H1 2022 banks profitability signals bright future of Tanzania economy
Tanzania’s banking sector showed robust profitability in H1 2022, bolstered by strong economic indicators and improved financial stability post-COVID-19. Despite challenges like rising inflation at 4.5% and economic uncertainties from global events, banks benefited from efficient asset management and strategic loan portfolios. The sector’s resilience was underscored by prudent financial strategies amid competitive pressures and regulatory changes under Basel III, influencing profitability dynamics positively despite market volatilities.
TANZANIA’S financial steadiness setting and bank profitability signal that banks are coming off the wood after most major lenders’ H1 2022 audited publications were out. From audited financial publications, it is strong that Tanzania’s economy looks bright.
My point of view is also shared by Absa’s Head of Markets, noting that Tanzania’s economy is anticipated to continue to improve post covid-19 endemic eased by the government vaccination determinations, supportive macro-economic policies and above all constructive financial conditions.
Amidst Absa’s economic outlook in mind (Daily news 12/08/2022 pg.16), the business and finance section (Daily news 9th/08/2022 pg.18) presented an analysis examining the bank’s profitability focusing on published audited financial and what ratios could mean.
Today’s post-mortem explores the features that could have led to the profitability of major lenders for H1 2022.
Even as inflation rises to a five-year record 4.5% in July 2022, from 4.4% recorded in June 2022, according to NBS the highest rate since November 2017, undeniably, lenders’ high bank profitability during H1 2022, seeing ratios and profit indicate there was a large percentage of loans in total assets, a high quantity of customer credits, worthy spotting efficiency, and low credit risk that all together could have boosted the bank’s gains on assets as the profitability measure.
From an economic perspective, profitability is vital for a bank to sustain ongoing lending activity and significantly for its investors to obtain a reasonable return on their investment.
Equally, it is too critical for regulators since it warranties more flexible capital ratios, even in the milieu of a riskier business environment.
As an investment analyst, it is known that there is abundant info on the determinants of bank profitability. Evident the present strategic status of the Tanzanian banking structure, and economic activities and considering banks’ firmness, revisiting the bank profitability drivers could help shed light on the rationalisation of declared banks’ profits earned in H1 2022.
Whilst I am aware not everyone knows certain terms used to ascertain banks’ profits and for education tenacities, the factors that determine the profitability of banks, in my view fall into two groups.
Primarily, the bases of profitability could be explicit to each bank and that, in many cases, could have a direct result of the bank’s managerial decisions that involve asset structure, asset quality, capitalization, financial structure, efficiency, size, and revenue diversification.
Other factors relating to profitability could be the industry structure and the macroeconomic setting within which the banking system functions, such as industrial strength, economic growth, inflation, interest rates charged to access credit etc.
Within the elements painted above, most of the banking literature concurs that a bank’s profitability is expected to increase as its portfolio of loans grows relative to other more secure assets such as government securities, considering the known relationship between risk and return, that economically can be redefined as risk-return trade-off.
Within this viewpoint, a greater relative percentage of loans in the portfolio of the bank is mostly tied with a greater liquidity risk resulting from the incapability of banks to adjust decreases in liabilities or to fund increases on the assets side of the balance sheet that consequently lead to a situation holding a low proportion of liquid assets with greater liquidity risk is more prone to earn high profits.
Hence, there appears to be unanimity that bank profitability is candidly related to the quality of the assets on its balance sheet, signifying that poor credit quality can lead to a negative effect on bank profitability and vice versa.
This relative occurs since an increase in the doubtful assets, which do not accrue income, compels a bank to allot a significant portion of its gross margin to provisions to cover anticipated credit losses that could result in low profitability.
Thus, why the evolution of the diminishing losses on loans and receivables rationalises a large part of the profitability of banks. But, if the financial system is well rewarded that is, if prices are set by the risk incurred to the extent advocated in the new banking regulation Basel II and, more lately, Basel III, riskier loans should produce higher interest income, with an optimistic bearing on profitability.
For a bank with capital below its equilibrium ratio, expected bankruptcy costs are relatively high, and an increase in capital ratios could raise expected profits by lowering interest expenses on uninsured debt.
This relative would help the bank to finance its assets at more favourable interest rates, increasing expected profitability and offsetting the cost of equity, which could be the most expensive bank liability in terms of expected return.
With positive interest rates, it is critical to acknowledge that the escalation of advances in information, communications and financial technologies has allowed banks to perform many of their traditional services more efficiently perhaps explaining cost reduction.
The cost-to-income ratio, a proxy for operational efficiency, could benefit roughly universally to different degrees, meaning that banks could have lower expenses for a given level of output. This relation could imply that operational efficiency is a prerequisite for rocketing the profitability of the banking system, with the most profitable banks having the lowest efficiency ratios.
In the literature, the average cost curve in banking has a relatively flat U-shape, with medium-sized banks being slightly more scale efficient than either large or small banks, a picture arising from the analysis of banks’ financial figures published during H1 2022.
Most banks’ interest margins compared to similar periods in previous years signal that most banks have changed their traditional role of banks and strained themselves to search for new sources of revenue to boost their profit. Some have typically increased diversification by moving into fee-based businesses, expanding their business into trading activities or underwriting insurance contracts.
To understand more about a bank’s profits, two theories are important, especially how the degree of sector concentration could affect bank profitability.
The structure-conduct performance assumption is also insinuated as the market-power theory states that a more concentrated sector favours bank profitability driven by the benefits of greater market power, which reflects the setting of prices that are less favourable to clients.
This means, that lower deposit rates and higher credit rates are a result of competitive imperfections in these markets. On the other hand, the efficient-structure principle rationalises the positive relationship between concentration and profitability as an indirect consequence of efficiency.
From profits acknowledged during H1 2022, better-managed banks or banks with more strategic efficient cost structures reducing mechanisms could see their market shares increase, rising in a higher degree of concentration i.e., the increased profitability would not be a consequence of greater market power but rather the indirect result of an improvement in efficiency.
Amidst market power and concentration, economic conditions’ significance can exacerbate the quality of the loan portfolio, generating credit losses and increasing the provisions banks need to hold, consequently reducing bank profitability while rising NPLs levels.
An increase in economic conditions, in addition to improving the solvency of borrowers, could increase demand for credit by households and businesses, with positive effects on the profitability of banks.
The issue of the relationship between bank cost-effectiveness and inflation is also vital in learning profit levels in the banking business.
The effect of inflation on bank profitability depends on how inflation affects both salaries and the other operating costs of the bank and businesses in general.
It means that the extent to which inflation impacts bank profitability will depend on whether the extent of inflation is fully likely or not. If the inflation rate is fully anticipated (according to NBS inflation by July is 4.5%from 4.4% recorded in June for example) this level of inflation will implicitly alarm the bank’s management to fine-tune interest rates appropriately to increase revenues faster than costs, which could have an optimistic impact on profitability.
What is being suggested here is that an environment of low-interest rates coupled with fierce competition among banks could limit the possibilities for banks to establish appropriate prices for their loans and deposits, putting pressure on the operating margin and negatively affecting banks’ profitability negatively or positively.
In a nutshell, having scanned all bank-printed audited financials for H1 2022 I am of the view that the main factors behind the high bank profitability in Tanzania for the H1 2022 caution several challenges face the Tanzania banking structure shortly.
Until the economy fully recovers from covid-19 and the effects of the Russia Ukraine war, the persistent economic watershed will likely continue to have an impact on the industry’s business volume, and this will affect borrowers’ ability to repay their loans.
Proportionately, for the Tanzania banking industry to be able to maintain profits earned during H1 2022, banks shouldn’t ignore barriers arising from instability in international capital markets, with the consequent increase in funding costs for banks.
And importantly, the new liquidity standards set by Basel III in my opinion could reduce bank profitability from traditional lending activities, whereas the higher capital requirements under the new banking regulation may have a positive effect on ROA and a negative effect on ROE.
Source Link : https://dailynews.co.tz/h1-2022-banks-profitability-signals-bright-future-of-tanzania-economy/
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