DETERMINANTS OF PROFITABILITY OF COMMERCIAL

BANKS USING CAMEL FRAMEWORK: A CASE OF TANZANIA

By
Fadhila Tiisekwa

This Dissertation is Submitted as a Partial Fulfillment of the Requirements for

Award of the Degree of Master of Accountancy And Finance of Mzumbe
University.

2013

i
 CERTIFICATION
We, the undersigned, certify that we have read and here by recommend for acceptance
by the Mzumbe University, a dissertation/thesis entitled Determinants of commercial
banks profitability using CAMEL framework: A Case of Tanzania, in partial
fulfillment of the requirements for award of the degree of Master of Accounts and
Finance of Mzumbe University.

Signature

___________________________
Major Supervisor

Signature

___________________________
Internal Examiner

Accepted for the Board of Faculty of Commerce.

……………………
Signature

DEAN, FACULTY OF COMMERCE

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 DECLARATION
I, Fadhila Tiisekwa, declare that this dissertation is my own original work and that it has
not been presented and will not be presented to any other university for a similar or any
other degree award.

Signature ___________________________

Date________________________________

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 COPYRIGHT

©2013
This dissertation is a copyright material protected under the Berne Convention, the
Copyright Act 1999 and other international and national enactments, in that behalf, on
intellectual property. It may not be reproduced by any means in full or in part, except
for short extracts in fair dealings, for research or private study, critical scholarly review
or discourse with an acknowledgement, without the written permission of Mzumbe
University, on behalf of the author.

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 ACKNOWLEDGEMENTS
First and for most I thank God who has blessed me and enabled me to do this work.
My profound gratitude is due to Prof. M. Srinivas for his guidance, supervision,
constructive criticism, encouragement and tireless effort throughout my study. Your
contribution is priceless. God bless you.
I thank my beloved family, my parents; Prof B. P. M Tiisekwa, Dr. Mrs. Jasmine
Tiisekwa and my siblings. Thank you for the moral and financial support; thank you for
being an example to live up to and thank you for the push. I truly feel blessed.
God bless you.
I thank my Lecturers at Mzumbe University, the knowledge they have instilled in me
has been of great help in fulfilling my study. God bless you.

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 DEDICATION
To all those I call family.

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 ABBREVIATIONS AND ACRONYMS
AIG American International Group
BOD Board of Directors
BOT Bank of Tanzania
CAMEL Capital adequacy, Asset quality, Management quality, Earnings,
Liquidity
CAR Capital Adequacy Ratio
CRDB CRDB bank PLC
DBS Directorate of Banking Supervision
DSE Dar es Salaam Stock Exchange
EAC East African Community
FI Financial Institution
FSSA Financial System Stability Assessment
FSR Financial Stability Report
GFC Global Financial Crisis
GDP Gross Domestic Product
LDR Loans to Deposits ratio
NBC National Bank of Commerce
NIM Net Interest Margin ratio
NMB National Microfinance Bank
NPL Non-Performing Loans ratio
OER Operating Expenses Ratio
PAR Portfolio at Risk
ROA Return on Assets
ROI Return on Investment
SAP Structural Adjustment Program
SSA Sub-Saharan Africa

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 ABSTARCT
The study primarily aims at determinants of profitability of commercial banks in
Tanzania applying CAMEL frame work. This study compares the financial performance
of three major banks CRDB, NBC and NMB. The three banks are also ranked based on
a CAMEL rating system. The study is undertaken in attempt to fill in the existing
research gap, also to confirm the role played by internal factors to determine
profitability and last but not least to provide information that can be used as a basis for
comparison with different studies.
This study involves the analysis of commercial banks operating in Tanzania for a period
of 7 years, from 2006 to 2012. Financial ratios in the context of CAMEL framework,
which include; Capital Adequacy, Asset Quality, Management Quality, Earnings and
Liquidity were applied. The research uses the data published by the sample banks in
their annual reports and financial statements. Descriptive statistics were applied in
analyzing the data, followed by deriving of CAMEL ratios and rating them and then
correlation analysis was performed and finally regression was applied.
The dissertation is organized into five chapters. Chapter one, problem setting; Chapter
two deals with literature review which includes theoretical review, empirical review and
conceptual framework. Chapter three is the research methodology; Chapter four is
concerned with data analysis, findings and discussion and Chapter five gives the
conclusion and recommendations.
The CAMEL model predicts 51.74% of ROA; this calls for a more robust way of
determining profitability to include external factors. NMB which is 50% foreign owned
and 30% government owned proved to out rank the other two major banks CRDB and
NBC. The study reveals that the profitability of commercial banks as measured by ROA
is significantly determined by quality of assets. In order to improve profitability; credit
information should be improved, and banks can opt to diversify their products so that
they do not heavily rely on loans.

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 TABLE OF CONTENTS

CERTIFICATION ............................................................................................................. i
DECLARATION .............................................................................................................. ii
COPYRIGHT ................................................................................................................... iii
ACKNOWLEDGEMENTS ............................................................................................. iv
DEDICATION .................................................................................................................. v
ABBREVIATIONS AND ACRONYMS ........................................................................ vi
ABSTARCT .................................................................................................................... vii
TABLE OF CONTENTS ............................................................................................... viii
LIST OF TABLES ............................................................................................................ x
LIST OF FIGURES ......................................................................................................... xi

CHAPTER ONE ............................................................................................................. 1

PROBLEM SETTING.................................................................................................... 1
1.1 Introduction ................................................................................................................. 1
1.1.1 Tanzania Banking Sector …………………………………………………...2
1.1.2 Tanzania banking sector reforms……………………………………………..2
1.2 Background of the problem ........................................................................................ 7
1.3 Statement of the Problem .......................................................................................... 10
1.4 Objectives ................................................................................................................. 10
1.4 Significance of the Study .......................................................................................... 11
1.5 Limitation of the Study ............................................................................................. 12

CHAPTER TWO .......................................................................................................... 13

LITERATURE REVIEW ............................................................................................ 13
2.1 Introduction ............................................................................................................... 13
2.2Theoretical Literature Review ................................................................................... 13
2.2 Empirical Literature Review ..................................................................................... 23
2.3 Conceptual Framework ............................................................................................. 29
2.4 Hypothesis................................................................................................................. 35

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CHAPTER THREE ...................................................................................................... 36
RESEARCH METHODOLOGY ................................................................................ 36
3.1 Introduction ............................................................................................................... 36
3.2 Scope of Study .......................................................................................................... 36
3.3 Study Population and Sample ................................................................................... 36
3.4 Data Type and Collection Methods .......................................................................... 37
3.5 Data Analysis ............................................................................................................ 37
3.6 Model Specification .................................................................................................. 42

CHAPTER FOUR ......................................................................................................... 44

FINDINGS AND DISCUSSION .................................................................................. 44
4.1 Introduction ............................................................................................................... 44
4.2 Descriptive Results ................................................................................................... 44
4.3 Profitability ............................................................................................................... 45
4.4 Capital Adequacy ...................................................................................................... 46
4.5 Asset Quality............................................................................................................. 47
4.6 Management Quality................................................................................................. 48
4.7 Earnings Performance ............................................................................................... 48
4.8 Liquidity Position...................................................................................................... 49
4.9 Ranking of the commercial banks............................................................................. 50
4.10 Correlation Analysis ............................................................................................... 51
4.11 Regression Analysis ................................................................................................ 52

CHAPTER FIVE .......................................................................................................... 55

CONCLUSIONS AND RECOMMENDATIONS ...................................................... 55
5.1 Introduction ............................................................................................................... 55
5.2 Summary ................................................................................................................... 55
5.3 Financial performance of major banks ..................................................................... 55
5.4 Ranking of banks based on CAMEL ratings ............................................................ 58
5.5 Determinants of profitability of commercial banks .................................................. 58
5.6 Scope for further studies ........................................................................................... 58
REFERENCES .............................................................................................................. 60
APPENDICES ............................................................................................................... 65

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 LIST OF TABLES
Table 2.1: Components, ratios and implications of CAMEL......................................... 18
Table 2.2: Rating base of CAMELS components .......................................................... 19
Table 2.3: BOT standards that account for NIM............................................................ 19
Table 2.4: Summary of empirical review ....................................................................... 28
Table 2.5: The expected impact of independent variables on ROA
(Return on assets) .......................................................................................... 33
Table 3.1: Statistics of the Sample Banks ...................................................................... 37
Table 4.1: Descriptive statistics of variables.................................................................. 44
Table 4.2: Comparative ROA analysis and rating ......................................................... 45
Table 4.3: Comparative CAR analysis and rating .......................................................... 46
Table 4.4: Comparative NPL analysis and rating .......................................................... 47
Table 4.5: Comparative OER analysis and rating .......................................................... 48
Table 4.6: Comparative NIM analysis and rating .......................................................... 49
Table 4.7: Comparative LDR analysis and rating .......................................................... 50
Table 4.8: Sample banks ranking ................................................................................... 50
Table 4.9: Correlation between ROA and other financial ratios .................................... 51
Table 4.10: Regression analysis for the dependent variable ........................................... 52
Table 4.11: Summary of findings ................................................................................... 54

x
 LIST OF FIGURES

Figure 2.1: Internal determinants of commercial banks profitability using

CAMEL framework ................................................................................ 29

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 CHAPTER ONE
PROBLEM SETTING

1.1 Introduction
An economy's financial sector is critical to its overall development. Banking systems
and stock markets play pivotal role in this process acting as intermediaries in balancing
the funds of the economy by transferring from surplus areas to required areas
enhancing economic growth enabling effective employment of resources of the country
for productive purposes. Strong financial systems provide reliable and accessible
information that lowers transaction costs, which in turn bolsters resource allocation and
economic growth. Indicators here include the size and liquidity of stock markets; the
accessibility, stability, and efficiency of financial systems; and international migration
and workers/remittances, which affect growth and social welfare in both sending and
receiving countries (World Bank Group, 2012). This means poor banking systems
hinder economic growth, due to inhibited allocation of resources. The financial sector
comprises of banks, investment funds, insurance companies and real estate.

In the Tanzanian financial system, banking institutions are the major players,
accounting for about 75% of total assets of the system. Effective supervision of the
banking sector is an essential component of a strong economic environment. The
primary objective of supervision is to ensure that banks and financial institutions
operate in a safe and sound manner and that, they hold capital and reserves sufficient to
absorb risks that arise in their operations. While the cost of effective banking
supervision is indeed high, the cost of poor supervision may be even higher. Therefore,
strong and effective banking supervision is essential for maintaining stability and
confidence in the financial system. Public confidence is a critical aspect to any
financial system (DBS report, 2010).

A world without banking systems is un-imaginable, especially in this era of

globalization, numerous innovation and technological advancement; furthermore the
world would not have reached this stage of development this fast without the support of
the financial sector.

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1.1.1 Tanzania Banking Sector
By 2013, according to the BOT website publication, the banking sector comprised of
32 commercial banks. As the banking institutions hold about 75 percent of the financial
assets as stated before, the linkages between the banking sector and the macro economy
are perceived to be particularly strong, giving rise to potential concerns about systemic
risk and financial stability. As part of its mandate to ensure the stability and soundness
of the banking sector, the Bank has subscribed to international prudential and
regulatory standards but adapted them to the domestic specificities. With financial
stability mandate in mind, the Bank of Tanzania‟s (BOT) supervising banks on a
consolidated basis, reflecting the way banking institutions themselves manage risks
and, in particular, recognizing the possibility of contagion risk within a banking group.
Indeed, the regular on-site examination of banks complemented by close off-site
surveillance plays a major role in detecting early warning signals that would require
prompt corrective action by the responsible bank. This approach has, over the years,
contributed significantly to mitigate the level of risks in the banking system.

By end of June 2010, the banking sector was made up of 41 banking institutions, out of
which 19 were foreign owned. The banking system showed a high concentration of
total assets - 57 percent - being held by four big banks, while 43 percent were
accounted for by the remaining 37 banks. Generally, foreign owned banks in Tanzania
account for about 48 percent of the banking industry‟s total assets. Despite this
significant market share, the effects of the Global Financial Crisis (GFC) had a limited
direct impact to foreign owned banks, notwithstanding the credit crunch suffered by
some of their parent companies in Europe and America.

The cushion over external exposure is mainly attributed to the structure of the
Tanzanian prudential financial sector regulation system, and the existing limitations on
foreign currency placements or foreign investments by Tanzanian firms (FSR, 2010).

1.1.2 Tanzania banking sector reforms

In Tanzania, poor performance of the state-owned financial sector in late 1980s forced
the government to search for new policy directions. NPLs were above 65 percent of the
loan portfolio, fiscal and financial operations were not separated, and an appropriate

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regulatory framework was missing. In 1990, a special presidential commission
recommended: (i) increasing competition by encouraging entry of foreign banks; (ii)
strengthening the existing financial institutions; (iii) developing management
accountability; and (iv) recovering NPLs. Based on these, the government has issued a
policy statement on financial sector reform with the aim of creating a market-based
financial system, efficient in mobilizing and allocating resources and supporting long-
term economic growth (Cihak and Podpiera, 2005).

Cihak and Podpiera (2005) further reveal that a new regulatory framework was
introduced, organization and financial restructuring of the two largest (formerly state-
owned) banks, NBC and Cooperative and Rural Development Bank (now CRDB), has
been implemented and the sector has been open to financial services providers. The
new Banking and Financial Institutions Act approved in the second half of 1991
allowed licensing of new banks, including subsidiaries of foreign banks. The first major
foreign bank (Standard Chartered) started operations in 1992, with other international
banks following––Stanbic (1993), Citibank (1995), and Barclays (2000). Several other
smaller foreign banks set up their subsidiaries during 1995–2002. The authors report
that history of non-repayment leads to slow replacement of NPLs and hence
necessitates, the banks to accumulate extensive holdings of government paper and off-
shore deposits in foreign exchange, limiting the amount of credit available to the
private sector.

Having recognized the need to create an environment more conducive to lending and
financial sector development overall, the authorities have recently introduced wide-
ranging reforms in the areas of legal, judicial, and information infrastructure, including
the Land Act 1999 and the Companies Act 2002. Judicial and court reform is one of the
basic priorities to which increasing attention is being paid. However, comparatively
little progress has been made, with training and facilities still remaining in need of
special attention. Furthermore, land registries, company registries, and registries of
mortgage interests are inefficient, and considerable improvements are needed before
they will provide a useful information basis for credit decisions (Cihak and Podpiera,
2005).

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Since the introduction of Structural Adjustment Programs (SAP) in the late 1980‟s, the
banking sector worldwide has experienced major transformations in its operating
environment. Countries have eased controls on interest rates, reduced government
involvement and opened their doors to international banks (Ismi, 2004).

Pastory and Qin, (2012) wrote that commercial banks in Tanzania have gone into
significant changes after the liberalization of the banking system in 1991.The reforms
removed barriers to entry of commercial banks and supported the improvement of
institutional framework and more efficiently the performance of commercial banks,
with this it has affected the profitability of commercial banks and increased banking
competition.

Financial sector assets have expanded rapidly in the past decade from a total of TZS
1,637 billion at end of December 2001 to TZS 10,040 billion in December 2009. The
growth was led by private sector deposits in the banking system.

The Financial Stability Report (FSR) of 2010 also reveals that while the banking sector
plays a dominant role in the financial system stability due to its intermediation
function, internationally, there is a growing convergence between banking and other
sectors as banks broaden their activities to include other financial services. In the EU
region, banks are licensed under universal banking laws which allow them to expand
their services to include banking, pension, insurance, securities and other financial
services. However, the existing banking laws in Tanzania restrict banks from engaging
in non-banking financial services. Banks which intend to diversify into other financial
services are required to establish separate subsidiaries. The separation of banking
services from other financial services provides some cushion against the transmission
of shocks across different sectors in the financial system. Nevertheless, there is a
significant inter-linkage across the financial sub-sectors in Tanzania. The linkages also
imply that reforms that are undertaken by the other financial sub-sector will ultimately
affect the performance of the banking sector.

Following the GFC, regulations and policies; monetary and fiscal, have been revised.

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The onset of the GFC became a wake-up call to many countries to re-examine their
macroeconomic management frameworks and policies in order to determine their
adequacy in terms of safeguarding financial stability by maintaining a robust, efficient
and resilient financial systems. The re-evaluation of policy frameworks centered on the
three major processes involved in financial stability analysis one being surveillance of
the financial system (FSR, 2010).

Despite the GFC the Directorate of Banking Supervision (DBS) report of 2010 reveals
that during the year 2010, the Tanzanian banking sector performed quite well. The
financial system in general and the banking sector in particular, was resilient enough to
absorb shocks of the crisis. Strong performance was attained in terms of earnings,
liquidity, capital adequacy and quality of assets. The banking sector sector‟s
contribution to GDP had grown from 6% in 2009 to 7% in 2010. Good progress was
made in terms of outreach as banks opened more. The FSR of 2011 reveals that,
besides interest income which accounts for about 50 percent of banks‟ profits, other
major sources of bank earnings include foreign exchange gain from exchange rate
movements – contributing about 13 percent of total income, and interest income from
investment in government securities – accounting for about 10 percent. Generally, the
banking sector continued to be profitable although the level of profitability has not
recovered to pre-crisis levels. For the year ending June 2011, the banking sector
recorded a decline of almost 50 percent in profits after tax. Specifically, profit after tax
declined from TZS 104.6 billion in the year ending June 2010 to TZS 69.9 billion. The
sharp decline in profitability in the banking industry can be associated with the increase
in NPLs; narrowing of interest margin caused by the increasing competition; reduced
earnings from foreign placements; and declining returns on government securities.

The banking sector is one whose performance is affected by the performance of all
other sectors in the economy whether directly or indirectly. Any amendments to the
fiscal or monetary policies will affect the banks performance, since the bank basically
depends on customers to save (deposit) as one of the sources of loans, and to have
savings they depend on other sectors to be doing well. If the monetary and fiscal
policies are favorable then many investments will prosper and people should be able to
save more and hence invest more.

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FSR of 2010 shows that the Bank of Tanzania with regard to the banking regulations;
follows international standards including those set out in the framework of the Basel
Committee on capital adequacy. It is the Bank‟s resolve to maintain high quality
banking supervision that conforms to international standards and best practices
including improving supervisory standards through continuous upgrading of
regulations in line with international standards such as those under Basel Capital
Adequacy Framework (DBS, 2010).

The Bank of Tanzania conducts regular review of the legislative and regulatory
measures in use for the banking sector and the national payment system so as to
identify areas that need enhancement. The review process has led to – among others -
the enhancement of the required minimum core capital for banks from TZS 5.00 billion
to TZS 15.00 billion, with a view to strengthening the capability of the banking system
to absorb potential losses. The proposed changes are also expected to improve solvency
level of the industry, encourage consolidation and mergers, and further promote
competition in the banking sector.

The current financial crisis has generated a range of proposals and recommendations
for strengthening the resilience of the global financial system, which might be adapted
by countries at national level. The envisaged regulatory reforms are centered on:
strengthening capital; enhancing transparency and valuation; and strengthening
governments‟ responsiveness to risks in the financial system. The key items on the
international financial regulatory agenda include: changes to capital requirement,
appropriate oversight and systemic crisis management and resolution frameworks.

According to the new proposal by the Basel Committee of Banking Supervision on

capital known as “Basel III”, the Committee seeks to increase the quality and quantity
of capital (especially Tier 1 capital) and to discourage banks‟ excessive leverage and
risk taking. Under this new proposal, among others, banks are required to maintain a
minimum core capital ratio of 6.0 percent of risk-weighted assets and an overall total
capital ratio of 8.0 percent. In addition to minimum capital requirements under the new
proposal, banks will have to hold a capital conservation buffer of 2.5 percent of risk-
weighted assets to withstand future periods of stress. With the conservation buffer, the

6
new minimum ratio to risk-weighted assets for core capital is 8.5 percent and 10.5
percent for total capital. At this juncture, it is worth to take note of progress made by
Tanzania with regard to strengthening regulatory capital requirements. Currently, the
Bank of Tanzania requires banks to maintain core capital ratio of 10.0 percent to risk-
weighted assets and 12.0 percent for total capital, both of which are already above the
new Basel requirements (FSR, 2010).

Under these new circumstances and reforms including the minimum capital
requirement, the new regulatory frameworks, increased competition etc. that have taken
place and are on-going in Tanzania, the banks survival prosperity is closely associated
with its efficiency in managing the affairs for getting sufficient profits. Studies on
determinants of profitability always help in getting feedback and policy improvement
for further betterment.

1.2 Background of the Problem

Despite liberalization and reforms, interest rates spreads in most African countries still
remain high. In the last two decades studies have shown that commercial banks in Sub-
Saharan Africa (SSA) are more profitable than the rest of the world with an average
Return on Assets (ROA) of 2 percent (Flamini et al., 2009). For the period of this study
CRDB bank has reported a ROA of as high as 4.5% in 2008 and the average ROA of
approximately 3% for all the commercial banks under study. Ongore and Kusa, (2013)
argue that one of the major reasons behind high return in the region was investment in
risky ventures. The other possible reason for the high profitability in commercial
banking business in SSA is the existence of huge gap between the demand for bank
service and the supply thereof. That means, in SSA the number of banks are few
compared to the demand for the services; as a result there is less competition and banks
charge high interest rates. This is especially true in East Africa where the few
government owned banks take the lion's share of the market. The net interest rate
spread is a key determinant of a financial institution's profitability (or lack thereof). In
simple terms, the net interest spread is like a profit margin. The greater the spread, the
more profitable the financial institution is likely to be; the lower the spread, the less
profitable the institution is likely to be. In Tanzania, there is currently no fully owned
government commercial bank, the Government gave up most of its shareholding in

7
major banks after it started the privatization process in 2005 but two among the five
largest commercial banks, NMB and NBC have approximately 30% government
interest to date. This poses the question of whether Tanzania banks are profitable due to
exceptional efficiency or are the customers charged higher interests than they should be
for the high returns of the commercial banks. Another question one would ask is
whether the risk of the ventures the banks engage in, is as high as the interest rates they
set? Are the non-performing loans a product of a poor operating environment of the
sector and not just poor credit policy or human resource employed by the banks?
According to Sacerdoti (2005) in his paper reports, there is a wide concern that bank
spreads are too high in Africa. Analysis conducted in a number of Financial System
Stability Assessment Reports (FSSA) indicate that the causes of the spreads in most
SSA banking system are the relatively large share of NPLs, high operating costs,
difficulties in obtaining and using collateral, and the absence of efficient judicial
procedures to facilitate loan recovery. So the banks charge high interest rates on
lending to compensate them for the loans they do not recover and the high risk they
take. Does the net interest margin determine profitability?

In a country where the financial sector is dominated by commercial banks, any failure
in the sector has an immense implication on the economic growth of the country. This
is due to the fact that any bankruptcy that could happen in the sector has a contagion
effect that can lead to bank runs, crises and bring overall financial crisis and economic
tribulations(Ongore and Kusa, 2013). Banking crisis could entail financial crisis which
in turn brings the economic meltdown as happened in USA in 2007 (Marshall, 2009.)
That is why governments regulate the banking sector through their central banks to
foster a sound and healthy banking system which avoid banking crisis and protect the
depositors and the economy (Shekhar, 2012).

We are going through the phase of after “THE GREAT CRASH OF 2008” that is
usually linked with the fall of two financial tycoons The Bear Stearns Companies Inc
and Lehman Brothers Holdings Inc who were considered to be the major players of the
market in United States from last 100 years and a controversial narrow escape of
American International Group (AIG) Inc through government bailout. These
bankruptcies were not anticipated or tracked by regulator rating system or external

8
rating agencies. The Great Depression 1930‟ s is also an example of economic crisis
caused by the banking sector and financial institutions that left behind 9 million
peoples losing their savings and more than five thousand banks to closed (lal, 2010).
Notwithstanding the above, the great depression of the 1940s coupled with bank
failures experienced in the United States drove considerable attention to bank
performance. Since then, the attention on bank performance has grown from levels to
levels (Heffernan, 2005).Thus, to avoid the crisis due attention is given to banking
performance.

Profitability of commercial banks is pro foundation for product innovation,

diversification and efficiency of the commercial banks (Hempell, 2002). The stability
of commercial banks as whole in the economy depends on profitability level. More
profitability level has tendency to absorb risks and shocks that commercial banks can
face. Moreover profitability is the perquisite condition for the efficiency of commercial
banks (Pastory and Qin, 2012). Empirical evidence from detriguache (1999) has shown
that the soundness of commercial banks performance depends on profitability. Francis
(2006) has indicated that markets reforms in the sub-Saharan Africa has worsen the
profitability of commercial banks due to high level of non-performing loans. This is
contradictory to the early study of Chijoriga (1997) who indicated that market
liberalization is essential for high level profitability of commercial banks. According to
the Bank of Tanzania (2010), the commercial banks profitability has improved to the
greatest extent and most of them are above the regulatory requirements, the greatest
profitability earned by these commercial banks indicates that the internal factors has
played a great role toward this profitability. This study therefore aims to confirm the
role played by internal factors in determining profitability, whether it is due to the
efficiency of commercial banks or otherwise. There aren‟t many studies carried out in
Tanzania on the determinants of commercial banks profitability that have taken the
CAMEL approach which represents internal factors, this study is unique in that sense.
Given all the reforms that have taken place over the years, the determinants of
profitability may have changed and this study aims to find out what internal factors are
significant to profitability of commercial banks.

9
1.3 Statement of the Problem
Many studies have been under taken about commercial banks profitability in Africa but
very few have been specific to Tanzania. Pastory and Qin (2012) did a study on the
commercial banks profitability position: The case of Tanzania, where they used three
major banks, CRDB, NBC and NMB. Three ratios where used in their analysis,
including return on average assets, net interest income to average bearing assets and
non-interest expenses to average assets. This study aims to fill the existing research gap
using a CAMEL approach.

The study also aims to confirm the role played by internal factors in determining
profitability of commercial banks. It can thus be derived whether the high profitability
of commercial banks in Tanzania compared to the rest of the world is on account of its
efficiency or high interest rates charged to customers.

The CAMEL framework is a widely used model according to Baral (2005) and
according to Gopinathan (2009), financial ratios analysis measures various aspects of
performance and analyses fundamentals of a company or institution. Ho and Zu (2004)
have reported that the evaluation of a company‟s performance has been focusing the
operational effectiveness and efficiency, which may influence the company‟s survival
directly. Elyor (2009) and Uzhegova (2010) have both successfully used the CAMEL
model to examine the factors affecting banks profitability. This study can therefore be
used for comparison with other literature that has taken the same approach. It is also
measures the performance of the banks, and thus can used as a basis to predict survival
of the banks.

For the purpose of this study, three major banks will be used, CRDB, NBC, and NMB.
The three banks hold a significant market share of the commercial banks in Tanzania.

1.4 Objectives
The main objective is to determine the factors that affect commercial banks
profitability in Tanzania.

10
The specific objectives include;
To compare the financial performance of major commercial banks with
different ownership structures based on their CAMEL ratios
To rank the sample banks on the basis of CAMEL rating.
To determine whether capital adequacy, asset quality, management, earnings
performance or liquidity affect the profitability of commercial banks

1.4 Significance of the Study

There is little information about commercial banks performance in Tanzania that would
be important for policy guidance of the sector. In addition, the world specifically the
banking institutions, is going through a global financial crisis evidenced by the current
banking failures in the developed countries and the bailouts the that could have been
prevented to an extent by constant financial check –up; hence studies like these can
detect early warning signs that will help the commercial banks combat and prevent
problems that would otherwise lead to their collapse. Thus, to take precautionary and
mitigating measures, there is dire need to understand the performance of banks and the
determinants of profitability.
Not only the commercial banks but also any FIs require regular health check-up to
maintain the confidence of private sector in financial system of the country and protect
the interest of depositors, lenders, shareholders and other stakeholders.

This study is also significant as its results will be applicable in enhancing commercial
banks sustainability. Studies that seek to investigate the performance of banks and their
various determinants are steps in the right direction to identifying the means of
promoting the survival and growth of the sector that serves as the backbone of the
financial system of developing economies (Esther and Mathew, 2012).

Banking investments among individual investors are increasing as banks continue to

enlist in the DSE and a basic CAMEL rating knowledge can help them gain better
understanding about their investment on their own rather than seeking the investment
agencies. It will assist the investors in understanding the current situation of the banks
and their strengths and weaknesses. This helps them make precise and timely decisions
towards their investment.

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1.5 Limitation of the Study
The study is limited to three (3) banks only. There are resource constraints since I am a
self-sponsored student and this limits my ability to inquire into deep search of data.
There is also the issue of confidentiality of some of the banks data, due to the nature of
their business and this limits the study. Last but not least is the inconsistency in the
publishing of the banks data, which limits the consistency of the research layout in a
few cases.

12
 CHAPTER TWO
LITERATURE REVIEW

2.1 Introduction
This chapter is written in consideration of the critical points of current knowledge
including theoretical, substantive findings as well as methodological contributions
(empirical review) relative to this topic.
The chapter discusses what theories say in relation to the components of my research;
this includes mainly defining the key concepts about banking and theories about the
CAMEL framework. I also reveal what other researchers who have done similar studies
in different locations using different methods have found out. This created a basis for
the conceptual framework, how to operationalize my work and form a basis for
prediction.

2.2Theoretical Literature Review

In the theoretical literature review about profitability, commercial banks, the meaning
of CAMEL and its components, the CAMEL rating base and information about the
sample banks are presented.

Concept of profit and profitability

Profit is the surplus remaining after total costs are deducted from total revenue, and the
basis on which tax is computed and dividend is paid. It is the best known measure of
success in an enterprise.

Profit is reflected in reduction in liabilities, increase in assets, and/or increase in

owners' equity. It furnishes resources for investing in future operations, and its absence
may result in the extinction of a company. As an indicator of comparative performance,
however, it is less valuable than return on investment (ROI). Profit is also called
earnings, gain, or income (Business Dictionary, 2013).

Profitability refers to the potential of a venture to be financially successful. This may

be assessed before entering into a business or it may be used to analyze a venture that is
currently operating. Although it may be found that one set of factors is not likely to be

13
successful or has not been successful, it may not be necessary to abandon the venture.
It may instead be feasible to change operational factors such as pricing or costs.
There are three basic situations that can describe a business‟ financial situation. It can
be profitable, it can break even, or it can operate at a loss. In most cases, an
organization‟s goal is to make a profit.

Concept of a Commercial Bank

A bank is a financial institution and a financial intermediary that accepts deposits and
channels those deposits into lending activities, either directly by loaning or indirectly
through capital markets. A bank is the connection between customers that have capital
deficits and customers with capital surpluses.

Due to their influence within a financial system and an economy, banks are generally
highly regulated in most countries. Most banks operate under a system known as
fractional reserve banking where they hold only a small reserve of the funds deposited
and lend out the rest for profit. They are generally subject to minimum capital
requirements which are based on an international set of capital standards, known as the
Basel Accords.

An institution which accepts deposits, makes business loans, and offers related
services. Commercial banks also allow for a variety of deposit accounts, such as
checking, savings, and time deposit. These institutions are run to make a profit and
owned by a group of individuals, yet some may be members of the Federal Reserve
System. While commercial banks offer services to individuals, they are primarily
concerned with receiving deposits and lending to businesses.

The CAMEL approach

CAMEL framework often used by scholars to proxy the bank specific factors (Dang,
2011).The Basle Committee on Banking Supervision of the Bank of International
Settlements (BIS) has recommended using capital adequacy, assets quality,
management quality, earnings and liquidity (CAMEL) as criteria for assessing a FI in
1988 (ADB 2002). The sixth component, market risk (S) was added to CAMEL in
1997 (Gilbert, Meyer and Vaughan 2000). However, most of the developing countries

14
are using CAMEL instead of CAMELS in the performance evaluation of the FIs. The
central banks in some of the countries like Nepal, Kenya use CAEL instead of
CAMELS. The CAMELS framework is a common method for evaluating the
soundness of FIs. This system was developed by regulatory authorities of the U.S
banks. The Federal Reserve Bank, the Comptroller of the Currency and the Federal
Deposit Insurance Corporation all use this system (McNally 1996). Monetary
authorities in the most of the countries are using this system to check up the health of
an individual FI. In addition, International Monetary Fund also is using the aggregated
indicators of individual FIs to assess the financial system.

The BOT also applies CAMEL in the supervision of the financial institutions; the
banking supervision says apart from the risk framework review of the five key
components of the institutions, that is Capital adequacy, Asset quality, Management
quality, Earnings capability and Liquidity (CAMEL) at least once a year for every
institution done on site. In addition, supervisors do verify compliance with laws and
regulations and assess the effectiveness of the institutions' internal control system.

The purpose of CAMELS ratings is to determine a bank‟s overall condition and to

identify its strengths and weaknesses: Financial, Operational and Managerial. The scale
is from 1 to 5 with 1 being strongest and 5 being weakest. Banks with a rating of 1 are
considered most stable; banks with a rating of 2 or 3 are considered average, and those
with rating of 4 or 5 are considered below average, and are closely monitored to ensure
their viability. STRONG: indicative of performance that is significantly higher than
average. SATISFACTORY: reflects performance that is average or above. FAIR:
represents performance that is flawed to some degree. MARGINAL: reflects
performance that is significantly at below average. UNSATISFACTORY: indicative of
performance that is critically deficient and in need of immediate remedial attention.
Each bank is accorded a composite rating that is predicated upon the evaluation of the
specific performance dimensions. The composite rating is also based upon a scale of 1
through 5 in ascending order of supervisory concern. The CAMELS rating components
have the following weights: Capital Adequacy 20%, Asset Quality 20%, Management
25%, Earnings 15%, Liquidity 10% Sensitivity to market risk 10% (Parveenbari, 2010).

15
The CAMELS framework system looks at six major aspects of an FI: capital adequacy,
asset quality, management soundness, earnings, liquidity, and sensitivity to market risk
(Hilbers, Krueger and Moretti 2000).

Capital Adequacy
Capital Adequacy shows the financial strength of a bank, and this financial strength
usually shows by bank through Capital Adequacy ratio (CAR). CAR = Tier I + Tier
II/Risk weighted Assets. This ratio determines the ability of the bank to meet with
obligation on time and other risks such as operational risk, credit risk, etc. Tire I is a
type of capital, it is a composed of core capital or we can say own capital which
consists primarily of common stock, preferred stock, retain earnings. Tier II is a
supplementary form of capital of banks. Items include in tier II Capital are, undisclosed
reserves, subordinate term debt, general provision, revaluation reserves (Christopoulos,
et al, 2011, p. 12).

Asset Quality
Quality of bank‟s assets is related to the left side of its balance sheet. Usually top
management of the bank is concerned mostly with quality of the loans they provided to
their customers as it provides earnings to their bank. Assets quality and loan quality are
two words that have same meaning but most often they are used inter changeably.
Quality of the assets as its affects both cost to the banks and economies of scales for the
bank (Bernstein, 1996, p. 1). Assets that have low quality usually have higher
possibility to become a Non-Performing Loan. Non-Performing loans are usually bad
debts that are in default or they are near to be in default. There is no specific standard
for the banks across the globe that elaborates which assets to be included in non-
performing loans, but in Pakistan those which are in default for more than three months
are included in non-performing loans (Chang, 2006).
Management Quality
It is difficult to determine the sound performance of management of the bank. For
individual institution it is not a quantitative factor it is primarily qualitative factor.
However to determine the soundness of the management we took the ratio which is,
Management expenses/total earning. The lower ratio, the better for bank since it shows
that management has good ability to handle the bank operations (Baral, 2005, p. 44).

16
Earnings
According to Couto and Brasil, it is necessary for the banks to generate sufficient
earning to stay in the market for a longer period of time, to make shareholders satisfied,
protect and improve its capital (Couto and Brasil, 2002, p. 3). To measure earnings the
ratios used are, Return on Assets, and Return on Equity. ROA = Net profit/total assets.
This ratio avoids the volatility of earnings linked with unusual items, and measures the
profitability of the bank; the higher the ratio, the greater the profitability. The second
ratio is ROE = net profit/own capital. This ratio shows the efficiency of the bank, that
how the bank uses its own capital in an efficient manner (Christopoulos, et al, 2011, p.
13).

Liquidity
To well manage liquidity of the financial institutions such as banks is a prime objective
of its management. Liquidity is ability of a firm to convert its financial assets into cash
most rapidly or in a quick succession or we can say availability of the funds to pay off
all its financial obligations when they become due. Liquidity of a firm can be
calculated by using liquidity financial ratios. There are several ratios that can be used to
measure liquidity of the firm but in our research that is based upon the usage of
CAMELS system, we used two liquidity ratios. These ratios are Loan to Total Deposits
(L1) ═ Total Loans / Total Deposits and Circulating Assets to Total Assets (L2). (Bar
and Zeb, 2011)Table 2.1 gives a summary of the components, ratios and implications
of CAMEL.

17
Table 2.1: Components, ratios and implications of CAMEL
CAMEL Ratio(s) Implications
component
Capital CAR Shows dependency of institution on outside funding for
Adequacy Leverage ratio operations,
Debt to Assets ratio Shows overall capital sufficiency
Dependency ratio Indicates provisioning requirements on loan portfolio for
current period

Asset Quality Loan loss Provision ratio Measures amount of default in portfolio
Portfolio in Arrears Indicates extent of uncollectible loans over the last period
Loan loss ratio Indicates adequacy of reserves in relation to portfolio
Reserve ratio
Non-performing assets
ratio
Management Earnings per employee Indicated performance of loan officer and efficiency of
Quality Portfolio per Credit methodology
Officer Indicates performance of manager and efficiency of
Cost per unit of money methodology
lent Indicates potential financial productivity of loan officer
Operating Expenses Indicates efficiency in disturbing loans (in monetary
Ratio terms)
Cost per loan Indicates efficiency in disbursing loans
Earnings Return on Equity Indicator of efficiency of lending operations
Return on Assets Shows ability of Institution to cover costs of operations
Profit Margin which includes financial and non-financial expenses with
Financial Cost Ratio internally generated income
Administrative cost ratio Indicates financial productivity of credit services and
Operating Self- investment activities
sufficiency Ratio
Financial Self-
sufficiency ratio

Liquidity Current Ratio Shows ability of Institution to meet projected near term
Cash and Equivalents to obligations
Total Assets Ratio
Cash and Equivalents to
Total Debt ratio
Loan to Total Deposit
Ratio
Source: Authors own composition, 2013

CAMEL Rating Base

All six components of CAMELS rating model are rated on the basis of following
criteria on the scale of 1 to 5. Component having rating 1 shows strong position while
rating 5 indicates worst position of a bank in the particular component. Each
component has a well thought out scale of rating based on the prevailing financial and
economic conditions (Saltzman & Salinger, 1998). For this study I chose to adopt the
rating base methodology of Babar and Zed (2011). This rating base is consistent with
the ratios I have chosen under the CAMEL framework.

18
Key ratios of CAMELS rating system to evaluate the rating for different banks are
capital adequacy ratios, asset quality ratios, management ratios, earnings ratios and
liquidity ratios as shown in Table 2.2.

Table 2.2: Rating base of CAMELS components

CAMELS Rating 1 Rating 2 Rating 3 Rating 4 Rating 5
Rating
Components
Capital ≥15% 12% - 14.99% 8% - 11.99% 7% - 7.99 ≤6.99%
Adequacy
Ratio
Assets quality ≤1.25% ≤2.5% - 1.26% ≤3.5% - 2.6% ≤5.5% – 3.6% ≥5.6%
Ratio
Management ≤25% 30% – 26% 38% – 31% 45% – 39% ≥46%
Earnings ≥1% 0.9% – 0.8 0.35 – 0.7 0.25 – 0.34 ≤0.24
(ROA)
ROE ≥22% 17% -21.99 % 10% - 16.99% 7 – 9.99% ≤6.99
Liquidity ≤0.55 0.62 - 0.56 0.68 – 0.63 0.80 – 0.69 ≥0.81
Ratio L1
Liquidity ≥50% 45% - 49.99% 38% - 44.99% 33% - 37.99 ≤32%
Ratio L2
Sensitivity ≤25% 30% - 26% 37% - 31% 42% - 38% ≥43%
Ratio
Source: Babar and Zeb, 2011

Since the table 2.2 does not specify on the rating of NIM, the BOT standards as
adopted by Pastory and Qin, 2013; are followed instead. Table 2.3 displays the BOT
standards.

Table 2.3: BOT standards that account for NIM

Rating Net Interest income to average earning assets
1 Above 5%
2 5% - 3%
3 1% - 3%
4 0% - 1%
5 Below 0%
Source: Qin and Pastory, 2012

About The Banks

The following is information from the respective banks official websites about their
profile, mission, vision, BODs and ownership structure.

19
NBC
NBC Ltd. was formed on 1st April 2000 when NBC (1997) Ltd. It was privatized and
sold to ABSA Group Ltd. of South Africa. NBC (1997) Ltd. was itself born out of the
nationalization of banks and financial institutions in Tanzania in 1967.Tanzania later
deregulated banking in 1991. In 1997, a decision was taken to split NBC into three
entities, namely NBC Holding Corporation, National Micro-finance Bank (NMB) and
NBC (1997) Limited. This was the first step towards the privatization of NBC.

NBC Ltd. needs to be seen as a partner with government, and other organizations, in
promoting the socio-economic development and prosperity of Tanzania. The
government of the Republic of Tanzania has committed itself to transforming the
economy of the country from being public-sector driven to being private-sector driven.
To this end, privatization has been chosen as one of the key routes by government.
Privatization entails that government is moving out of business - as in the management
of companies - and promoting an enabling environment for economic growth and
development as supported by the private sector.

Mission Statement
We are a caring financial services provider, partnering with all our stakeholders to
create prosperity through a customer centric, innovative and diverse product offering
Vision
To be the 'Go-To' bank

Brand Purpose
Helping people achieve their ambitions in the right way

Shareholding Structure
1. ABSA Group Ltd. 55%
2. Government of the republic of Tanzania 30%
3. International Finance Corporation 15%

20
The NBC organization structure is currently not published
NMB
In 1997, the National Microfinance Bank Limited Incorporation Act established the
NMB. In 2005, The Government of the United Republic of Tanzania started the
privatization process and sold part of its shareholding (49%) to a consortium led by the
CoöperatieveCentraleRaiffeisen-Boerenleenbank B.A. ('Rabobank Group'). In 2008,
the Government reduced its share to 30% through the sale of shares to the general
public in an IPO (16%) and to the NMB staff (5%). NMB became listed on the Dar es
Salaam Stock Exchange on 6th November, 2008.

NMB is the largest bank in Tanzania, both when ranked by customer base and branch
network. With over 143 branches we are located in more than 80% of Tanzania's
districts. This broad branch network distinguishes NMB from other financial
institutions in Tanzania. We are committed to sustaining and enhancing our branch
network in order to provide access to capital to citizens in all areas of Tanzania,
including the most remote.

Mission
Through innovative distribution, and its extensive branch network, NMB offers
affordable, customer focused, financial services to the Tanzanian community, in order
to realize sustainable benefits for all its stakeholders.

Vision
To be the preferred financial services partner in Tanzania.
Shareholding Structure
The current shareholders of NMB are:
1.CoőperatieveCentraleRaiffeisen-Boerenleenbank B.A “Rabobank Nederland”
49%
Rabobank
2. Treasury Registrar (Government of Tanzania) 31.8%
3. Standard Chartered Bank (T) Nominee Limited 2.0%
4. National Investment Company Limited (NICOL) 6.6%
5. Exim Bank Tanzania 4.6%

21
6. AunaliF.Rajabali 1.7%
7. SajjadF.Rajabali 1.6%
8. Standard Bank Plc 1.3%
9. Parastatal Pension Fund (PPF) 0.8%
10. National Social Security Fund (NSSF) 0.7%
11. TCCIA Investment Company Limited 0.5%

BODs
There are nine members in the NMB Board of Directors.

CRDB
CRDB Bank Plc is a leading, wholly-owned private commercial bank in Tanzania. The
Bank was established in 1996 and has grown and prospered over the years to become
the most innovative, first choice, and trusted bank in the country. CRDB Bank has been
recording progressive profit every year since its foundation and has paid dividends
annually. The Bank reached an important milestone recently and was listed on the Dar
es Salaam Stock Exchange on 17th of June, 2009.

CRDB Bank offers a comprehensive range of Corporate, Retail, Business, Treasury,

Premier, and wholesale microfinance services through a network of over 85 branches,
250 ATMs, 15 Depository ATMs, 12 Mobile branches, 900 Point of Sales (POS)
terminals and scores of Microfinance partners institutions. The Bank also operates
through Internet and Mobile banking services.
Mission
CRDB Bank is committed to provide quality and competitive financial services with a
strong focus on retail banking and customized corporate and institutional services,
while ensuring the confidence and trust from our stakeholders

Vision
CRDB Bank is to be the leading bank, which is customer need driven with competitive
returns to shareholders.

22
Shareholding Structure
1. DANIDA Investment Fund 21.5%
2. Parastatal Pension Fund 10%
3. SCB (T) Nominee Ltd SCB (M) Re Pictet and CIE A/C 6.1%
4. Public Service Pension Fund 3.3%
5. SCB (T) Nominee Ltd SCB (Mauritius) GHANA 3.1%
6. The Local Authorities Pension Fund 2%
7. SCB (T) Nominee Ltd SCB(M) Re Altree Custody Serv 2.4%
8. Western Zone Tobacco Growers Cooperative 1.7%
9. Union Ltd 1.6%
10. CMG Investment Ltd 1.3%
11. Hans Macha 1%
12. Lindi Development Fund
13. Shareholders Owning Shares Below 1% 46%
Grand Total 100%

BODs
The Board consists of ten (10) Directors (including the Chairman). The directors are all
Tanzanian with the exception of one, who is Danish.

2.2 Empirical Literature Review

In this part of the study substantive findings by other researchers who have done
similar studies in terms of the conclusions they derived and methods they used in
drawing their conclusions are presented.

Pastory and Qin (2012) revealed results from their regression model indicate that
capital adequacy, liquidity and asset quality are more crucial in profitability of
commercial banks, in absence of them the commercial banks will always incur losses.

Naceur (2003) using a sample of ten Tunisian banks from 1980 to 2000 and a panel
linear regression model, reported a strong positive impact of capitalization to ROA.
Sufian (2009), studied the determinant of commercial banks profitability, the paper
indicated that both the internal determinant and external determinant are crucial in the

23
profitability of commercial banks. Nazir (2010), analyzed the financial performance in
India, his study indicated that capital adequacy, liquidity, asset quality and management
are crucial in influencing the financial performance of the commercial banks. Naceur
(2003) investigated the determinant of commercial banks in Tunisia; the study revealed
that the financial structure, banks characteristics and macroeconomic variables have
potentials effect on the profitability of the commercial banks. Molyneux and Thornton
(1992) investigated the profitability of 18 European countries; their findings revealed
that interest rates, government policy and bank regulation has potential impact on
profitability of the commercial banks, also Demerguc-kunt and Huizigha (1999) in their
study on determinant of commercial banks profitability revealed the same story.
However other studies such as miller and Noulas (1996) indicated that the profitability
of commercial banks is being determined by the efficiency of the commercial banks
itself. Staikous and Steliaros (1999) showed that the profitability of commercial banks
has been influenced by the inflation rate, proprietary regime and core capital.
Furthermore Khrawish (2011) investigated the determinant of commercial banks in
Jordan, bank size and total liabilities to total asset are found to have negative impact on
the profitability while GDP and inflation are found to have a negative impact on the
financial performance of commercial banks.

In principle a bank‟s capacity to absorb unforeseen losses determines its level of risk
(Goddard et al., 2004). Several ratios are commonly used to proxy for risk, including
the CAR and the liquidity ratio. In theory an excessively high CAR could signify that a
bank is operating over-cautiously and ignoring potentially profitable investment
opportunities. A bank holding a relatively high proportion of liquid assets is unlikely to
earn high profits, but is also less exposed to risk; therefore shareholders should be
willing to accept a lower return on equity (Goddard et al., 2004).

The trend of commercial banking is changing rapidly. Competition is getting stiffer

and, therefore, banks need to enhance their competitiveness and efficiency by
improving performance. Normally, the financial performance of commercial banks and
other financial institutions has been measured using a combination of financial ratios
analysis, benchmarking, measuring performance against budget or a mix of these
methodologies (Avkiran, 1995). Gopinathan (2009) has presented that the financial

24
ratios analysis can spot better investment options for investors as the ratio analysis
measures various aspects of the performance and analyzes fundamentals of a company
or an institution.

Furthermore, Ho and Zhu (2004) have reported that the evaluation of a company‟s
performance has been focusing the operational effectiveness and efficiency, which
might influence the company‟s survival directly. The empirical results of the researches
(Raza et al., 2011; Tarawneh, 2006) explained that a company, which has better
efficiency, it does not mean that always it will show the better effectiveness. Alam et
al. (2011) study concludes that ranking of banks differ as the financial ratio changes.
Bakar and Tahir (2009) in their paper used multiple linear regression technique and
simulated neural network techniques for predicting bank performance. ROA was used
as dependent variable of bank performance and seven variables including liquidity,
credit risk, cost to income ratio, size and concentration ratio, were used as independent
variables. They concluded that neural network method outperforms the multiple linear
regression method however it need clarification on the factor used and they noted that
multiple linear regressions, not-withstanding its limitations, can be used as a simple
tool to study the linear relationship between the dependent variable and independent
variables. There are number of studies, which examine the bank performance using
CAMEL framework, which is the latest model of financial analysis. Emre (2012) in a
study on Determinants of bank profitability, identified the ratio of loan loss provision to
gross loans, total costs to total income both have a significant and negative relationship
with ROA. Elyor (2009) and Uzhegova (2010) have used CAMEL model to examine
factors affecting bank profitability with success. The CAMEL Framework is the most
widely used model (Baral, 2005).

Javaid et al. (2011) analyzed the determinants of top 10 banks‟ profitability in Pakistan
over the period 2004 to 2008. They focused on the internal factors only. Javaid et al.
(2011) used the pooled ordinary least square (POLS) method to investigate the impact
of assets, loans, equity, and deposits on one of the major profitability indicator of banks
which is return on asset (ROA). The empirical results found strong evidence that these
variables have a strong influence on profitability. How-ever, the results show that
higher total assets may not necessarily lead to higher profits due to diseconomies of

25
scales. Also, higher loans contribute towards profitability but their impact is not
significant. Equity and deposits have significant impact on profitability. The
performance of commercial banks can be affected by internal and external factors (Al-
Tamimi, 2010; Aburime, 2005). According to Aburime (2008), the profitability of a
bank depends on its ability to predict, evade and monitor risks, possibly to cover losses
brought about by risks that coms about. Although it is important for banks to be liquid
to avoid a run on it, Kamau (2009) argues that when banks hold high liquidity, they do
so at the opportunity cost of some investment, which could generate high returns.
Again, Sufian and Chong (2008) draws a very strong relationship between firm
performance and the management efficiency through management of expenses.

Studies done by Olufemi and Onaolapo (2012) on „Effect of capital adequacy on

profitability‟, reveal that CAR does not reflect much on performance indicators
including ROA; Contrary to a study done on Determinants of capital adequacy ratio in
Jordanian banks by Al-sabbagh (2004), which shows that there is a positive significant
relationship between capital adequacy ratio and return on assets. Chan and Vong
(2009) in a study on determinants of bank profitability reveal that a well-capitalized
bank is perceived to be of lower risk and such an advantage will be translated into
higher profitability.

In a study done in Malaysia by Aziz et al. (2008), on the Impact of NPL towards
profitability performance, it was discovered that there is a significant impact of NPLs
to profitability performance. Financing to purchase residential property turned out to be
a leading contributor to non-performing loans. The study on Malaysian banks by Guru
et al. (2001) also show that efficient management is among the most important factors
that explain high bank profitability. There is also an extensive literature based on the
idea that an expense-related variable should be included in a profit function. For
example, Bourke (1989) and Molyneux and Thornton (1992) found a positive
relationship between better-quality management and profitability. A study carried out
by Kutsienyo (2011), reveals that the results for the ROA model indicate that capital
adequacy, liquidity and bank size are positively significant to bank profitability while
asset quality and operating expense are negatively significant to bank profitability. A
study on the effects of interest margins on the profitability of commercial banks in

26
Kenya by Mutungi(2011), found that the relationship between net interest margin and
return on assets was not significant given the non-significance of the F-statistic
(F=4.550, p=0.123). The study also found that net interest margin had a negative effect
on return on assets (-3.926). However, the impact was not significant at 5% level (p =
0.123).

Vong and Chan (2009) in their study revealed that although bank loans are the main
source of revenues and are expected to affect profits positively, findings from various
studies are not conclusive. While the study by Abreu and Mendes (2000) documents a
positive relationship between the loan ratio and profitability, studies by Bashir and
Hassan (2003) and Staikouras and Wood (2003) show that a higher loan ratio actually
impacts profits negatively. The latter study notices that banks with more non-loan
earnings assets are more profitable than those that rely heavily on loans.

Out of all the reviewed studies as presented in Table 2.4; only a few have used the
complete CAMEL model in determining profitability. This necessitates the use of the
popular model to arrive at the determinants of profitability in Tanzania.

27
Table 2.4: Summary of empirical review
S/N Author(s) & Year Title & place Methodology Determinants of
Profitability
1. Pastory and Qin (2012) Commercial banks profitability Financial ratios Asset quality,
position: The case of Tanzania analysis and capital adequacy
Regression analysis and liquidity
2. Nuceur (2003) Determinants of the Tunisian Multiple regressions Bank loans, capital
banking industry profitability: analysis and high overheads
Panel evidence
3. Emre (2012) Determinants of bank Multiple regressions Ratio of loan loss
profitability: An investigation analysis provisions to gross
of Turkish banking sector loans; total costs to
total income.
4. Sufian and Habibullah Bank specific and Multivariate Liquidity, credit
(2009) Macroeconomic determinants of regression analysis risk, capitalization
bank profitability: Empirical and economic
evidence from the China growth
banking sector
5. Nazir (2010) Analyzing financial Financial ratio
performance of commercial analysis
banks in India: Application of
CAMEL model
6. Molyneux and Thorton Determinants of European bank Multivariate Management quality
(1992) profitability: A note regression analysis
7. Goddard, Molyneux and The profitability of European Multivariate Capital to asset ratio
Wilson (2004) banks: A cross-sectional and regression analysis
dynamic panel analysis
8. Mutungi (2011) The effect of interest margins Descriptive
on profitability of commercial statistics, graphs,
banks in Kenya multiple regression
analysis and
inferential statistics
9. Vong and Chan (2009) Determinants of Bank Capital strength and
Profitability in Macao asset quality
10. Javaid, Anwar, Zaman, Determinants of Bank Correlation and Equity and deposits
Gafoor (2011) Profitability in Pakistan: Multiple regression
Internal factor analysis analysis
11. Al-Sabbagh (2004) Determinants of capital Correlation and Capital adequacy
adequacy ratio in Jordanian regression analysis ratio
banks
12. Aziz et al (2008) Impact of NPL towards Regression analysis Non-performing
profitability performance: loans
Malaysia
13. Guru et al. (2001) Determinants of commercial Regression analysis Management quality
banks profitability in Malaysia
14. Munyambonera (2012) Determinants of commercial Multivariate Capital adequacy,
bank profitability in Sub- regression analysis Liquidity,
Saharan Africa operational
efficiency
15. Staikouras and Wood Determinants of European bank Regression analysis Loan ratio
(2003) profitability
16. Kutusienyo (2011) Capital adequacy,
liquidity, bank size,
asset quality and
operating expenses.
17. Olufemi and Onaolapo Effect of capital adequacy on OLS estimation
(2012) profitability of the Nigerian
banking sector
Source: Authors own composition

28
 2.3 Conceptual Framework
This chapter gives the approach that has been taken in conducting the research, given
the theoretical and empirical review. Proponents claim that when purpose and
framework are aligned, other aspects of empirical research such as methodological
choices and statistical techniques become simpler to identify. The conceptual
framework also expresses my expectations of the outcomes of the effect the
independent variables will have on the dependent variable.

From each CAMEL component, one ratio is derived and based on that the banks were
rated according to Table 2.2. The derived ratio will further be used to run a multiple
regression that tests the hypotheses and gives the determinants of profitability.
The aim is to find out if the CAMEL components determine profitability of a
commercial bank as shown in figure 2.1.

CAPITAL CAR
ADEQUACY

I
D
NPL N
E ASSET D
P
E
E QUALITY P
N
E
D INTERNAL N
E
D
N ROA DETERMINANTS OF OER
T
MANAGEMENT E
N
PROFITABILITY
V
QUALITY T

A
V
R
I NIM A

A EARNINGS R
I
B
A
L
B
E
L
LDR E
LIQUIDITY S

Figure 2.1: Internal determinants of commercial banks profitability using CAMEL framework

Source: Authors own composition

The Ratios
The ratios used were chosen based on the availability of data for the computation in the
financial statements of the sample banks. Another reason is that they are widely used

29
ratios according to many studies that were reviewed and this can provide a basis for
comparison. The ratios for each CAMEL component can be described as follows;

Return on assets (ROA)

A high ratio indicates that the business is earning more money and investing less on
assets. It is an indicator of the asset intensity of a company. Manufacturing firms
usually have lower return on assets as they require huge investments in assets
compared to the service industries. A low ratio shows that the company is more asset-
intensive. A high percentage indicates that the company is less asset-intensive. It also
means that lesser investments are needed in assets to make profits. In the industry, as a
general rule, return on assets ratio below 5% indicates that the company is asset heavy
and above 20%indicates that the company is asset-light (Dogra, 2013).

ROA helps to determine a lot of factors as well as aids in taking certain decision related
to business and investment including assessment of asset management, determination
of investment decisions, profit indication and determination of shareholder‟s profit.

Capital Adequacy Ratio (CAR)

CAR is measure of a bank's capital. This ratio is used to protect depositors and promote
the stability and efficiency of financial systems around the world. Two types of capital
are measured: tier one capital, which can absorb losses without a bank being required
to cease trading, and tier two capital, which can absorb losses in the event of a winding-
up and so provides a lesser degree of protection to depositors.

Capital adequacy ratio is the ratio which determines the bank's capacity to meet the
time liabilities and other risks such as credit risk, operational risk etc. In the more
simple formulation, a bank's capital is the "cushion" for potential losses, and protects
the bank's depositors and other lenders. Banking regulators in most countries define
and monitor CAR to protect depositors, thereby maintaining confidence in the banking
system (Wikipedia, 2013).The regulatory CAR for Tier 1 capital is 10% and for tier 1
and tier 2 capital combined is 12% according to BOT standards.

30
Non-performing loans ratio (NPL)
NPL is a sum of borrowed money upon which the debtor has not made his or her
scheduled payments for at least 90 days. A nonperforming loan is either in default or
close to being in default. Once a loan is nonperforming, the odds that it will be repaid
in full are considered to be substantially lower. If the debtor starts making payments
again on a nonperforming loan, it becomes a re-performing loan, even if the debtor has
not caught up on all the missed payments.

Operating Expense Ratio (OER)

The financial ratio known as the operating expense ratio, or OER, is considered a
measurement of management efficiency. Using information found on the income
statement, this metric looks at the ratio of operating expenses to net sales. While
management can take certain actions to control expenses, the price of a product or
service is typically a function of market demand. The operating expense ratio allows
investors and analysts to understand how efficiently a business is able to produce goods
or supply services.

When viewed over time, the operating expense ratio can also reveal if management is
able to expand operations without dramatically increasing expenses. If revenues were
to expand year-over-year and the OER goes down; this would indicate that
management is able to scale production efficiently; revenues expanded more quickly
than expenses increased. This is a very positive outcome from a profitability
standpoint.

NIM (Net interest margin ratio)

Net interest margin is the ratio of net interest income to invested assets. Banks are
keenly interested in their net interest margins because they lend at one rate and pay
depositors at another. However, comparisons between net interest margins of different
banks are not always useful because the nature of each bank's lending and deposit
activities varies. Net interest margin is a measure of an investing strategy's success,
especially when investors are attempting to "arbitrage" the market by borrowing at a
rate that they believe is below what their potential returns will be (Investing Answers,
2013).

31
The net interest margin (NIM) measures how large the spread between interest
revenues and interest costs that management has been able to achieve by close control
over earning assets and the pursuit of the cheapest sources of funding (Rose et al.,
2006).

LDR (Loans to deposits ratio)

Is a ratio between the banks total loans and total deposits. If the ratio is lower than 1,
the bank did not borrow the money first from another bank in order to then loan it
further to its customers, but did only use its own deposits. If, on the other hand, the
ratio is greater than 1, the bank did not use only its deposits, but it first borrowed
additional money from another bank and loaned it to its customers at higher rates.
Banks may not be earning as much as they could be, if the ratio is too low; on the other
hand, if the ratio is too high, it means that banks might not have enough liquidity to
cover any unforeseen fund requirements or in case of crisis. It is a commonly used
statistic for assessing a bank's liquidity.

Based on reading different theories on profitability and CAMEL, expectations of how

the independent variables will affect the dependent variable are predicted. Table 2.5
summarizes these expectations. Overall the conceptual framework of this study can be
summarized by Fig. 2.1 and Table 2.5.

The expectations of how the independent variables impact the dependent variable
where predicted on the following basis;
ROA in this context is a reflection of the net profit of a bank. The expectations are
based on empirical and theoretical findings. The expected impact of the independent
variables can further be explained as follows.

32
Table 2.5: The expected impact of independent variables on ROA (Return on
assets)
CAMEL RATIO SYMBOL FORMULA PREDICTED
COMPONENT IMPACT ON
ROA= Net
Income/ Total
assets
Capital Capital CAR CAR = Tier I + Tier +ve
Adequacy Adequacy Ratio II/Risk weighted
Assets
Asset Quality Non-performing NPL NPL= -ve
loans Ratio Nonperforming
assets/ Total loans
and advances
Management Operating OER OER= Total -ve
Quality Expenses Ratio operating expense/
Total operating
revenue
Earnings Net Interest NIM NIM= (Interest +ve
Performance Margin received- Interest
paid)/ Average
earning assets
Liquidity Loan to Deposit LDR LDR= Total loan -ve or + ve
Management Ratio and advances/ Total
deposit
Source: Authors own composition

In the case of the CAR, which represents the capital base, it is expected that it will
move in the same direction as the net profit i.e. the stronger the capital base the more
profitable an institution is. According to Onaolapo and Olufemi (2012) it is discussed
that the ultimate strength of a bank lies in its capital funds given its significance as a
tool for meeting liabilities in times of financial crisis and as a cushion of insulating a
bank in times of varying market adversities and is a tool for operating profitably. They
say that every business exerts some influence on its environment, customers, general
public and government and this is derived from its financial resources and profitability
which is a function of availability of funds to prosecute identified investment.

According to the 2001 annual report of Japan, it is said that the first mechanism by
which the problem of non-performing loans drags on the economy is that banks'
intermediary function declines as non-performing loans erode banks' profitability.

33
NPL which represents non-performing loans; the quality of assets, is expected to move
in the opposite direction with net profit. The higher the non-performing loans the less
profitable the bank is supposed to be, because there is a loss in collection of interest
income derived from the non-performing loans which is the most depended on source
of revenue to the bank.

Operating expenses ratio reflects on the ability of the management to control costs. The
operating costs in the income statement appear under expenses and are deducted from
the gross profit to arrive at the net profit. The higher the expenses the less the net profit
is. That is why I expect the net profit to move in a negative direction with the OER. A
study done by Vong and Chan stated that as conventional wisdom suggests, the higher
the expense of a bank, the lesser the bank‟s profitability will be. Such a negative
relation between expenses and profitability has been supported by studies of Bourke
(1989) and Jiang et al.(2003), implying that profitable banks are able to operate at
lower cost. On the contrary, Molyneaux and Thornton (1992) find that the expense
variable affects European banking profitability positively. They propose that high
profits earned by firms in a regulated industry may be appropriate in the form of higher
salary and wage expenditures. Their findings support the efficiency wage theory, which
states that the productivity of employees increases with the wage rate. This positive
relationship between profitability and expenses is also observed in Tunisia (Naceur
2003) and Malaysia (Guru et al. 2002). The proponents argue that these banks are able
to pass their overheads to depositors and borrowers in terms of lower deposit rates
and/or larger lending assets.

It is expected that as net interest income which is revenue increases the net profit will
also increase, given the layout of the income statement. The effect of liquidity was a bit
tricky to predict. Increasing the number of loans means increasing the interest income
given insignificant number of non-performing loans and hence increasing the net profit
of the bank. But when there is a significant number of non-performing loans there is
less interest income and more expenses on recovery of the loans which eventually leads
to deteriorating net profit. Studies e.g., by Sacerdoti (2005), show that spreads are too
high and one reason being large share of NPLs in Africa. If this also applies to
Tanzania that means a high loan portfolio will lead to deteriorating net profit. Another

34
way that net profit can be eroded is the high performing loans will lead to the failure of
commercial banks to meet their financial obligations, which may lead to the loss of
customers and investors and this means a loss of non-interest income as well and
therefore reduced profits.

2.4 Hypothesis
Based on the objectives of the study, the hypotheses are;
H1: There is no significant relationship between capital adequacy ratios and
profitability of the banks
H2: There is no significant relationship between asset quality ratios and profitability of
the banks
H3: There is no significant relationship between management quality ratios and
profitability of the banks
H4: There is no significant relationship between earnings ratios and profitability of the
banks
H5: There is no significant relationship between liquidity ratios and profitability of the
banks

35
 CHAPTER THREE
RESEARCH METHODOLOGY

3.1 Introduction
The purpose of this study is to analyze the factors determining the profitability of
Tanzania commercial banks. The ratios based on the CAMEL framework of three
commercial banks; CRDB, NMB, NBC, were derived, compared, rated and used to run
a multiple regression to determine which ratios affect the profitability. The study has a
descriptive financial analysis to describe, measure, compare and classify the
performance of commercial banks.

3.2 Scope of Study

For the purpose of this study, annual audited financial statements published by the
respective commercial banks for the period of seven years, January 2006 to December
2012 were used.

3.3 Study Population and Sample

The study population is the existing 32 commercial banks which are in operation in
Tanzania. To make a sample for my research criteria sampling method was selected.
Due to working on the CAMELS rating system, it is necessary to work upon bank‟s
annual financial reports. My criteria for the banks to be included as a sample are the
availability of their audited consolidated annual financial reports.

For the purpose of this study 3 banks; CRDB, NBC and NMB were selected, I have
decided to opt for the three banks because of their consistent and full disclosure of the
financial statements throughout the period of study.

Other reasons for choosing these banks are that they are the three largest banks in terms
of network according to DBS report of 2010, so their services and products cover a
large part of Tanzania, and my study is a case of Tanzania.

36
Table 3.1: Statistics of the Sample Banks
Name of Bank Branch network Total Assets (Millions) Total Deposits (Millions)
CRDB 58 2,305,226 2,009,073
NBC 56 1,471,220 1,225,175
NMB 139 2,107,079 1,820,137
Source: DBS REORT 2010, APPENDIX VI

According to the DBS report of 2009, as at 31st December 2009, the three largest
banks had 48% of the sector‟s total assets, 49% of the sector‟s total gross loans, 50% of
the sector‟s deposits and 44% of the banking sector‟s total capital. The three banks
referred to here are CRDB, NBC and NMB and it is evident they hold a significant part
of the market share which was by then out of 27 commercial banks. The study also
chooses a sample of 7 years from 2006 to 2013, based on judgment and this is due to
the consistency and availability of information for all three banks and also that this is
the most current information available hence bearing results that are up to date.

3.4 Data Type and Collection Methods

The data that was used is historical data disclosed by annual reports of the sample
commercial banks. Methods of collection include browsing the internet and reading
published sources of annual reports.

3.5 Data Analysis

The analysis of this study is based on CAMEL framework as described in the
theoretical literature to include capital adequacy, asset quality, management quality,
earnings, and liquidity management. The ratios were analyzed by correlation and
multiple regressions to obtain the determinants of profitability. The software used is
STATA.
The analysis concepts, tests of reliability and basis of interpretation are explained in
detail as follows:

37
Correlation
Pearson's correlation coefficient, normally denoted as r, is a statistical value that
measures the linear relationship between two variables. It ranges in value from +1 to -1,
indicating a perfect positive and negative linear relationship respectively between two
variables. The calculation of the correlation coefficient is normally performed by
statistical programs, such SPSS and SAS, to provide the most accurate possible values
for reporting in scientific studies. The interpretation and use of Pearson's correlation
coefficient varies based on the context and purpose of the respective study in which it
is calculated. Report a correlation value close to 0 as indication that there is no linear
relationship between the two variables. As the correlation coefficient approaches 0, the
values become less correlated which identifies variables that may not be related to one
another. Report a correlation value close to 1 as indication that there is a positive, linear
relationship between the two variables. A value greater than zero that approaches one;
results in greater positive correlation between the data. As one variable increases a
certain amount; the other variable increases in a corresponding amount. The
interpretation must be determined based on the context of the study. Report a
correlation value close to -1 as indication that there is a negative, linear relationship
between the two variables. As the coefficient approaches -1, the variables become more
negatively correlated indicating that as one variable increases, the other variable
decreases by a corresponding amount. The interpretation again must be determined
based of the context of the study (Perdue, 2013).

Regression
Multiple regressions are based on a set of assumptions that have to be met before
running the regression analysis and some tests have been done before interpretation of
the result is made. This is required to ensure that the results are what they appear to be.
The assumptions underlying the multiple regressions are: normality, referring to the
shape of the data distribution; homoscedasticity, which requires that dependent
variables exhibit equal levels of variance across the range of explanatory variables;
linearity association between variables; and absence of correlated errors.

There are four principal assumptions which justify the use of linear regression models
for purposes of prediction:

38
 (i) linearity of the relationship between dependent and independent variables
(ii) independence of the errors (no serial correlation)
(iii) homoscedasticity (constant variance) of the errors
(a) versus time
(b) versus the predictions (or versus any independent variable)
(iv) normality of the error distribution.

If any of these assumptions is violated (i.e., if there is nonlinearity, serial correlation,

heteroscedasticity, and/or non-normality), then the forecasts, confidence intervals, and
economic insights yielded by a regression model may be (at best) inefficient or (at
worst) seriously biased or misleading (Wooldridge, 2013).

Normality
Many researchers believe that multiple regressions require normality. This is not the
case. Normality of residuals is only required for valid hypothesis testing, that is, the
normality assumption assures that the p-values for the t-tests and F-test will be valid.
Normality is not required in order to obtain unbiased estimates of the regression
coefficients. OLS regression merely requires that the residuals (errors) be identically
and independently distributed. Furthermore, there is no assumption or requirement that
the predictor variables be normally distributed. If this were the case, than we would not
be able to use dummy coded variables in our models (Wooldridge, 2013).

Homoscedasticity
One of the main assumptions for the ordinary least squares regression is the
homogeneity of variance of the residuals. If the model is well-fitted, there should be no
pattern to the residuals plotted against the fitted values. If the variance of the residuals
is non-constant then the residual variance is said to be "heteroscedastic."

The first test on heteroskedasticity given by imest is the White's test and the second one
given by hottest is the Breusch-Pagan test. Both test the null hypothesis that the
variance of the residuals is homogenous. Therefore, if the p-value is very small, we
would have to reject the hypothesis and accept the alternative hypothesis that the
variance is not homogenous (Wooldridge, 2013).

39
Multicollinearity
When there is a perfect linear relationship among the predictors, the estimates for a
regression model cannot be uniquely computed. The term collinearity implies that two
variables are near perfect linear combinations of one another. When more than two
variables are involved it is often called multicollinearity, although the two terms are
often used interchangeably.

The primary concern is that as the degree of multicollinearity increases, the regression
model estimates of the coefficients become unstable and the standard errors for the
coefficients can get wildly inflated. In this section, we will explore some Stata
commands that help to detect multicollinearity.

We can use the vif command after the regression to check for multicollinearity. vif
stands for variance inflation factor. As a rule of thumb, a variable whose VIF values are
greater than 10 may merit further investigation (Wooldridge, 2013).

Autocolleration
In statistics, the Durbin–Watson statistic is a test statistic used to detect the presence of
autocorrelation (a relationship between values separated from each other by a given
time lag) in the residuals (prediction errors) from a regression analysis. Durbin-Watson
(DW) statistics is the ratio of sum of squares of successive differences of residuals to
the sum of squares of errors. As a rule of thumb, if the DW statistic is less than 2, there
is evidence of positive serial correlation (Büyüksalvarcı and Abdioğlu, 2011).

Tests of reliability
Coefficient of determination (R-squared)
In statistics, the coefficient of determination denoted R2 and pronounced R squared,
indicates how well data points fit a line or curve. It is a statistic used in the context of
statistical models whose main purpose is either the prediction of future outcomes or the
testing of hypotheses, on the basis of other related information. It provides a measure of
how well observed outcomes are replicated by the model, as the proportion of total
variation of outcomes explained by the model. A caution that applies to R2, as to other
statistical descriptions of correlation and association is that "correlation does not imply

40
causation." In other words, while correlations may provide valuable clues regarding
causal relationships among variables, a high correlation between two variables does not
represent adequate evidence that changing one variable has resulted, or may result,
from changes of other variables.
A measure used in statistical model analysis to assess how well a model explains and
predicts future outcomes. It is indicative of the level of explained variability in the
model. The coefficient, also commonly known as R-square, is used as a guideline to
measure the accuracy of the model. One use of the coefficient of determination is to
test the goodness of fit of the model. It is expressed as a value between zero and one. A
value of one indicates a perfect fit, and therefore, a very reliable model for future
forecasts. A value of zero, on the other hand, would indicate that the model fails to
accurately model the dataset.

Adjusted R-squared
The use of an adjusted R2 (often written as and pronounced "R bar squared") is an
attempt to take account of the phenomenon of the R2 automatically and spuriously
increasing when extra explanatory variables are added to the model. It is a modification
due to Thiele of R2 that adjusts for the number of explanatory terms in a model relative
to the number of data points. The adjusted R2 can be negative, and its value will always
be less than or equal to that of R2. Unlike R2, the adjusted R2 increases when a new
explanator is included only if the new explanator improves the R2 more than would be
expected in the absence of any explanatory value being added by the new explanator. If
a set of explanatory variables with a predetermined hierarchy of importance are
introduced into a regression one at a time, with the adjusted R2 computed each time, the
level at which adjusted R2 reaches a maximum, and decreases afterward, would be the
regression with the ideal combination of having the best fit without excess/unnecessary
terms.

The adjusted R squared is different than the Coefficient of Determination, because the
Coefficient of Determination will increase are more independent variables are added to
the regression. This may occur whether or not the independent variables add to the
explanatory power of that regression. The Adjusted R Squared will only increase if the

41
independent variables that are added to the regression help the overall explanatory
power of the regression (Wooldridge, 2013).

Statistical Significance Testing

In statistical significance testing the p-value is the probability of obtaining a test
statistic at least as extreme as the one that was actually observed, assuming that the null
hypothesis is true. One often "rejects the null hypothesis" when the p-value is less than
the predetermined significance level which is often 0.05 or 0.01, indicating that the
observed result would be highly unlikely under the null hypothesis. Many common
statistical tests, such as chi-squared tests or Student's t-test, produce test statistics which
can be interpreted using p-values.

The p-value is a key concept in the approach of Ronald Fisher, where he uses it to
measure the weight of the data against a specified hypothesis, and as a guideline to
ignore data that does not reach a specified significance level (Wooldridge, 2013).

3.6 Model Specification

The study used an econometric multivariate model to analyze the determinants of
profitability.
The model will be as follows;

ROAt = β0+β1Xt1 + β2Xt2 + β3Xt3 + β4Xt4 + β5Xt5 + ε

Where;
ROA- Return on Assets
X1- CAR (Tier 1 Capital + Tier 2 Capital / risk weighted Assets),
X2- NPL (non-performing loans/total loans),
X3- OER– Operating expenses/ Total revenue
X4- NIM – Net interest margin,
X5-LDR - Loan and Advances to deposit ratio.

In the equation, β0 is constant and β is coefficient of variables while ε is the residual

error of the regression.

42
All estimations will be performed in the STATA software program whereas the
ordinary calculations in Excel.

The dependent variable: Return on Assets (ROA)

The independent variables:
Capital adequacy ratio (CAR)
Non-performing loans ratio (NPL)
Operating expenses ratio (OER)
Net interest margin (NIM)
Loan to deposit ratio (LDR)

43
 CHAPTER FOUR
FINDINGS AND DISCUSSION

4.1 Introduction
In this section of the dissertation, empirical findings which are based upon financial
tools such as ratios derived from the annual consolidated financial statements of the
sample banks; CRDB, NBC, NMB; for the year from the year 2006 to 2012 are
presented. Descriptive results are first presented and discussed. Then a total of six (6)
financial ratios for all 3 banks of my sample were calculated; five that represent the
five components of CAMEL and a sixth that represents profitability. Tables of each
component of CAMEL and profitability and their respective ratings are also presented
which gives a foundation for financial performance comparison. The banks are then
ranked based on their respective ratios and ratings. This chapter further presents
correlation analysis and findings based on the multiple regressions which give the
determinants of profitability. The chapter is presented in the order of first the
descriptive results, followed by the CAMEL ratios and their rating and finally the
correlation and regression analysis. Discussions are presented hand in hand with their
respective findings. Analysis and conclusion chapter of this study will be based upon
these findings.

4.2 Descriptive Results

Summary statistics for variables used in this study are provided in Table 4.1. The
dependent variable is return on assets (ROA) a measure of profitability and the
independent variables are also indicated.

Table 4.1: Descriptive statistics of variables

Variable Obs Mean (%) Std. Dev. Min(%) Max(%)
(%)
Roa 21 2.965714 1.237257 .16 4.5
Car 21 16.63762 7.638438 10 46.4
Npl 21 6.595714 4.099093 1.59 17.8
Oer 21 51.63143 8.658281 42.87 73.8
Nim 21 9.985238 2.021892 4.36 13.67
Ldr 21 55.43143 11.75312 19.91 73.7
Source: Worked out from STATA software, 2013

Return on assets (ROA) ranges from a high of 4.5% to a minimum of 0.16%. ROA has
a 42% deviation from the mean as depicted by the standard deviation. Capital adequacy

44
ratio (CAR) ranges from a high value of 46.4% to a minimum of 10% with a variation
of 46% about the mean of 16.6%. Non-performing loans ratio (NPL) ranges from a
very high value of 17.8% to a low of 1.59%. The variability for this ratio is 62% about
the mean of 6.6%.

Operating expenses ratio (OER) ranges from a high value of 73.8% to a low value of
42.9%. There is a 17% uncertainty in NPL value. The mean NPL is 51.6%. Net interest
margin (NIM) reaches a high value of 13.67% to a low value of 4.36%. The deviation
about the mean of 10%; is 20%. Loan to deposit ratio (LDR); ranges from a high value
of 73.7% to a low value of 19.91%. The mean is 55.43% and there is a 21% variability
of the LDR. Non-performing loans ratio shows the highest variability compared to the
other ratios.

4.3 Profitability
In this study the position of profitability has been measured with the help of ROA.
Table 4.2 is the tabular presentation of the ROA of the sample commercial banks and
their respective ratings as per Table 2.2. ROA is a comprehensive measure of the
overall bank performance from an accounting perspective (Sinkey and Joseph, 1992). It
is obvious that commercial financial institutions are undertaking their business
activities and accept risk for the purpose of attaining positive returns.

Table 4.2: Comparative ROA analysis and rating

Year CRDB (%) Rating NBC (%) Rating NMB (%) Rating
2006 3.13 1 3.26 1 4.4 1
2007 3.27 1 3.7 1 4.11 1
2008 4.5 1 3.7 1 3.71 1
2009 1 1 3.3 1 3.01 1
2010 3 1 0.16 5 3.85 1
2011 2 1 0.77 3 3.31 1
2012 4 1 2.1 1 3 1
Average 2.98 1 2.42 1 3.62 1
Source: Worked out from field data extracted from annual reports of sampled banks, 2012

The ROAs of all sample banks have been positive during the selected period of study,
the performance of the banking system in Tanzania is reasonable in terms of net profit.
Most ROA values are higher than the mean which is 2.9%. The sample banks have

45
experienced no problem of covering operation costs which include financial and non-
financial expenses with internally generated income over the period of study. NMB had
the highest average ROA over the seven (7) year period followed by CRDB and then
NBC. This implies that NMB has had better asset management strategies and investors
would thus be more willing to invest in NMB given the ROAs. The highest ROA of
4.5% was experienced by CRDB in 2008 and the lowest by NBC in 2010 of 0.16%. All
the ROAs are below 5% indicating that the banking system is an asset heavy industry.
All of the banks have an average rating of 1 which signifies a strong position of ROA
according to the rating base given in table 2.1. Throughout the study period the banks
experienced a strong ROA position except for NBC in the year 2010 and 2011 where
the ROA was 0.16% and 0.77% respectively. The positive returns may indicate an
efficiency of management of the sample banks. Constantly profit-making banks add
equity to the total capital fund, reduce risk of insolvency and finally increase the wealth
of their shareholders.

4.4 Capital Adequacy

The position of capital adequacy has been measured by CAR. Table 4.3 is the tabular
presentation of the CAR of the sample commercial banks and their respective ratings as
per Table 2.2.

Table 4.3: Comparative CAR analysis and rating

CRDB NBC NMB
Year (%) Rating (%) Rating (%) Rating
2006 14 2 16.7 1 46.4 1
2007 19 1 18.31 1 29.7 1
2008 17 1 16.8 1 28 1
2009 21 1 16.24 1 24 1
2010 18 1 11.96 3 23 1
2011 15 1 12.6 2 22 1
2012 16 1 10 3 21 1
Average 17.14286 1 14.65857 2 27.72857 1
Source: Worked out from field data extracted from annual reports of sampled banks, 2012

Banks under study are well capitalized and they are complying with the directive of
BOT on the capital adequacy ratio which requires a minimum of 12% total capital to
risk weighted capital. This means the banks should be able absorb to potential shocks

46
that may occur. For this reason the Tanzanian banking system continued to perform
well even though the globe was hit by a financial crisis. NMB has maintained the
highest CAR over the period of study followed by CRDB and the NBC.
The banks have all scored a rating of “1” as per table 2.1 throughout the whole period
of study which means a strong capital adequacy position with one exception of CRDB
which scored a rating of “2” in the year 2006. The overall performance of the sample
banks shows a good capital sufficiency.

4.5 Asset Quality

Asset quality has been measured by NPL. Table 4.4 is the tabular presentation of the
NPL of the sample commercial banks and their respective ratings as per Table 2.2.

Table 4.4: Comparative NPL analysis and rating

CRDB NBC NMB
Year (%) Rating (%) Rating (%) Rating
2006 3 3 5.1 4 6 5
2007 6.07 5 4 4 4.4 4
2008 4.5 4 4.3 4 5.54 4
2009 6 5 7.1 5 3.75 4
2010 11 5 17.8 5 3.69 4
2011 11 5 9.48 5 1.59 2
2012 7 5 14.7 5 2.4 2
Average 6.938571 5 8.925714 5 3.91 4
Source: Worked out from field data extracted from annual reports of sampled banks, 2012

Management of the banks are usually concerned with the quality of their assets as they
constitute most part of the bank‟s cost and play an important role in the profitability of
a bank. The performance of commercial banks largely depends on the quality of the
assets held by them, and the quality of assets relies on the financial stability of their
borrowers in terms of character, capacity, collateral and covenant (4Cs). The
observation from Table 4.4 is that NMB has the lowest average NPL over the study
period followed by CRDB and then NBC. The overall peak of NPL ratio given the data
was experienced by NBC in 2010 which is the same year that CRDB hit its peak NPL
ratio. During 2010, the ratio of NPLs edged upwards, mainly because of the limited
debt service by businesses whose profitability was impacted by the GFC, the Financial
Stability Report of 2011 notes. The sample banks experience poor asset quality ratings

47
implying poor quality of assets. This means the profitability of the banks do not reach
their potential.

4.6 Management Quality

The position of management quality has been measured by OER. Table 4.5 is the
tabular presentation of the OER of the sample commercial banks and their respective
ratings as per Table 2.2.

Table 4.5: Comparative OER analysis and rating

CRDB NBC NMB
Year (%) Rating (%) Rating (%) Rating
2006 47.04 5 42.87 4 52.58 5
2007 43.42 4 43.85 4 51.53 5
2008 45.6 4 50.32 5 46.75 5
2009 46 5 45.2 4 51.45 5
2010 48 5 57.4 5 57.13 5
2011 46 5 72.11 5 55.55 5
2012 47 5 73.8 5 60.66 5
Average 46.15143 5 55.07857 5 53.66429 5
Source: Worked out from field data extracted from annual reports of sampled banks, 2012

Sound performance of management is difficult to measure. It is primarily a qualitative

factor applicable to individual institutions. The banks all scored an average rating of
“5” which implies management performance concerns. CRDB has the least average
OER followed by NMB and then NBC. These bad ratings imply inefficiency of
methodology used by loan officers or managers.

4.7 Earnings Performance

The position of earning quality has been measured by NIM. Table 4.6 is the tabular
presentation of the NIM of the sample commercial banks and their respective ratings as
per Table 2.2.

48
Table 4.6: Comparative NIM analysis and rating
CRDB NBC NMB
Year (%) Rating (%) Rating (%) Rating
2006 9.36 1 8.6 1 9.6 1
2007 10.09 1 9.4 1 13.67 1
2008 10.3 1 8.75 1 11.78 1
2009 10 1 8.88 1 10.69 1
2010 9 1 9.99 1 12.6 1
2011 9 1 8.15 1 12.43 1
2012 10 1 9.4 1 13 1
Average 9.678571 1 9.024286 1 11.96714 1
Source: Worked out from field data extracted from annual reports of sampled banks,2012

Although theory states it is difficult to compare NIM due to different lending rates and
borrowing rates, the findings at least prove to be positive for all banks throughout the
study period. Despite the GFC the Tanzanian banks maintained a NIM in the year
2010.
All the sample banks have maintained a positive average NIM with a rating of “1”
which shows a strong earning position. A strong NIM implies good lending operations
and also good investing choices resulting into financial productivity from the credit
services and investment activities.

4.8 Liquidity Position

Liquidity position has been measured by LDR. Table 4.7 is the tabular presentation of
the LDR of the sample commercial banks and their respective ratings as per table 2.2.

49
Table 4.7: Comparative LDR analysis and rating
CRDB NBC NMB
Year (%) Rating (%) Rating (%) Rating
2006 51.55 1 52.55 1 19.91 1
2007 59.08 2 58.84 2 34.66 1
2008 66.5 3 73.7 4 48.56 1
2009 61 2 64.55 3 47.22 1
2010 57 2 58.33 2 48.06 1
2011 63 3 53.23 1 63.12 3
2012 67 3 57.2 2 59 2
Average 60.73286 2 59.77143 2 45.79 1
Source: Worked out from field data extracted from annual reports of sampled banks,
2012

The LDR measures the ratio of funds that a bank has utilized in credit out of deposits
collected. The higher the LDR the more effective the bank utilizes the fund it has
collected. Both liquidity deficit and liquidity surplus indicate a problem in the financial
status of a bank. Much more liquidity surplus hurts the profitability of the commercial
bank by reducing the return on assets. Similarly, liquid deficit also costs much to the
commercial banks in term of the higher purchasing price of liquidity and hurt in the
reputation of the banks. Therefore, commercial banks should strike the trade-off
between the profitability and liquidity risk. NMB has the best average rating position of
“1” followed by both CRDB and NBC which have a rating of “2”. NBC in 2008 scored
a rating of “4” with LDR of 73.7%, this rating implies that there should be concerns in
case the depositors where to pull out their deposits at the same time hypothetically.

4.9 Ranking of the commercial banks

In table 4.8 all sample banks of this research are ranked on the basis of the total
component score attained by every individual bank.

Table 4.8: Sample banks ranking

Bank ROA CAR NPL OER NIM LDR Total Components Score Ranking
CRDB 1 1 5 5 1 2 15 2
NBC 1 2 5 5 1 2 16 3
NMB 1 1 4 5 1 1 13 1
Source: Worked out from field data extracted from annual reports of sampled banks,
2012

50
The lower the score is, the better the ranking of the bank. It is important to note also
that ranking of banks may change depending on the ratios used. NMB has performed
relatively well and ranked number 1 followed by CRDB which is number two and then
NBC which takes the 3rd position. NMB and NBC both have 30% government
ownership whereas CRDB is wholly privately owned. NBC has majority foreign
ownership (70%) and thus control; whereby 55% is taken by ABSA group of South
Africa and 15% by a United Nations Organization called International Finance
Organization, whereas CRDB has 21.5% foreign ownership by DANIDA of Denmark
and NMB is approximately 50% foreign owned by Rabobank of Netherlands. CRDB
and NMB are listed on DSE.

NBC ranking 3rd is likely due to its high rate of NPL and high operating expenses
compared to the other two banks. NMB on the other hand has the lowest average LDR
but has the highest average NIM; this could imply that it is giving fewer loans but
charging higher interest than the other two banks but on the other hand it also has better
quality assets since it has the lowest average NPL. NMB also leads in having the least
average OER, meaning it has more revenue that contributes to profit than the other two
banks, making it more profitable as depicted by its average ROA.
4.10 Correlation Analysis
The degree of relationship among the study variables depicted in the model were tested
using descriptive measure of correlation between ROA and the determinants of the
bank‟s profitability ratios, which is presented in Table 4.9.

Table 4.9: Correlation between ROA and other financial ratios

Roa Car Npl oer Nim ldr
Roa 1.0000
Car 0.2749 1.0000
Npl -0.7083 -0.1325 1.0000
Oer -0.5167 -0.1808 0.3697 1.0000
Nim 0.2354 -0.0903 -0.2244 0.1385 1.0000
Ldr -0.2105 -0.4449 0.0960 -0.1277 -0.1712 1.0000
Source: Worked out from STATA software, 2013

51
The results show that ROA is positively correlated with CAR (0.2749) and NIM
(0.2354). This means the capital adequacy moves in the same direction as profitability
which is represented by ROA. NIM represents the earnings of the bank, the higher the
earnings of the commercial bank the higher the higher the profitability. Both the CAR
and NIM have weak linear relationships with ROA.

On the other hand, ROA was negatively correlated with NPL (-0.7083), OER (-
0.5167), LDR (-0.2105) as expected. This means for NPL which exhibits a strong
negative relationship, the more assets are deteriorated the less profitable the bank is.
They move in opposite directions. The same applies to the OER, the more management
spends the less the commercial bank is profitable. LDR represents the liquidity
condition of the commercial banks, the higher the ratio the less profitable the bank, but
the correlation is not strong which means a weak linear relationship.

4.11 Regression Analysis

The regression findings of the commercial banks are presented in table 4.10.
The coefficient of determination, R-squared was 0.6380 and the adjusted R-squared
was 0.5174. This shows the reliability of the model, that the independent variables were
collectively 51.74% related to the dependent variable ROA. The remaining 48.3% of
changes will be identified by other factors not captured in the model.

Table 4.10: Regression analysis for the dependent variable

Roa Coef. Std. Err. T P>t [95% Conf. Interval]
Car .015727 .0295875 0.53 0.603 -.0473373 .0787913
Npl -.1572128 .0533003 -2.95 0.010 -.2708198 -.0436058
Oer -.049285 .0254751 -1.93 0.072 -.1035839 .0050139
Nim .0929337 .1027819 0.90 0.380 -.1261407 .3120082
Ldr -.014243 .0193008 -0.74 0.472 -.0553818 .0268957
_cons 6.147186 2.374445 2.59 0.021 1.086177 11.20819
Source: Worked out from STATA software, 2013

The Durbin-Watson statistic is 2.2248 which is greater than 2; it means that there is no
serial correlation between independent variables and ROA. Therefore, this meets one of
the regression assumptions. The mean VIF is 1.31 and the VIF of all independent
variables is below 5, which means that co-linearity does not exist between the
independent variables present in the model.

52
The breusch-pagan test for heteroscedasticity gave a probability of 0.9206, making it
significant hence accepting the null hypothesis that variables have constant variances.

The analysis in Table 4.10 exhibits some interesting results. Four variables namely
CAR, OER, NIM and LDR are insignificant at the 95% confidence level. The only
variable namely NPL is not only significant at 95% confidence level as well negatively
significant. This means increase an in NPL will lead to a decrease in ROA.

Based on the regression results in Table 4.10 the model of this study can be written as
follows:

Empirical Model:

ROA= 6.147 + 0.0157CAR – 0.1572NPL – 0.0493OER + 0.0929NIM – 0.0142LDR

Significant model:
ROA= β0 – 0.1572NPL
Model shows that a 0.0157 point increase in CAR will lead to a 1 point increase in
ROA, which means CAR is positively correlated to ROA. Along with CAR, NIM also
has a positive relation with the ROA. As model shows 0.0929 point increase in NIM
will lead to a 1 point increase in ROA. But a 0.1572 point increase in NPL will result in
a decrease of 1 point in ROA, a 0.0493 point increase in OER will result in a decrease
of 1 point of ROA and a 0.0142 increase in LDR will result in a decrease of 1 point of
ROA. This shows a negative relation between these three variables namely NPL, OER
and LDR with ROA. The significance of the model is with 1 independent variable,
NPL.
In the econometric model, NPL is significant while CAR, OER, NIM and LDR are not
significant. Therefore, we reject hypothesis 2. We do not reject hypothesis 1,
hypothesis 3, hypothesis 4 and hypothesis 5.

The relationship between CAMEL components and profitability of commercial banks

using ROA can be summarized by Table 4.11 which presents the findings based on the
hypotheses and specific objective of the study of finding out the determinants of
profitability.

53
Table 4.11: Summary of findings
s/n Hypothesis p-value Empirical
conclusion
1 H 1 : There is no significant relationship between 0.603 Do not reject
capital adequacy ratios and profitability of the banks null
2 H 2 : There is no significant relationship between asset 0.010 Rejected
quality ratios and profitability of the banks
3 H 3 : There is no significant relationship be tween 0.072 Do not reject
management quality ratios and profitability of the null
banks
4 H 4 : There is no significant relationship between 0.380 Do not reject
earnings ratios and profitability of the banks null
5 H 5 : There is no significant relationship between 0.472 Do not reject
liquidity ratios and profitability of the banks null

Based on the findings, the NPL which reflects that loans are in default or close to being
in default, and the odds that the loan will be repaid is significantly low represents asset
quality and measures amount of default in portfolio. Since this is what affects the
profitability in Tanzania it means our banks will suffer significantly in terms of
generating profits in a sustained manner if they do not recover the loans, both principal
and interest; that they give to customers. The NPL of the sample banks have an
average low rating of 4.67, which means that the assets are managed poorly but they
still are profitable with an average ROA and NIM rating of 1. This means that the
banks charge too high interest rates to compensate on the poor asset quality that is
maintained. As a result the customers have a heavy burden of paying back high interest
on loans. The Tanzanian banking sector therefore has a potential to maximize profits by
properly managing loans and as a result reduce interest rates, this way the loans
become more affordable to the customers and at the same time the bank makes
significant profits.

54
 CHAPTER FIVE
CONCLUSIONS AND RECOMMENDATIONS

5.1 Introduction
In this section of this study, conclusions are given and suggestions on improvement of
commercial banks profitability. The limitations of using CAMEL framework are also
stated and scope for further studies is presented.

5.2 Summary
The study analyzed determinants of profitability of commercial banks in Tanzania
taking into account three sampled major banks, CRDB, NBC and NMB; for the period
of seven (7) years starting from 2006 to 2012. Financial performance of the sample
banks was determined and compared based on their CAMEL ratios and the banks
appear to have sound profitability, capital adequacy, earnings and liquidity. On the
other hand they appear to have poor asset quality and high operating expenses.

NMB out-ranked CRDB and NBC on the basis of the internal factors used to rank
them. In determining profitability, the most important variable was found to be non-
performing loans ratio which represents the internal factor of the quality of assets
which proved to be a significant factor.

5.3 Financial performance of major banks

Based on objective one of this study, the financial performance of the three major
sample banks was derived and compared. The following are conclusions made and
recommendations on improvement of performance.

Profitability
The commercial banks generally displayed a satisfactory profitability trend measured
by ROA. Overall the performance of commercial institutions was sound. Generally the
profitability of commercial banks remains to be sound in all three commercial banks
and this has been due to the dominance of market share in the industry. NMB showed
the strongest ROA among the three banks.

55
Capital Adequacy
The commercial banks are well capitalized and have a firm capital base relative to risk-
weighted assets. According to international convention of rating, their capital base is
adequate. The banks should maintain their CAR or improve it so they can better
manage any potential shocks to their balance sheets. The CAR was strong enough over
the period and managed possible shocks to their balance sheets that may have been an
outcome of the GFC. NMB displayed the strongest capital base among all three
commercial banks.

According to Basel II, it is important that financial institutions have an Internal Capital
Adequacy Assessment Process (ICAAP) in place for assessing its overall capital
adequacy in relation to its risk profile and a strategy for maintaining appropriate capital
levels. The Basel III, on the other hand aims to strengthen the risk coverage of the
capital framework by promoting more integrated management of market and
counterparty credit risk, provide incentives to strengthen the risk management of
counterparty credit exposures, raise counterparty credit risk management standards by
including wrong-way risk, reduce procyclicality etc.

Asset Quality
The NPL of the commercial banks generally exhibited poor ratings. Financial
institutions generally fail due to a large percentage of non-performing loans in
comparison with their total capital and loan reserves. Asset quality affects earnings
through provisions to the loan reserve. An inadequate reserve will require additional
provisions, which reduces earnings through reduced interest income. Loans past due
are not paying interest as scheduled, have a negative impact on the interest income. Of
all three banks, NMB showed better quality of assets.

Therefore commercial banks should work on reducing their non-performing loans and
their provision to the loan reserve. This can be done by improving the loan recovery
system, setting limits to credit officers in terms of portfolio at risk (PAR), retrieve
authority to disburse loans from those loan officers who seem to be incompetent in loan
authorization.

56
The banks should generally make sure they adopt effective policies before loans are
made, enforce these policies, monitor the portfolios before loans are made and maintain
an adequate allowance for loan losses.

Management Quality
Management as measured by OER has displayed worst ratings. CRDB had a better
spending pattern than the other two major commercial banks. Measuring management
quality can be tricky but generally a good management takes into account the value of
money by concentrating on the three E‟s; economy, efficiency and effectiveness.
Therefore the commercial banks are expected to reduce their OER, which may in turn
improve profitability. Other ways of measuring management include; satisfaction of
employees and customers, job turnover, number of people applying for a job, number
of customers joining the bank, number of customers closing their accounts etc. The
answers to this question may be used to judge the management of a bank.

Earnings
The earnings performance of the commercial banks based on NIM depict best ratings
with NMB being at the top. The commercial banks have the worst spending ratings but
yet have the best earning performance.
Earnings are the primary means for a bank to increase capital internally, specifically
through retained earnings.

Liquidity
Liquidity of commercial banks displays a fair rating, NMB being comparably better in
its liquidity management.
Information should be readily available for day-to-day liquidity management and risk
control as well as during times of stress. Data should be appropriately consolidated,
comprehensive yet succinct, focused and available in a timely manner. Ideally, the
regular reports a bank generates will enable it to monitor liquidity during a crisis.
Management should keep crisis monitoring in mind with effective management
information systems.

57
5.4 Ranking of banks based on CAMEL ratings
NMB which is a joint venture commercial bank partly owned by the government, partly
by foreigners and partly by individual investors; has out-ranked the other two banks
CRDB and NBC based on the ratios which represent internal factors based on CAMEL
using a CAMEL rating system.

5.5 Determinants of profitability of commercial banks

It can be concluded from the multiple regressions analysis that the NPL was significant
but had a negative effect on ROA, while CAR, OER, NIM, and LDR had an
insignificant effect on ROA. So instead of shooting interest rates above other countries
around the world; Tanzanian banks should focus on improving the quality of their
assets since the quality of assets is what determines profitability. So instead of having a
large loan size or large spread it is the quality of the loan that matters. The government
also has a role to play in improving the legal, judicial and information infrastructure to
smoothen the loan recovery process hence reduced risks which will lead to reduced
interest rates. Another way forward could be for banks to diversify their products and
not heavily rely on loans whose potential income is uncertain as compared to other
services which require fees and commissions like advising on mergers and acquisitions,
structured finance and syndicated loans, cash management services etc.

5.6 Scope for further studies

This dissertation leaves room for further studies. Other researchers can apply
triangulation using other methods or using a different time period to allow further
comparison of results and improving credibility of results.
Based on this research it is now clear that quality of assets which is an internal factor
determines profitability but the model has a reliability percentage of 51.4% only
meaning there could be external factors which are not introduced in the model which
could explain the profitability of commercial banks. In view of these findings, it is
recommended that a follow up involving a deeper study aimed at understanding the
external factors as well which could include inflation, GDP etc. The results of the
proposed study would enable commercial banks to understand better what determines
profitability and thus be able to address the issues accordingly.

58
Another area being recommended for further study is the use of the comprehensive
CAMEL rating system to include both qualitative and quantitative factors. The quality
of assets has proven to be a significant determinant of commercial bank profitability,
commercial banks may also opt to diversify their products so that they do not rely
heavily on loans this way they may become more profitable from the fees and
commission generated from offering diversified products. Further studies may be
carried out to compare profitability of banks that offer diversified products and those
that rely heavily on loans, to determine which banks are more profitable OR studies on
whether diversification improve banks profitability and efficiency. The findings of this
study will guide managers in making a decision on whether to diversify their products
or not.

59
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 APPENDICES

Appendix 1
List of commercial banks operating in Tanzania.
S/N Name of Chief Executive Contacts Head Office
Bank Officer Location
1 P. O. Box 95608,
Kijitonyama /
Dar es Salaam,
Opst. Kijiji cha
AccessBank Managing Director
Makumbusho,
(T) Ltd Mr. Roland Coulon TEL: +255 22 2774355
FAX: +255 22 2774340
Dar es Salaam
www.accessbank.co.tz
2 P. O. Box 34459,
Dar es Salaam,
Ag. Chief Executive ManzeseDarajani.
Advans Bank
Officer
(T ) Ltd Tel: +255 22 2401174/6
Mr. Peter Moulders Dar es Salaam
Fax: +255 2401175
www.advansbanktanzania.com
3 P. O. Box 31,
African Dar es Salaam, Barclays House,
Banking Managing Director Ohio Street,
Corporation Mr. Boniface Nyoni Tel: +255 22 2137089
(T) Ltd Fax: +255 22 2119301 Dar es Salaam
www.africanbankingcorp.com
4 P. O. Box 669,
Dar es Salaam, Amani Place, Ohio
Akiba
Managing Director Street
Commercial
Mr. John Lwande Tel: +255 22 2118344
Bank Ltd
Fax: +255 22 2114173 Dar es Salaam
www.acbtz.com
5 P. o. Box. 9771, Golden Jubillee
Dar es Salaam building ,
Amana Bank Managing Director
Tel: +255 22 2129007/8 Garden/Ohio Street
Ltd Dr. Idris Rashid
Fax: +255 22 2129013
www.amanabank.co.tz Dar es Salaam
6 P. O. Box 9271,
Mawasiliano
Dar es Salaam,
Chief Executive Towers, Sam
Azania Bank
Officer Nujoma Road
Ltd Tel: +255 22 2412025-7
Mr. Charles Singili
Fax: +255 22 2412028
Dar es Salaam
www.azaniabank.co.tz
7 P. o. Box 96,
Dar es Salaam,
Chief Executive Ocean Road
Bank M (T)
Officer
Ltd Tel: +255 22 2127825
Mr. Sanjeev Kumar Dar es Salaam
Fax: +255 22 2127824
www.bankm.co.tz
8 P. O. Box 5356,
Dar es Salaam, Sokoine
Bank of
Managing Director Drive/Ohio Street
Baroda (T)
Mr. Deba P. Gayen Tel: +255 22 2124472
Ltd
Fax:+255 22 2124457 Dar es Salaam
www.bankofbaroda.com
9 Bank of India Managing Director P. O. Box 7581, Maktaba Street
(T) Ltd Mr. Ramesh Kadam Dar es Salaam,

65
 Dar es Salaam
Tel: +255 22 213 5358
Fax: +255 22 2135363
www.boitanzania.co.tz
10 P. O. Box 5137,
Dar es Salaam, Barclays House,
Barclays Bank Managing Director Ohio Street,
(T) Ltd Mr. KiharaMaina Tel: +255 22 2129381
Fax :+255 22 2129757 Dar es Salaam
www.africa.barclays.com
11 P. O. Box 3054,
Managing Director Dar es Salaam, Kivukoni/Ohio
BOA Bank Mr. Street
(T) Ltd AmmishaddaiOwusu- Tel: +255 22 2113593
Amoah Fax: +255 22 2116422 Dar es Salaam
www.boatanzania.com
12 P. O. Box 71625,
Dar es Salaam, Peugeot House, 36
Ag. Managing
Citibank (T) upanga Road.
Director
Ltd Tel: +255 22 2117575,
Mr. Gasper Njuu
Fax: +255 22 2113910 Dar es Salaam
www.citibank.co.tz
13 P. O. Box 9640,
Dar es Salaam, Amani Place, Ohio
Commercial
Managing Director Street,
Bank of
Mr. YohaneKaduma Tel: +255 22 2130113
Africa Ltd
Fax :+255 22 2130116 Dar es Salaam
www.cba.co.tz
14 P. O. Box 268,
Dar es Salaam
Azikiwe Street
CRDB Bank Managing Director
Plc Dr. Charles Kimei Tel: +255 22 2117441-7
Dar es Salaam
Fax: +255 22 2116714
www.crdb.com
15 P. O. Box 115,
Harbor View
Dar es Salaam,
Diamond Chief Executive Towers
Trust Bank Officer Samora Avenue
Tel: +255 22 2114888
(T) Ltd Mr. VijuCherian
Fax: +255 22 2114210
Dar es Salaam
www.dtbafrica.com
16 P. O. Box 20500,
Dar es Salaam,
Sokoine Drive
Ecobank (T) Managing Director
Ltd Mr. Enoch Osei-Safo Tel: +255 22 2137447
Dar es Salaam
Fax: +255 22 2137446
www.ecobank.com
17 P. O. Box 1431,
Dares Salaam, Exim Tower,
Exim Bank Managing Director Ghana Avenue
(T) Ltd Mr. Anthony Grant Tel: +255 22 2293400
Fax: +255 22 2119737 Dar es Salaam
www.eximbank-tz.org
18 P. O. Box 110183,
Quality Centre
Equity bank Dar es Salaam,
Managing Director Mall, Nyerere road
Tanzania
Mr. Samuel Makome
limited Tel: 2865188
Dar es Salaam
www.equitybank.co.tz

66
19 P. O. Box 8298,
Dar es Salaam,
Samora Avenue
FBME Bank General Manager
Ltd Mr. John Lister Tel: +255 22 2126000
Fax +255 22 2126006 Dar Es Salaam
www.fbme.com

20 P. O. Box 72290,
Dar es Salaam,
Chief Executive 2nd Floor – FNB
First National
Officer: House, Ohio Street
Bank ( T ) Ltd Tel +255 768 989000/41
Mr. Richard Hudson Dar es Salaam
Fax +255 768 989010/44
www.fnbtanzania.co.tz
21 P. O. Box 70086,
Dar es Salaam, Zanaki/Indira
Habib African Managing Director Gandhi Street
Bank Ltd Dr. Hassan S. Rizvi Tel: +255 22 211109
Fax: +255 22 2111014 Dar es Salaam
www.habib.com
22 P. O. Box 1509,
Dar es Salaam,
Chief Executive Maktaba Street
I & M Bank
Officer
(T) Ltd Tel: +255 22 2110212
Mr. AnuragiDureha Dar es Salaam
Fax:+255 222118750
www.imbank.com
23 P. O. Box 9363,
Morogoro
Chief Executive Dar es Salaam,
International Road/Jamhuri
Officer
Commercial Street;
Mr. Baseer Tel:+255 22 2110518
Bank (T) Ltd
Mohammed Fax: +255 22 2110196
Dar es Salaam
www.icbank.com
24 P. O. Box 804, Harambee Plaza,
Dar es Salaam, Ali Hassan
KCB Bank (T) Managing Director Mwinyi/Kaunda
Ltd Mr. Moez Mir Tel: +255 22 2664388 Drive
Fax: +255 22 2115391
www.kcb.co.ke Dar es Salaam
25 P. O. Box 38448,
St. Joseph
Dar es Salaam,
Mkombozi Managing Director Cathedral,
Commercial Mrs. Edwina Mansfield Street;
Tel: 2137806/7
Bank Plc Lupembe
Fax: +255 22 2137802
Dar es Salaam,
www.mkombozibank.com
26 P. O. Box 9213,
NMB House,
Dar es Salaam,
National Jamhuri/Azikiwe
Managing Director
Microfinance Street
Mr. Mark Wiessing Tel: +255 22 2161351,
Bank Plc
Fax: +255 22 2161352
Dar es Salaam
www.nmbtz.com
27 P. O. Box 1863,
Dar es Salaam,
Managing Director Sokoine Drive
NBC Bank
Mr. Lawrence
Ltd Tel: +255 22 2113914
Mafuru Dar es Salaam
Fax: +255 22 2112887
www.nbcltd@nbctz.com
28 P. O. Box 20268, Harbor View
NIC Bank (T) Managing Director Dar es Salaam, Towers,
Ltd Mr. James Muchiri Samora Avenue
Tel: +255 22 2118625

67
 Fax:+25522 2116733 Dar es Salaam
www.sfltz.com
29 P. O. Box 1173,
Zanzibar,
Peoples‟ Bank Darani,
Managing Director
of Zanzibar
Mr. Juma Mohamed Tel: +255 24 2238481
Ltd Zanzibar
Fax: +255 22 2231121
www.pbzltd.com
30 P. O. Box 72647,
Ali Hassan
Dar es Salaam,
Mwinyi/Kinondoni
Stanbic Bank Managing Director
Road
(T) Ltd Mr. Bashir Awale Tel: +255 22 2666430
Fax: +255 22 2666301
Dar es Salaam
www.stanbicbank.co.tz
31 P. O. Box 9011, Dar es Garden
Standard Salaam, Avenue/Shaaban
Managing Director
Chartered Tel: +255 222113785 Robert Street
Mr. Jeremy Awori
Bank (T) Ltd Fax: +255 22 2113770
www.standardchartered.com Dar es Salaam
32 P. O. Box 80514,
Dar es Salaam;
United Bank Managing Director Nyerere Road
for Africa(T) Mr. Daniel W. K.
Tel: +255 22 2763452/3
Ltd Addo Dar es Salaam
Fax:+255 22 2863454
www.ubagroup.com
Source: Published in http://www.bot-tz.org/BankingSupervision/RegisteredBanks.asp, BOT, 2013

68
Appendix 2
Regression table
. reg roa car npl oer nim ldr

Source SS df MS Number of obs = 2

> 1
F( 5, 15) = 5.2
> 9
Model 19.5344545 5 3.90689089 Prob > F = 0.005
> 4
Residual 11.0816604 15 .738777359 R-squared = 0.638
> 0
Adj R-squared = 0.517
> 4
Total 30.6161149 20 1.53080574 Root MSE = .8595
> 2

>
roa Coef. Std. Err. t P>|t| [95% Conf. Interval
> ]

>
car .015727 .0295875 0.53 0.603 -.0473373 .078791
> 3
npl -.1572128 .0533003 -2.95 0.010 -.2708198 -.043605
> 8
oer -.049285 .0254751 -1.93 0.072 -.1035839 .005013
> 9
nim .0929337 .1027819 0.90 0.380 -.1261407 .312008
> 2
ldr -.014243 .0193008 -0.74 0.472 -.0553818 .026895
> 7
_cons 6.147186 2.374445 2.59 0.021 1.086177 11.2081
> 9

Appendix 3
Durbin-watson test for autocorrelation
. tsset index
time variable: index, 1 to 21
delta: 1 unit

. dwstat

Durbin-Watson d-statistic( 6, 21) = 2.224834

69
Appendix 4
Hettest for heteroskedasticity
. hettest

Breusch-Pagan / Cook-Weisberg test for heteroskedasticity

Ho: Constant variance
Variables: fitted values of roa

chi2(1) = 0.01
Prob > chi2 = 0.9206

Appendix 5
Multicollinearity test
. vif

Variable VIF 1/VIF

ldr 1.39 0.717837

car 1.38 0.723199
oer 1.32 0.759256
npl 1.29 0.773834
nim 1.17 0.855331

Mean VIF 1.31

70