RESEARCH REPORT ON: A STUDY ON THE RELATIONSHIP BETWEEN ECONOMIES OF SCALES AND PROFITABILITY OF COMMERCIAL BANKS IN TANZANIA
Agathon Kipandula was an MBA student at Mzumbe University at Dar es salaam Business School from 2008 to 2010 when he graduated. This extended extract of the research is published here to give highlight to other student so that in case a student is interest in this research can contact the author of Mzumbe University for further information. Full report is available at Mzumbe University and to the author (Agathon Kipandula).
EXTENDED ABSTRACT
The purpose of this research was to study the relationship between economies of scale and profitability for 25 commercial banks in Tanzania over the period of four years from 2005 to 2008 which were considered to have current, substantial and manageable data. The research has tried to examine what happens when a commercial bank expands by the way of increasing number of its branches and its impact on profitability. The research also tried to answer what happens to growth of assets, revenues and capital when number of branches increase. It also tried to examine when a bank do performs high on a larger scale, when branches are new or when they are old enough.
The study has covered all the twenty five commercial banks that were operating in Tanzania from January 2005 to December 2008. Financial statements were extracted from audited annual reports of these commercial banks over the stated period and performance variables were consolidated which were then analysed using the spread sheet for graphical analysis and interpretations.
It was observed, that as the number of branches of individual commercial banks increased, profits were growing, assets, revenues and capital of these banks were also growing positively. Further, it was observed that Foreign based commercial banks of American, European and Asian origin either were recording losses or lower profits in 2008 as a result of world economic crisis in the relevant year. Further more, it has been observed that the size of capital of a commercial bank is an indicator for a commercial bank to record profits in a specific financial year, the larger the amount of capital, the more the profits were recorded.
The research concludes that there is a positive relationship between economies of scale and profitability for commercial banks in Tanzania. As number of aggregate branches increased from 239 in 2005 to 339 in 2008 which is an increase of 42% whereby aggregate profits grew by 123% aggregate revenues grew by 105% aggregate capital grew by 162% and aggregate assets grew by 95%
STATEMENT OF RESEARCH PROBLEM
Phillof (1999) documented that profitability is higher with larger banks than smaller banks. In addition, Amato and Bursan (2007) confirmed that world-wide there are not many empirical facts on the relationship between bank sizes and profitability. This gave me opportunity and interest to undertake this research in Tanzania on the relationship between economies of scale and profitability in commercial banks.
The relationship between economies of scale in commercial banks in Tanzania and their effect on profitability and general performance of those banks especially on the growth of assets, revenues and capital.
The gap here is that there were no significant knowledge on this relationship between increased economic activities in banks especially in relation to number of branches and profitability and general performance of commercial banks in Tanzania on the basis of the above mentioned performance variables.
The main research issue was that, banks have been expanding over a period of time, by opening new branches all over Tanzania. What was the relationship between number of branches of a commercial bank and their profitability and general performance in Tanzania?
SELECTED LITERATION
The second case is a study on United States Branch banking which was titled “Bank branch growth has been steady-will it continue?” Spiecker (2004) has analysed the importance of branch banking in USA. The study was aimed at looking on the impact that has been brought by the change of law to allow branches banking in USA. Branch banking in USA has come in the era where by technological advancement in electronic banking has been so high. These advances include the increase of automated teller machines and the rise of internet banking and the increasing of broadband capacity which enabled customers to bank online (Spiecker, 2004).
The paper among other things investigated and reviewed some of the reasons behind bank branching trends in America. Three factors were observed these included: the first factor was changes in bank branching laws that led to structural shifts in branching. The second factor towards bank branching trends in America was that branching when well executed appears to improved performance and the third factor is favourable economic and demographic trends encourage branching in certain markets (Spiecker, 2004).
In another observation Spiecker (2004) pointed out on reasons for branches banking in America as conveniences of its customers. Part of the Spiecker report on branch banking reported:
However, over time, bank branches have proven to be highly effective and profitable distribution channels perhaps very simply because people seem to like the convenience of bank branches. The ability to leverage branch networks to generate business has helped distinguish banks in an extremely competitive financial service market place (Spiecker, 2004).
On the surface it would seem unusual that banks with larger branch network are the most efficient because branches are expensive. Indeed, estimates indicated that a typical branch may cost upward of $ 2 million to open, notwithstanding ongoing staffing and management costs. Further, non interest costs are higher relative to assets for companies with more branches. Perhaps surprisingly though, cost decisions may not be the driving force behind improved performances of banks with more branches (Spiecker, 2004).
In this important banking report in America it was further observed that in general banks with larger branch networks have much higher non interest revenue. (Spiecker, 2004). In fact, the report stated that banks with more than 11 branches have a median non interest income ratio of 39 basis point or 82 % higher than banks with one office or unit banks. The report insists that banks with more branches therefore seem to better able to generate greater relative revenues and therefore they have a better efficiency ratio (Spiecker, 2004).
In this USA report the aspects of technology advancement have also been considered as important when a bank wants to perform high. However, throughout the report the truth has been that branches are the most powerful single factor for a bank to perform higher in terms of income and hence profitability as partly quoted:
Banks by adopting new technologies and providing new services or higher service quality may have increased costs but revenue enhancement outpaced those higher costs. These improved efficiencies for banks with larger branch networks are reflected in overall profitability for banks under $ 1 billion in consolidated assets, the median return on assets for banks with more than 11 branches is 23 basis points higher than those with one office or branch (Spiecker, 2004). However despite the technological advances that have made it easier to conduct financial services activities without physically entering a bank branch, it seems that banking consumers like the convenience of bank branches. While it would be difficult to predict what consumer preference for physical branches will be going forward, the general trends suggest that branching will continue at least in some markets (Spiecker, 2004).
This report by Spiecker (2004) is fundamental to this research work on a study on the relationship between economies of scale and profitability of commercial banks in Tanzania. The strength of having many branches has clearly been outlined and strong findings and result have given a proper look that there was positive relationship between economies of scales and profitability of commercial banks in other parts of the world as has been supported by various research reports that have been covered in this part.
“Because it’s a repeat operation there’s a lot of scarring there. Sometimes the heart can be scarred all the way into the chest wall, and just opening up the chest can be risky because there could be very serious bleeding,” Jonathan Rome, M.D. Director of the Cardiac Catheterization Program at The Children’s Hospital of Philadelphia, told Ivanhoe.
