxy for economic growth has found to insignificant in the profitability of bank equation. According to some theories, if inflation is not anticipated and banks are sluggish in adjusting their interest rates, there is a possibility that bank costs may increase faster than bank revenues and hence adversely affect bank profitability. Our result confirms this hypothesis inflation reduce bank profitability in Ethiopia. Financial sector development and bank profitability measured in terms of NIM have opposite relation. This may show that as the financial sector development increases in increases competition this in turn reduces the gain from interest rate.