Traditional measures of performance but also the most

This preview shows page 31 - 33 out of 95 pages.

traditional measures of performance but also the most important measures of bank profitability in the literature. 2.2.2a Return on Asset (ROA) Return on Asset (ROA) is the ratio of net income to total assets which measures net income earned per dollar of assets. It reflects how well the management is utilizing the bank’s real investment resources to generate profit (Vong & Chan, 2009). Thus, it shows how efficient and profitable a bank’s management is, on the basis of its total asset. Mathematically, ROA is expressed as, 𝑅𝑅𝑅𝑅𝑅𝑅 = 𝑁𝑁𝑁𝑁𝑁𝑁 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝑁𝑁 𝑇𝑇𝐼𝐼𝑁𝑁𝑇𝑇𝑇𝑇 𝑅𝑅𝐴𝐴𝐴𝐴𝑁𝑁𝑁𝑁𝐴𝐴 (1 ) For banks with similar risk profiles, ROA is a useful static for comparing bank profitability as it avoids distortions produced by differences in financial leverage (Bhattarai, 2014). From an accounting perspective, ROA is a comprehensive measure of overall bank performance (Jr Sinkey & Sinkey Jr, 1992). ROA has been widely used as a metric of bank profitability while examining the relationship between credit risk management and bank performance in earlier studies such as that of Alshatti (2015), Berríos (2013), Bhattarai (2014), Kaaya and Pastory (2013), Kurawa and Garba (2014), Nawaz et al. (2012), Ndoka and Islami (2016), Ogboi and Unuafe (2013), Adeusi et al. (2014), Poudel (2012), Zou and Li (2014), Zubairi and Ahson (2014) etc. thus, providing us an argument for using return on asset (ROA) as an indicator of bank profitability.
23 2.2.2b Return on Equity (ROE) Return on Equity (ROE) is the ratio of net income to total equity capital which measures the return to shareholders on their equity. It measures how well the management is utilizing the shareholder’s invested money to generate profit (Athanasoglou, Brissimis, & Delis, 2008). ROE is one of the most important measures for evaluating efficiency and profitability of bank’s management based on the equity that shareholders have contributed to the bank. The equation for ROE is written as, 𝑅𝑅𝑅𝑅𝑅𝑅 = 𝑁𝑁𝑁𝑁𝑁𝑁 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝑁𝑁 𝑇𝑇𝐼𝐼𝑁𝑁𝑇𝑇𝑇𝑇 𝑅𝑅𝐸𝐸𝐸𝐸𝐸𝐸𝑁𝑁𝐸𝐸 (2 ) Generally, a bank with higher ROE has a tendency to be able to generate more return to their shareholders. The higher the bank’s ROE compared to its competitors, the better the bank is. Therefore, the stockholders of the banks always prefer higher ROE however this could sometimes be a threat to the bank (Saunders & Cornett, 2011) because an increase ROE implies that net income is increasing faster relative to total equity. Further, a huge drop in equity capital may result in a violation of minimum regulatory capital standards which tends to increase the risk of solvency for the banks (Saunders & Cornett, 2011). A number of previous empirical studies (Aduda and Gitonga (2011), Afriyie and Akotey (2012), Alshatti (2015), Berríos (2013), Ndoka and Islami (2016), Adeusi et al. (2014), Zou and Li (2014), Zubairi and Ahson (2014)) examining the relationship between credit risk management and bank performance have used ROE as a metric of profitability. Thus, the second measures of profitability used in the study is ROE.