Determining Factors of Profitability of NBFIs

Based on a study on 5 selected NBFIs in Bangladesh

Determining Factors of Profitability of NBFIs

Prepared for:
Syeda Mahrufa Bashar

Course Instructor, Financial Institutions

Prepared by: Md. Raihan Shourov [139] Ferdous Kabir [140] Chalan Kanti Roy [141] Md. Mohaiminul Hasan Khan [150] Batch MBA 46 D

Date of Submission: January 10, 2013

Institute of Business Administration University of Dhaka

LETTER OF TRANSMITTAL
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January 10, 2013

Syeda Mahrufa Bashar Course Instructor, Financial Institutions and Markets IBA, University of Dhaka
Subject: Submission Of Term Paper On Determining Factors Of Profitability Of Nbfis

Dear Madam:

It is our great pleasure to submit the term paper on Determining Factors of Profitability Of NBFIs " which is a partial requirement of Financial Institutions and Markets course. We have found this report informative, beneficial as well as insightful. We have tried our level best to prepare an effective report.

We put forth our sincere efforts to study related materials, documents and examine relevant records for preparation of the report. Within the time limit, we have tried our best to compile the pertinent information as comprehensively as possible and if you need any further information, you can reach us at raihandhk@gmail.com.

Sincerely, Md. Raihan Shourov [139] Ferdous Kabir [140] Chalan Kanti Roy [141] Md. Mohaiminul Hasan Khan [150]
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ACKNOWLEDGEMENT This term paper has been prepared through continual assistance and guidelines from several generous minds without whom this report completion would have been unreachable. First of all, we would like to thank and give our attribute to our honorable course instructor Syeda Mahrufa Bashar, who has been very much friendly and approachable to us through the course and has given us, a lot of guidance in the preparation of our term paper. We would also like to express our appreciation to the people, who have helped all through the term paper. We also like to thank our all group members who were very much friendly and sincere to complete this term paper properly. However, we hope that this course as well as this term paper experience will help us to build our career in a successful and precise way in this area.

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Table of Contents
TABLE OF CONTENTS....................................................................V EXECUTIVE SUMMARY.................................................................VII 1. INTRODUCTION.........................................................................1 1.1 BACKGROUND OF THE STUDY...................................................1 1.2 RATIONALE OF THE STUDY.......................................................1 1.3 OBJECTIVES OF THE STUDY......................................................2 1.4 METHODOLOGY.......................................................................2
1.4.1 Data, sample and period under study ........................................................2 1.4.2 Data Analysis............................................................................................2

1.5 SCOPE OF THE STUDY..............................................................3 1.6 LIMITATIONS...........................................................................3 2. LITERATURE REVIEW.................................................................4 3.1 NON-BANK FINANCIAL INSTITUTIONS IN BANGLADESH...............6 3.2 SERVICES PROVIDED................................................................ 6 3.3 CLASSIFICATION......................................................................6 3.4 DATA SOURCE AND ANALYSIS FRAMEWORK..............................7
3.4.1 Dependent Variable...................................................................................7 3.4.2 Independent Variables...............................................................................7 3.4.3 Variables Summary:..................................................................................9

3.5 HYPOTHESES.........................................................................10 4. ANALYSIS...............................................................................11

4.1 Descriptive Statistics..................................................................................11 4.2 Correlation .......................................................................................................................12 4.3 Regression Result ......................................................................................13 4.3.1 Analysis Process:.......................................................................................................13 4.4 Simple Regression Analysis .....................................................................................14 4.5 Multiple Regression Analysis....................................................................................17 4.6 Findings & Interpretation:...........................................................................20

5. CONCLUDING REMARKS...........................................................21 6. REFERENCES...........................................................................22

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EXECUTIVE SUMMARY
The FI (Financial Institutions) sector is considered to be an important source of financing for all over the world. The contribution of this industry towards the economy has been enhanced dramatically and investors are also recognizing this to be a promising one. So, the profitability of this sector is also getting much attention among the stakeholders in recent times. The objective of this study is to find out the major financial features affecting the profitability (ROE) in the Non-bank Financial Institutions (NBFI) industry of Bangladesh, to spot out the most influential factor behind the NBFI industrys profitability and to evaluate the aspects. The data was collected for five different NBFIs for a period of over five years (2007-2011). For analysis we used Microsoft Excel 2010. In the analysis, we defined ROE as the dependent variable and the independent variables are-natural log of total asset (firm size), equity capital to total asset ratio(capital adequacy), total loan to total asset ratio (asset quality), total deposit to total asset ratio (deposit financing), loan provision to average total loan ratio (credit risk), noninterest income to average total asset ratio (noninterest income), operating expenses to average total asset ratio (management efficiency), net interest margin to average total asset ratio (interest income) etc. In the analysis, we have conducted correlation matrix, simple regression and multiple regression along with descriptive statistics. There were a number of limitations to this study one of them being multicollinearity. To test how much it affected the results, we made a correlation matrix among all the independent variables and pointed out six major correlations which could hamper the multiple regression results. However, we still progressed with the report assuming that the multicollinearity was not that severe. The factors that were found and the ratios used to determine those factors are discussed in details in Table 01 and the multiple regression model provided as well. From these we devised eight hypotheses tests in total and continued to find a significant relationship between the dependent and respective independent variables. The analysis was carried out with the t-test and the p-value analysis simultaneously with a 95% confidence level. Among the eight factors four were found to have a significant relationship with ROE based on the simple linear regression. However, in the multiple regression analysis we find that two out of those four have a significant relationship. Thus, we have concluded that those two factors, namely Capital Adequacy and Non-interest Income are reliable indicators to consider during management decisions which would have a considerable impact on ROE. This is further supported by the fact that a high capital takes down the equity multiplier in value, thus, the return on equity also goes down whereas noninterest income should increase the ROE.

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1. INTRODUCTION 1.1 BACKGROUND OF THE STUDY

The financial system is the ultimate engine for achieving economic prosperity of a country, and is involved in the mobilization of financial resources from the surplus to the deficit sector. Primarily the major responsibility is assigned to banks for the channelization of funds in most of the countries, particularly in developing countries. As the development process proceeds, NBFIs become prominent alongside the banking sector. Both can play significant roles in influencing and mobilizing savings for investment. Their involvement in the process generally makes them competitors as they try to cater to the same needs. However, they are also complementary to each other as each can develop its own niche, and thus may venture into an area where the other may not, which ultimately strengthens the financial mobility of both. In addition, the development of both banks and non-bank financial institutions (henceforth NBFIs) are necessary for assuring a strong and stable financial system for the country as a whole. In addition, NBFIs add power to the economy in such a way that enhances the resilience of the financial system to economic crisis. Non-Bank Financial Institutions (NBFIs) play a significant role in meeting the diverse financial needs of various sectors of an economy and thus contribute to the economic development of the country as well as to the deepening of the countrys financial system. The importance of NBFIs can be emphasized from the structure of the financial system. In the financial system of Bangladesh, commercial banks have emerged in a dominant role in mobilizing funds and using these resources for investment. Due to their structural limitations and rigidity of different regulations, banks could not expand their operations in all expected areas and were confined to a relatively limited sphere of financial services. Moreover, their efforts to meet long term financing with short term resources may result in asset-liability mismatch, which can create pressure on their financial base. They also could not broaden their operational horizon appreciably by offering new and innovative financial products. These drawbacks led to the emergence of NBFIs in Bangladesh for supporting industrialization and economic growth of the country.

1.2 RATIONALE OF THE STUDY

The FI (Financial Institutions) sector is considered to be an important source of financing for all over the world. The common assumption is that growing financial performance will lead to better functions and actions of the organizations. In most of the cases, whenever we refer to Financial Sector, we actually mean the banking sector. In reality, now-a days, the NBFI (NonBanking Financial Institution) has also become one of the most prospective sectors in Bangladesh. The contribution of this industry towards the economy has been enhanced
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dramatically and investors are also recognizing this to be a promising one. So, the profitability of this sector is also getting much attention among the stakeholders in recent times. Plenty of research works have been conducted on the banking sector for identifying its profitability determinates. But no major work has been done in the NBFI sector yet. So, in this paper we are asserting an endeavor to conduct a study for determining profitability indicators of NBFI sector.

1.3 OBJECTIVES OF THE STUDY

1. To find out the major financial features affecting the profitability in the Non-bank Financial Institutions (NBFI) industry of Bangladesh. 2. To spot out the most influential factor behind the NBFI industrys profitability. 3. To evaluate the aspects and make a recommendation based on that to enhance the sectors prosperity.

1.4 METHODOLOGY
The study is empirical in nature that covers a number of variables. Among these Profitability which is indicated by ROE (Return on Equity) is considered as the dependent variable. On the other hand, the independent variables are natural log of total asset (firm size), equity capital to total asset ratio(capital adequacy), total loan to total asset ratio (asset quality), total deposit to total asset ratio (deposit financing), loan provision to average total loan ratio (credit risk), noninterest income to average total asset ratio (noninterest income), operating expenses to average total asset ratio (management efficiency), net interest margin to average total asset ratio (interest income) etc. We have considered the relative figures rather than absolute figures in calculation.

1.4.1 Data, sample and period under study

The study is essentially based on the secondary data collected from annual report of the concerned Non-bank Financial Institutions (NBFI). Information from books, journals and online publications produced by academicians were abundantly used. In Bangladesh, currently 32 NBFIs are operating in full fledge. So, we used the whole population for pursuing the study and from therein we have selected 5 NBFIs through convenient sampling. The data was taken from five different financial institutions for a period of five years, 2007 2011. All financial data are denominated in terms of Bangladeshi Taka.

1.4.2 Data Analysis

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To observe the issues determining profitability, statistical tools such as correlation, simple regression, and multiple regression have been used as deemed appropriate. The statistical tests have been executed by using the Microsoft Excel 2010.

1.5 SCOPE OF THE STUDY

The report has been designed to address the factors determining the profitability of non bank financial institutions. For this particular case, we are only focusing on the ROE of the institutions. We have primarily chosen five NBFIs for collecting information. They are Industrial Promotion and Development Company of Bangladesh Ltd (IPDC), Industrial Development leasing Company of Bangladesh Ltd (IDLC), United Leasing Company Ltd (ULC), Lank Bangla Finance Company Ltd. and Industrial and Infrastructure Development Finance Company Ltd (IIDFC). However, the list may change depending on the quality of the data collected as we will try to The study has been conducted by using the data of 5 NBFIs between the periods of 2007 to 2011.

1.6 LIMITATIONS
Major limitation of this study is insufficiency of accessible data, the main sources of which are the annual reports of the non banks. In annual reports, companies usually give stress on the information that generate affirmative intuition about the company and present the information in their own way, which may become a chief limitation in illustrating the precise scenario of authenticity. Moreover, though there has been an ample amount of researches regarding the bank sectors profitability but no substantial work has so far been done in Bangladesh on the determinants of profitability of NBFIs. So there is a scarcity of literature in this arena. Morever, we could not break down the data given in the annual report due such as noninterest income because the annual reports were concise. On the other hand, our sample size is very small which may have led us to inappropriate conclusion and the impact of competition from commercial banks was left out in the analysis.

2. LITERATURE REVIEW
To get an insight of profitability indicators, several studies have been executed up to till date. But the fact suggests that, most of the researches have been conducted on banking industry. So, the evidence with regard to profitability is scarce in the NBFI sector. Also, the studies have been on topics which bring about a number of other variables on analyzing the return, thus, a single paper on the studies of ROE of NBFIs has been found. However, the following shows the category and span of research which have been done on peripheral topics related to return on equity. Sayla (2012) in Capital Structure Determinants of Non-Bank Financial Institutions (NBFIs) in Bangladesh tried to relate capital structure decision with several variables including profitability, liquidity, operating leverage, growth rate, firm size etc. She used long term debt ratios, short term debt ratios and total debt ratios as the measures of the dependent variable i.e. capital structure. The finding was profitability ratio is insignificant in all the three cases of long term debt ratio, short term debt ratio. And also does not comply with the hypothesis that profitability has a negative relation with debt ratio in case of long term and total debt ratio. However profitability has a negative relation to short term debt complying with hypothesis though the result is statistically insignificant. Ahmed and Chowdhury (2007) stated in their paper Non-Bank Financial Institutions in Bangladesh: An Analytical Review that commercial banks of the country are engaged in nonbank finance activities within the existing banking rules, which is posing difficulties for nonbank financial institutions. While assessing the development and performance of NBFIs in Bangladesh, Hossain and Shahiduzzaman stated that the performance of the NBFIs in leasing business suggests that the industry can be growing up in a sustainable basis and they should concentrate more on their activities in the capital market. However, at present, with high cost of fund non-banks are forced to compete with the banks those have relatively low cost of fund. This situation somewhat hampers the growth and development of NBFIs. According to the analysis Non-Bank Financial Institutions Profitability Indicators: Evidence from Bangladesh by Rahman and Farah (2012) it is clear that the chosen (Operating Efficiency, Capital Structure, Fixed Charges and Income, Liquidity Position) profitability indicator variables have impact upon net profit, but among the independent variables the Liquidity Condition and Operating Efficiency exert significant influence on Profitability of Non-Bank sector in Bangladesh. Financial stability report (2010) of Bangladesh Bank reported increasing ROA and ROE ratios of the then NBFIs from 2006 to 2010 which they claim the consequence of better utilization of assets and equity. Moreover, A decomposition of the sources of total income shows that the
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dominant contribution is on account of interest income from traditional business, which lends to higher profitability. The empirical findings of the study of banks profitability by Sufian and Chong (2008) suggest that all the bank-specific determinant variables have a statistically significantly impact on the profitability of the Philippines banks. During the period under study, the results suggest that size, credit risk, and overhead expenses are negatively related to bank profitability, while non-interest income and capitalisation have a positive impact. The empirical findings seem to suggest that the rate of inflation is negatively related to Philippines banks' profitability level suggesting that during the period under study the level of inflation was unanticipated by banks. On the other hand, economic growth, the growth in the money supply, and the level of stock market capitalisation have not significantly explained the variations in the profitability of the Philippines banks. Gul, Irshad and Zaman stated that individual bank characteristics (internal and external factors) are considered as determinants of bank profitability in Pakistan. Banks with more equity capital, Total Assets, Loans, Deposits and macro factors i.e., economic growth, inflation and stock market capitalization are perceived to have more safety and such an advantage can be translated into higher profitability. For this purpose, two hypotheses have been developed for analyzing banks profitability over specific determinants i.e., Hypothesis 1 states that microeconomic factors have significant impact on profitability. Whereas, hypothesis 2 states that external factors of the banks have significant impact on the profitability. The result shows that both hypotheses have been accepted and have a significant impact on profitability of the Banks in Pakistan. The study by Saklain (2012) of commercial banks profitability in Bangladesh identified that asset size does not have a significant effect on profitability. It suggests that to achieve a higher level of ROA it is not always necessary to be a larger bank. Interest income is always considered to be the main source of income of a bank, but in the study it is found that NIM/assets ratio does not have a significant impact on profitability. But the most significant variable which affects the profitability was found to be the non-interest income/assets ratio. This indicates that greater diversification in banking activities positively influence profitability. It is also identified that investment activities, mainly in shares and debentures (quoted and unquoted) of private sectors has a significant positive impact on ROA. It suggests that banks which are more exposed to the capital market or invest higher proportion of funds in unquoted shares and debenture may achieve higher profitability. Hifza Malik (2011) used ROA and five independent variables that represent age of company, size, volume of capital, leverage and loss ratio to test which factor best explains profitability of Pakistani insurance companies. Result shows that there is no relationship between profitability and age of the company and there is significantly positive relationship between profitability and size. Result also shows that volume of capital was significantly and positively related to profitability. On the other hand the analysis suggests that a reverse and significant relationship between leverage ratio and loss ratio as independent variables and profitability so this result

supports last two hypotheses. Hence it is concluded that ROA is affected positively by size, volume of capital and negatively by leverage and loss ratio.

3.1 NON-BANK FINANCIAL INSTITUTIONS IN BANGLADESH

Non-Bank Financial Institutions (NBFIs) are licensed and regulated under the Financial Institution Act, 1993. NBFIs play an important role in financing various sectors like industry, trade, housing, transport, information technology as well as the capital market. There are 30 NBFIs in the country. As on 30th September, 2011 there are 158 branches of which 60 in Dhaka, 22 in Chittagong and the rest 76 in other districts. As on 30th June, 2011 the total amount of capital and reserve of the NBFIs stood at BDT 51726.32 million. Total assets and total deposits of the NBFIs were BDT 273424.38 million and BDT 106276.19 million respectively. Total outstanding loans and leases of the NBFIs was BDT 190398.6 million. Major sources of funds of NBFIs are Term Deposit, Credit Facility from Banks and other NBFIs, Call Money as well as Bond and Securitization. NBFIs are allowed to mobilize term deposit only of tenor not less than six months.

3.2 SERVICES PROVIDED

NBFIs offer all sorts of banking services, such as loans and credit facilities, private education funding, retirement planning, trading in money markets, underwriting stocks and shares, TFCs and other obligations. These institutions also provide wealth management such as managing portfolios of stocks and shares, discounting services e.g. discounting of instruments and advice on merger and acquisition activities. The number of non-banking financial companies has expanded greatly in the last several years as venture capital companies, retail and industrial companies have entered the lending business. Non-bank institutions also frequently support investments in property and prepare feasibility, market or industry studies for companies.However they are typically not allowed to take deposits from the general public and have to find other means of funding their operations such as issuing debt instruments.

3.3 CLASSIFICATION
Depending upon their nature of activities, non- banking finance companies can be classified into the following categories: 1. 2. Development finance institutions Leasing companies 3. 4. Investment companies Mudaraba companies
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5. 6.

House finance companies Venture capital companies

7.

Discount & guarantee houses

3.4 DATA SOURCE AND ANALYSIS FRAMEWORK

To analyze the determinants of the profitability of nonbank financial institutions 8 variables are included in this study, one of them are the dependent and the others are as explanatory or independent variables.

3.4.1 Dependent Variable

ROE measures the rate of return on the ownership interest (shareholders equity) of the

common stock owners. It measures a firms efficiency at generating profits from every unit of shareholders equity (also known as net assets or assets minus liabilities). It shows how well a company uses investment funds to generate earnings growth.

3.4.2 Independent Variables

By reviewing several literatures it is found that several researchers identified some common factors which influence profitability of a bank. Since NBFIs and commercials banks have almost similar type of operation, factors affecting profitability should be similar for these two types of businesses. So we included the following bank specific variables to capture the determinants of profitability of the NBFIs:
Asset Size(Firm Size) is used to capture the fact that larger institutions are better placed

than smaller institutions in harnessing economies of scale in transactions to the plain effect that they will tend to enjoy a higher level of profits. Consequently, a positive relationship is expected between size and profits. However, the effect of a growing banks size on profitability may be positive up to a certain limit. Beyond this point the effect of size could be negative due to bureaucratic and other reasons. Generally natural logarithm of total asset (ln A) is used to represent firm size.

Equity capital (Capital Adequacy) has been measured by the ratio of equity capital to

total assets. Its interesting to note that higher the capital level breeds higher profitability level since by having more capital, an institution has excess capital that can be provided as loans. In other words, the higher this ratio, the lower the need for external funding and thus leads to the higher profitability of the bank. Equity to total assets ratio is expected to have positive relation with performance of the NBFI.

 Loans (Asset Quality) has been addressed by using loans to total assets ratio. As loans is

one of the main sources of income of an NBFI, the ratio of loans to total assets is expected to affect profitability positively unless an unacceptable level of risk is taken by an NBFI. Other things constant, the more deposits are transformed into loans, the higher the interest margin and profits. However, if a financial institution needs to increase risk to have a higher loan-to-asset ratio, then profits may decrease.
Deposits (Deposit Financing) has been measured by the ratio of total deposits to total

assets which is another liquidity indicator but is considered as a liability. Deposits are the main source of NBFIs funding and hence it has an impact on the profitability. The more deposits are transformed into loans, the higher the interest margin and profit. Hence, deposits generally have positive impact on profitability of the banks. But if a bank cant transform its deposits into loans efficiently it may bring negative impact on profitability also.

Loan Provision (Credit Risk) has been measured by the ratio of Loan Loss Provisions

to average Total Loans which shows us how much of the loans have a reserve for a loan loss. This, in turn, gives us the credit risk of the company as a higher ratio means more provision for absorbing a loss and vice versa. The coefficient of LLP/TL is expected to be negative because bad loans are expected to reduce profitability.

Non Interest Income has been measured by the ratio of Non-interest Income to average

Total Assets. Non-interest income consists of commission, service charges, and fees, guarantee fees, net profit from sale of investment securities etc. The ratio is also included in the regression model as a proxy measure of diversification into non-traditional activities. The variable is expected to exhibit positive relationship with NBFI profitability.

Operating Expenses (Management Efficiency) has been measured by the ratio of Non-

interest expense to average Total Assets. This measures how efficient the management is to minimize non-interest expense while working with assets. The relationship between the NIE/TA variable and profitability levels may be negative.

Net Interest Margin ( Interest Income ) has been measured by the difference between

the interest income generated by the financial institutions and the amount of interest paid
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out to their lenders (for example, deposits), relative to the amount of their assets. It is similar to the gross margin of non-financial companies. The NIM variable is defined as the net interest income divided by average total assets. NIM is focused on the profit earned on interest activities. A positive relationship is expected between net interest margin and ROE of an NBFI.

3.4.3 Variables Summary:

Factor Dependent Variable Independent Variables Profitability Firm Size Capital Adequacy Asset Quality Deposit Financing Credit Risk Non-interest Income Management Efficiency Interest Income
Table - 01

Variable ROE Asset Size Equity capital Loan Deposit Loan Provision Non-interest Income Operating Expenses Net Interest Margin

Measurement Return on Equity = Net Profit/Average Equity Natural Logarithm of Total Assets Equity/Total Assets Loans/Total Assets Deposits/Total Assets Loan-Loss Provisions/ Avg. Total Loans Non-Interest Income/ Avg. Total Assets Non-interest Expense/ Avg. Total Assets (Interest Income Interest Expense)/Avg. Total Assets

Notation ROE lnA CA LA DP CR NII NIE NIM

So our profitability model would be as follows: ROE = 0 + 1lnA + 2CA + 3LA + 4DP + 5CR + 6NII + 7NIE + 8NIM +

3.5 HYPOTHESES
The objective of the study is to find out the relationship between the above mentioned variables as well as the factors that they represent with the institutions profitability, in this case, ROE. Thus the following hypotheses were formed: H1: There is a significant relationship between ASSET SIZE and NBFIs profitability. H2: There is a significant relationship between EQUITY CAPITAL and NBFIs profitability. H3: There is a significant relationship between LOANS and NBFIs profitability. H4: There is a significant relationship between DEPOSITS and NBFIs profitability. H5: There is a significant relationship between LOAN PROVISION and NBFIs profitability. H6: There is a significant relationship between NON-INTEREST INCOME and NBFIs profitability. H7: There is a significant relationship between OPERATING EXPENSES and NBFIs profitability. H8: There is a significant relationship between NET INTEREST MARGIN and NBFIs profitability.
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Note: The independent factors used on the above hypotheses are discussed in the previous section in details.

4. ANALYSIS
This section deals with the results of the study which include the descriptive statistics, correlation, simple and multiple regressions, which are relevant for the study. In this section, an attempt has been done to find out the associations between profitability and performance indicating variables with assistance of few statistical tools. At first, a simple regression model is executed with each of the independent explainers. In the second part of analysis, the investigation has been done through multiple regression models. The dependent and independent factors are kept the same as the simple regression model.

4.1 Descriptive Statistics

The basic descriptive statistics of the variables are presented in Table 2. For each variable, the table shows mean, median, standard deviation, minimum and maximum value from 2007 to 2011 of five non bank financial institutions of Bangladesh.
Equity Capital 15.49% 13.10% Loan Provisi on 1.01% 0.89% Non Interest Income 2.49% 1.98% Operatin g Expenses 2.10% 1.88% Net Interest Margin 4.24% 3.42% 11

ROE Mean Median 22.04% 14.70%

Size 22.95 22.89

Loan 49.65% 49.34%

Deposit 42.94% 40.67%

Standard Deviation Minimum Maximum

Table 2

15.08% 2.60% 59.68%

0.60 21.50 24.16

7.66% 6.25% 29.45%

17.01% 21.69% 87.76%

9.98% 18.91% 63.36%

0.78% -0.48% 2.85%

1.86% 0.31% 6.60%

0.86% 1.24% 5.06%

2.29% 1.14% 10.46%

On average, those NBFIs have a return on equity (ROE) of 22.04%. The ROE varies greatly across different NBFIs as the standard deviation is 15.08% and also the minimum and maximum values are 2.60% and 59.68%. Asset size has been determined by the natural logarithm of Total Asset the mean of which is 22.95 and standard deviation is 0.60 which indicates that all the NBFIs have almost same size. Capital adequacy, asset quality and deposit-these variables are widely dispersed around the mean and their ranges also support this observation. It means that the NBFIs have engaged in various combinations of capital structure to finance their operation. As a result, their earning distribution (ROE) and interest spread would vary accordingly. If we see that Net Interest Margin we find the support of this observation since NIM is widely dispersed. Operating expenses of the NBFIs is represented by management efficiency in this table which has a lower standard deviation than that of other variables but still it has a long range in the data set. Credit risk i.e. loan loss provision has a lower mean of 1.01% for the NBFIs which is certainly a good thing for profitability but it has a standard deviation of .78% which is moderately high. Non-interest income represents the level of diversification the NBFI is engaged in. Since NBFIs by definition, should have different types of businesses including investments, leasing, consultancy, underwriting, issue management etc. and income from these businesses should be significant. In the table, this income has a mean and standard deviation of 2.49% and 1.86% respectively. The standard deviation shows that all the NBFIs do not invest in and receive from investments other than lending in the same proportion of their asset base. Still NIM has a higher mean than that of non-interest income which means that NBFIs in Bangladesh rely heavily on lending in their asset portfolio.

4.2 Correlation
Equity Capital Deposi t Loan Provisio n Non Interest Income Operatin g Expenses Net Interest Margin

ROE ROE Size Equity Capital Loan Deposit Loan provision Non Interest Income 1.00 0.19 -0.48 0.46 -0.23 0.29 0.71

Size

Loan

1.00 -0.52 0.18 0.34 -0.58 0.20 1.00 -0.12 0.02 0.11 -0.22

1.00 -0.16 0.22 0.80

1.00 -0.47 -0.29 1.00 0.18 1.00 12

Operating Expenses Net Interest Margin

Table 3

0.42 0.16

-0.15 -0.30

0.06 0.17

0.57 0.02

-0.10 0.09

0.37 0.50

0.54 -0.08

1.00 0.65 1.00

From the table, we can see that ROE has positive correlation with size, asset quality (loans), credit risk (loan loss provision), noninterest income, operating expenses and net interest margin. All of these were expected except the correlation with loan provision and operating expenses. But high operating expenses may be associated with increased businesses and this relationship is moderate. Non-interest income has strong (.71) relationship with the ROE whereas net interest margin has a weak relationship (.16). On the other hand, ROE has negative relation with capital adequacy and deposits. Deposits are liabilities but have the lowest cost. However, if the deposits are not turned into loans effectively then expenses will be higher than the income from the deposit, as a result a negative relationship is possible. High equity capital means high capital adequacy which needs lower external funding so profitability should increase but increase in equity might also dilute the ROE because increase in equity (denominator) might offset the increase in income (numerator). The correlation matrix between the variables is shown below in Table 3. The matrix shows that there are a few moderately strong correlations among the independent variables as we see that the absolute values are greater than 0.5 (less than .80) in only a few cases. Therefore, we can conclude that multicollinearity problem is not extremely severe for this scenario. If we consider the .50 as moderate or strong correlation we find 4 variables that have moderate or strong correlation with ROE. The variables are:
Correlation Equity Capital Loan Non Interest Income Income Operating expenses -0.48 0.46 0.71 0.42

4.3 Regression Result

4.3.1 Analysis Process:

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1. R2 (coefficient of determination)-refers to what percent variability in the dependent

variables can be explained by variability in the independent variables. R 2 equal to 50% or more will indicate reliable relationship.
2. Significance F (P-value of the F-test)- will tell about fitness or validity of the whole

model. Decision Rule: If p-value > .05 (level of significance), do not reject null hypothesis.
3. Individual P-value (t test)- will tell about the variable of an individual variable in the

model. Decision Rule: If p-value > .05 (level of significance), do not reject null hypothesis.
4. Since in the simple regression there is only on independent variable, so significance F

and P-value will be same which is not in case of multiple regression.

4.4 Simple Regression Analysis

The outputs of regression are summarized in the following table:

Dependent Variable Independent Variable Size Equity Capital Loan Deposit Loan Provision Noninterest Income Operating Expenses Net interest margin P value Equation r2 t-test of test ROE = -88.11 + 4.79SZ 0.0366 0.9345 0.3598 ROE = 36.74 - 94.84CA 0.2322 -2.6373 0.0147 ROE = 1.83 + 40.72AQ 0.2109 2.4793 0.0209 ROE = 36.89 -34.57DP 0.0524 -1.1273 0.2712 ROE = 16.29 + 567.72CR 0.0868 1.4784 0.1529 ROE = 7.7 + 576.23DV 0.5046 4.8404 0.0001 ROE = 6.63 + 734.15ME 0.1757 2.2141 0.0370 ROE = 17.46 + 108.15NIM 0.0269 0.7966 0.4338

Profitabilit y (ROE)

4.4.1 Hypothesis Test

H1: There is a significant relationship between SIZE and NBFIs profitability.

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The Model ROE = -88.11 + 4.79SZ The r2 value of 0.0365797 suggests that 3.66% variability in ROE is explained by the variability of the firm size as measured by the natural log of total asset which would make us depend less on the results. A low t-value of 0.93 and a high p-value of 0.35(higher than .05) suggest that we should not reject the null hypothesis, thus, we can conclude that we find no significant relationship between the size of the firm and its return on equity. H2: There is a significant relationship between Equity Capital and NBFIs profitability. The Model ROE = 36.74 - 94.84CA The r2 value of 0.2321 suggests that 23.21% variability in ROE is explained by the variability of the capital adequacy as measured by the equity capital to total asset. The p-value (.0147) is less than level of significance (.05) which suggests us to reject the null hypothesis. Thus, we can conclude that there is a significant relationship between equity capital and NBFIs profitability as measured by its ROE. H3: There is a significant relationship between loan and NBFIs profitability. The Model ROE = 1.83 + 40.72AQ The r2 value of 0.2109 suggests that 21.09% variability in ROE is explained by the variability of the asset quality as measured by the total loan to total asset. The p-value (.0209) is less than level of significance (.05) which suggests us to reject the null hypothesis. Thus, we can conclude that there is a significant relationship between loan and NBFIs profitability as measured by its ROE. H4: There is a significant relationship between DEPOSIT and NBFIs profitability. The Model ROE = 36.89 -34.57DP The r2 value of 0.0524 suggests that 5.24% variability in ROE is explained by the variability of the asset quality as measured by the total loan to total asset. The p-value (.2712) is higher than level of significance (.05) which suggests us to not reject the null hypothesis. Thus, we cannot conclude that there is a significant relationship between deposit and NBFIs profitability as measured by its ROE. H5: There is a significant relationship between loan provision and NBFIs profitability. The Model ROE = 16.29 + 567.72CR
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The r2 value of .0868 suggests that 8.68% variability in ROE is explained by the variability of the credit risk as measured by the loan loss provision to total loans. The p-value (.1529) is higher than level of significance (.05) which suggests us to not reject the null hypothesis. Thus, we cannot conclude that there is a significant relationship between loan provision and NBFIs profitability as measured by its ROE. H6: There is a significant relationship between Non Interest Income and NBFIs profitability. The Model ROE = 7.7 + 576.23DV The r2 value of .5046 suggests that 50.46% variability in ROE is explained by the variability of the diversification measured by the noninterest income to average total asset. The p-value (.0001) is lower than level of significance (.05) which suggests us to reject the null hypothesis. Thus, we can conclude that there is a significant relationship between noninterest income and NBFIs profitability as measured by its ROE. H7: There is a significant relationship between operating expenses and NBFIs profitability. The Model ROE = 6.63 + 734.15ME The r2 value of 0.1757 suggests that 17.57%. variability in ROE is explained by the variability of the management efficiency measured by the operating expenses to average total asset. The pvalue (.0370) is lower than level of significance (.05) which suggests us to reject the null hypothesis. Thus, we can conclude that there is a significant relationship between operating expenses and NBFIs profitability as measured by its ROE. H8: There is a significant relationship between Net Interest Margin and NBFIs profitability. The Model ROE = 17.46 + 108.15NIM The r2 value of 0.0269 suggests that 2.69% variability in ROE is explained by the variability of the net interest margin as measured by the net interest income to average total asset. The p-value (.4338) is higher than level of significance (.05) which suggests us to not reject the null hypothesis. Thus, we cannot conclude that there is a significant relationship between net interest margin and NBFIs profitability as measured by its ROE.
4.4.2 Summary: Variable Asset Size R2 (Reliability) 3.66% (Very Significance Level .05 Pvalue 0.3598 Null Hypothesis Do not Reject Observation No significant 16

Low) Equity capital Loan Deposit 23.22% (Low) 21.09% (Low) 5.24% (Very Low) Loan Loss Provision Non-interest income Operating expenses Net interest margin 8.68%(Very Low) 50.46% (Moderate) 17.57% ( Low) 2.69% (Very Low) .05 0.4338 Do not Reject .05 .05 .05 0.1529 0.0001 0.0370 Do not Reject Reject Reject .05 .05 .05 0.0147 0.0209 0.2712 Reject Reject Do not Reject

relationship Significant relationship Significant relationship No Significant relationship No Significant relationship Significant relationship Significant relationship No Significant relationship

Out of the 8 variables, we find that only 4 of them have Significant relationship with ROE (profitability). Moreover, only one of these 8 variables i.e. noninterest income has moderate r2. Others have very low or low r2 which reduces the reliability of the relation. However, among the remaining 7 variables, 3 found to have Significant relationship with ROE.

4.5 Multiple Regression Analysis

By using our selected 8 performance indicating variables, multiple regression analysis in Microsoft Excel 2010has been executed. We have got the following model for multiple regressions:
SUMMARY OUTPUT Regression Statistics Multiple R 0.87204428 R Square 0.760461226 Adjusted R Square 0.64069184 Standard Error 9.040150501 17

Observations

25

In the multiple regression result, we can see that r2 is 76.05% which indicates that 76.05% variability in the ROE can be explained by variability in the 8 independent variables. This value is strong enough to rely on. The adjusted r2 (adjusted to number of independent variables) is 64.07% which is also reliable. As a result, we will proceed with the result. In multiple regression, our goal is find out the relationship between the dependent variable and the entire set of independent variables. Thus our hypothesis: H9 : There is significant relationship between dependent variable and at least one of the independent variables.
ANOVA df Regression Residual Total 8 16 24 SS 4151.189487 1307.589137 5458.778624 MS 518.898685 8 81.7243210 8 F 6.34937897 3 Significance F 0.000874478

From the ANOVA table, we find that the p-value of F-test (.001) is less than .05, so we reject null hypothesis and can conclude that there is a significant relationship between dependent variable and at least one of the independent variables.
Coefficients 37.6490 -0.7416 -71.8335 -21.3865 -1.0092 100.5224 855.9066 -626.6803 340.4572 Standard Error 127.8714 5.4894 30.2846 21.0108 24.6737 472.7568 214.2377 568.2787 202.0212 t Stat 0.2944 -0.1351 -2.3719 -1.0179 -0.0409 0.2126 3.9951 -1.1028 1.6853 P-value 0.7722 0.8942 0.0306 0.3239 0.9679 0.8343 0.0010 0.2864 0.1113

Intercept Size Equity Capital Loan Deposit Loan Provision Non interest Income Operating Expenses Net interest margin

The following model shows us how we have setup our multiple regression analysis. ROE = 37.65 0.74logA 71.83CA 21.38NPL 1.01DP + 100.52CR + 855.90NII 626.68NIE + 340.45NIM +
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Now, we will go through the individual hypothesis:

Asset Size: P-value (.8942) higher than .05. So, do not reject null hypothesis and we cannot conclude there is significant relationship between asset size and ROE. Equity Capital: P-value (.0306) less than .05. So, reject null hypothesis and we can conclude there is significant relationship between equity capital and ROE. Loan: P-value (.3239) is higher than .05. So, do not reject null hypothesis and we can conclude there is no significant relationship between loan and ROE. Deposit: P-value (.9679) is higher than .05. So, do not reject null hypothesis and we can conclude there is no significant relationship between deposit and ROE. Loan loss Provision: P-value (.8343) is higher than .05. So, do not reject null hypothesis and we can conclude there is no significant relationship between loan loss provision and ROE. Non-interest Income: P-value (.0010) is lower than .05. So, reject null hypothesis and we can conclude there is significant relationship between noninterest income and ROE. Operating expenses: P-value (.2864) is higher than .05. So, do not reject null hypothesis and we can conclude there is no significant relationship between operating expenses and ROE. Net Interest Margin: P-value (.1113) is higher than .05. So, do not reject null hypothesis and we can conclude there is no significant relationship between net interest margin and ROE.

4.5.1 Summary:

Here, R2 = 76.05% (strong) which increases the reliability of the model. On the other hand, validity of the whole model is justified by the fact that significance F (0.000874478) is less than . 05.
Variable Asset Size Equity capital Loan Deposit Significance Level P-value Null Hypothesis Observation .05 .05 .05 .05 0.8942 0.0306 0.3239 0.9679 0.8343 0.0010 Do not Reject Reject Do not Reject Do not Reject Do not Reject Reject No Significant relationship Significant relationship No Significant relationship No Significant relationship No Significant relationship Significant relationship 19

Loan Loss Provision .05 Non-interest income .05

Operating expenses Net interest margin

.05 .05

0.2864 0.1113

Do not Reject Do not Reject

No Significant relationship No Significant relationship

From the results, we can see that only equity capital and noninterest income have Significant relationship with ROE. For non-interest income the result was same in simple regression. For equity capital, the result was also same in simple regression but r2 was low (23.22%).

4.6 Findings & Interpretation:

Variable Correlation Matrix Simple Regression Multiple Regression Sign/Slope Observation - 94.84 Significant Relationship No Significant relationship Significant Relationship No Significant relationship Sign/slope -71.8335

Observation Sign/Slope Observation Equity Capital Loan -0.48 Negative Significant Relationship Significant Relationship Significant Relationship Direct Relationship

0.46

Positive

+ 40.72

-21.3865

Non Interest Income Operating expenses

0.71

Positive

+ 576.23

855.9066

0.42

Positive

+ 734.15

-626.6803

Based on correlation matrix, above mentioned four variables have high correlation with ROE and among these, capital adequacy is negatively correlated with ROE.
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Simple regression results show that the same four variables have Significant relationship with ROE whereas capital adequacy has a negative slope which supports correlation matrix result. However, in simple regression, only noninterest income has a strong r2 whereas other 3 variables have low r2. On the hand, multiple regression shows that capital adequacy and noninterest income have direct relationship with ROE. Here, capital adequacy has negative slope and noninterest income has positive slope. The remaining 2 variables do not have significant relationship with ROE but they have positive slope. If we take a closer look, we see that the variables in multiple regression with significant relationship are the variables in correlation matrix with relatively high correlation.

The remaining four variables Have weak correlation with ROE based on correlation matrix Do not have significant relationship with ROE. But they might have indirect relationship both positively and negatively (simple and multiple regression) Interpretation: A slope of +10 or -10 means if independent variable increases by 1 unit, dependent variable will increase or decrease by 10 units, holding other variables constant.

5. CONCLUDING REMARKS
In the analysis, we have tried to identify the factors which affect the return on equity of NBFIs and have identified eight of them. However, through extensive statistical calculations we found that not all the factors we identified have a direct relationship. There is a major reason for this incoherence. As we have taken data for five institutions over a period of five years, our data set did not have enough to make a solid conclusive decision, thus, the statistical data gave us a nondependable result. But, the results that we have were found without any kind of manipulation and provide some background on how the factors should act and affect the ROE. In the analysis, we have conducted correlation matrix, simple regression and multiple regresson. Correlation matrix gave us four variables equity capital, loan, noninterest income and operating expenses that have moderate to high correlation with the ROE. Simple regression came up with similar variables saying that these variables have significant relationship with the ROE. Out of these four variables, equity capital was negatively related with ROE in both of the results. After that, multiple regression test has been conducted without omitting any variable. Because in simple regression, only the noninterest income had strong r2 whereas others had low r2 upon which we could not rely to further the test. In the multiple regression test, we found that the overall r2 is strong and there are only two variables which have significant relationship with ROE. These two variables are equity capital and noninterest income. Like the correlation matrix
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and simple regression, equity capital is negatively related with the ROE. It is obvious from the fact that if equity capital increases then the denominator in ROE increases which ultimately reduces the ROE ratio. However, noninterest income had significant positive relation in all the three tests which we could not break down further due to limited data. Usually, non interest income is the prime source of income for NBFIs which includes advisory fee, underwriting commission, issue management fee etc. Thus, it is safe for us to say that for these two factors, managers may decide to manipulate them to see and expect a considerable change on the ROE of a specific firm, provided that all external factors holds constant.

6. REFERENCES
1. Annual Report (2011- 2007): 1.1 United Leasing Company 2.1 IDLC 3.1 Lanka Bangla 4.1 IIDFC 5.1 IPDC 2. Sayla Sowat Siddiqui (January 2012). Capital Structure Determinants of Non-Bank Financial Institutions (NBFIs) in Bangladesh. World Review of Business Research Vol. 2. No. 1. January 2012. Pp. 60 78 3. Hossain And Shahiduzzaman. Development of Non Bank Financial Institutions

to Strengthen the Financial System of Bangladesh.

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4.

Rahman and

Farah (march 2012) . Non Bank Financial Institutions Profitability

Indicators: Evidence from Bangladesh IJAR-BAE Vol. 01. Issue 01. Article No. 03
5. Ahmed and Chowdhury (March 2007). Non-Bank Financial Institutions in Bangladesh:

An Analytical Review. Policy Analysis Unit (PAU) Research Department, Bangladesh Bank
6. Financial Stability Report 2010 (October 2011), Bangladesh Bank. 7. Sufian and Chong (2008). Determinants Of Bank Profitability In A Developing

Economy: Empirical Evidence From The Philippines .AAMJAF, Vol. 4, No. 2, 91112
8. Gul, Irshad and Zaman (March 2011). Factors Affecting Bank Profitability in Pakistan.

The Romanian Economic Journal

9. Saklain( May 2012). The Profitability Determinants Of Private Commercial Banks In

Bangladesh. Asian Institute of Technology (School of Management)

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