Journal of Economic Studies

Organizational-level profitability determinants in commercial banks: Swedish evidence

Peter Öhman, Darush Yazdanfar,
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 Organizational-level profitability determinants in commercial banks: Swedish evidence

Abstract
Purpose – The purpose of this study is to examine organizational-level determinants of
commercial bank profitability.
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Design/methodology/approach – Using bank-level longitudinal panel data for the 2005–

2014 period, this study conducts univariate and multivariate statistical analyses, i.e. ordinary
least squares (OLS), fixed-effects, and feasible generalized least-squares (FGLS) regressions,
to analyse profitability variables in Swedish commercial banks.

Findings – The findings indicate that the organizational-level determinants growth, lagged
profitability, and capital adequacy are positively related to banks’ current profitability. No
relationship was found between banks’ size and their profitability. Moreover, no relationship
was found between the macroeconomic control variable gross domestic product (GDP) and
bank profitability.

Practical implications – Given that organizational-level determinants explain sustainable

bank profitability, the findings can be used by bank managers as a basis for low-risk bank
policy formulation, and by regulators in monitoring banks relative to international standards
(i.e. the Basel Accords).

Originality/value – To the best of the authors’ knowledge, this is the first study to
investigate determinants of bank profitability in Sweden, a country with a strong tradition of
bank-based financing, with previous experience of a domestic bank crisis in the 1990s, and
where the recent global financial crisis had relatively little impact on domestic banks.

Keywords: Bank, Profitability, Organizational-level determinants, Regulation, Resource-

based approach
 Organizational-level profitability determinants in commercial banks: Swedish evidence

1. Introduction
As financial intermediaries banks mobilize and allocate savings, making funds available to
investors and thereby playing a crucial role in financing economic activities (Levine, 1998;
Frexias and Rochet, 2008). Technological development, globalization, and financial market
integration have intensified competition among financial institutions, particularly banks
(Trujillo-Ponce, 2013). This competitive environment requires that increased attention be
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paid to bank efficiency (Chronopoulos et al., 2015). In fact, Ongore and Kusa (2013) and
Osuagwu (2014) argued that bank profitability is a key factor shaping financial development
and economic growth, and Larsson et al. (2016) provided longitudinal empirical evidence
from eight European countries that bank profitability is higher and more stable than that of
companies in other industries.

The needs for an effective banking sector and profitable banks have become even more
obvious since the Lehman Brothers bankruptcy in 2008 and the enormous financial losses in
the banking sector worldwide due to the 2007–2009 global financial crisis. The crisis also led
to serious concerns about the solvency and liquidity of banks around the world (Acharya et
al., 2009), justifying the imposition of forward-looking regulatory requirements on banks (De
Moraes and De Mendonça, 2017). The Basel Committee for Banking Supervision has
presented international standards (i.e. the Basel Accords) for building capital buffers and
various safety nets against potential losses in banks. These standards, tied to regulatory
requirements for financial stability laws, have been adjusted since the financial crisis. Among
other requirements, banks must now ensure capital adequacy, and capital adequacy tests are a
frequent element of the ongoing supervision of banks (Chey, 2014). There are several
examples of banks being forced to spend significant amounts of money to meet these
regulatory requirements (Goodhart, 2011), and of small banks having difficulties amassing
the resources necessary to meet the stricter regulatory requirements (Klomp and De Haan,
2011).

Bank profitability can be analysed from a macro- or microeconomic perspective. From the
former perspective, a profitable banking sector is a significant requirement for financing
other industries and for the overall stability of the financial system. From the latter
perspective, the use of resources is a critical precondition for the competitive condition and

2
 the survival of individual banks. Previous research has indicated that internal (i.e.
organization-specific) factors are more important than external (i.e. environmental) factors in
explaining bank profitability (Papadopoulos, 2004; Kosmidou et al., 2006; Yildirim and
Philippatos, 2007; Rahman et al., 2015).

It is argued that organizational behaviour is context dependent and can vary between
financial systems (Mac an Bhaird and Lucey, 2014). In addition, the bank performance
literature has highlighted the impact of country-specific conditions, such as regulation, on
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bank profitability (Barth et al., 2004, 2008; Laeven and Levine, 2009; Pasiouras et al., 2009;
Klomp and De Haan, 2011; Chortareas et al., 2012). Given that country-specific contexts
differ, the generalization of bank profitability findings from different countries is hazardous
(Dietrich and Wanzenried, 2014; Larsson et al., 2016).

As the literature review in section 3 reveals, there is a lack of empirical studies of bank
profitability determinants in the Nordic countries. This paper is intended to fill that gap in the
literature by examining banks operating in the largest Nordic country, i.e. Sweden. The
purpose of this study is to examine organizational-level determinants of profitability in a
sample of Swedish commercial banks. The focus on organizational-level determinants
justifies a resource-based approach to analysing a longitudinal panel dataset.

Despite its limitations, for example, concerning data availability and the relatively small
number of sampled banks, this study contributes to the literature by examining a country that
differs from others as described in the next section. Given the importance of sustainable
profitability in the banking sector, especially in a bank-based financial system like that of
Sweden, this investigation will interest bank managers and regulators. From the bank
manager’s perspective, the present findings regarding profitability determinants may be
useful in formulating long-term strategies to improve bank performance. Regulators may find
the findings useful in monitoring bank financial conditions, not least in relation to the stricter
regulatory requirements for banks regarding capital adequacy and the difficulties smaller
banks face in meeting these requirements.

The remainder of the paper is structured as follows. Section two briefly presents the Swedish
context. Section three presents the theoretical framework and previous empirical studies in
order to support hypothesis development. Section four follows with an overview of the

3
 variable selection, data sample, and model specification. The fifth section presents the
empirical results, and the paper ends with concluding remarks.

2. The Swedish banking context

There are four main categories of banks in the Swedish market: Swedish commercial banks,
savings banks, and cooperative banks as well as foreign banks. In 2016, a total of 116 banks
were operating in Sweden (The Swedish Bankers’ Association, 2016). The present study
examines Swedish commercial banks, four of which (i.e. Nordea, SEB, Svenska
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Handelsbanken, and Swedbank) dominate the market for bank lending. Unlike the USA, the
UK, and other countries with market-based financial systems, Sweden has been characterized
as having a bank-based economy (Sjögren and Zackrisson, 2005; Larsson et al., 2016). In
such a system, banks are expected to ensure the availability of venture capital, and
commercial banks have traditionally dominated the financing of the business community in
Sweden (Larsson and Wallerstedt, 2015). The Swedish banking system is also described as
relation oriented (Silver and Vegholm, 2009) in that, for example, lending conditions are
negotiable and customers are loyal to their banks (Strandberg et al., 2015).

Sweden experienced a national banking crisis in the 1990s. The deregulation of Swedish
banks in the 1980s had fuelled increased credit volumes, high inflation, and low real wage
growth (Engwall, 1997). Over several years in the early 1990s, Swedish house prices
decreased 25 per cent and commercial property instruments lost substantial value. As a result
of the ensuing wave of company bankruptcies, bank credit losses equalled 12 per cent of
gross domestic product (GDP). To resolve this crisis, the Swedish government provided a
rescue programme valued at SEK 65 billion (Engwall, 1997). The government’s actions were
critical for recapitalizing the national banks and saving their reputation.

The Swedish context is also of interest due to the relatively small impact of the recent global
financial crisis on Swedish banks (Nordlund and Lundström, 2011). It is suggested that their
previous experience of a banking crisis and the resulting national requirements for capital
buffers resulted in Swedish banks being less affected by the recent global financial crisis than
were banks in many other countries. In addition, during the latter financial crisis, the Swedish
government provided guarantees to prevent transaction stoppages and maintain financial
stability in the country (Goodhart and Rochet, 2010; Rad, 2016), probably as a result of
lessons learned from the domestic crisis in the 1990s.

4
 3. Theoretical framework, previous empirical studies, and hypothesis development
3.1 Theoretical framework
The resource-based approach takes into account organizational-level variables in explaining
an organization’s ability to achieve and maintain long-term competitiveness (Wernerfelt,
1984). According to Barney (1991) and Barney and Hansen (1994), the resource-based
approach is based on two assumptions: resources are heterogeneous because each
organization possesses a unique resource mix, and resources are immobile as they cannot
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easily be transferred between firms. Not all resources lead to competitive advantage, but to
achieve sustained competitive advantage and superior profitability, some of an organization’s
resources must be unique (Rangone, 1999). Focusing on an organization’s internal strengths
and weaknesses, the resource-based approach emphasizes that the nature and magnitude of
the organization’s resources and its abilities to organize them are crucial to the organization’s
profitability.

Barney (1991) classified an organization’s resources into three categories. Physical assets
include the equipment and technology used in the organization, its geographical location, and
the availability of raw material. Human assets refer to the knowledge, skills, and abilities
embodied in firm personnel. Organizational assets include organizational culture, structure,
and learning. An organization’s particular resource composition creates its competitive
advantage; accordingly, an organization’s strategy should be based on its unique mix of
resources. Barney (1991) emphasized that not only do the resources themselves create value,
but value is created in how an organization chooses to combine its resources. An organization
does not create value simply by having better access to resources than does its competitors;
instead, value is created by using skills and combining the resources in the best possible way.

The resource-based approach emphasizes the differences between various organizations’

resources and how these differences affect the competitiveness of businesses in a given
market (Barney, 2001). The strength of this approach lies in its ability to explain why some
competitors are more profitable than others. It must be noted, however, that the resource-
based view, like most theoretical frameworks, has been criticized. Priem and Butler (2001)
claimed that the main drawback of this approach is that its basic theoretical assumptions are
tautological and therefore cannot meet the criterion of empirical testability. Nevertheless, the
resource-based approach is frequently used in empirical studies of profitability determinants.

5
 3.2 Previous empirical studies and hypothesis development
This literature review covers several of the most relevant previous empirical studies, of which
those by Short (1979) and Bourke (1989) were the first to identify determinants of bank
profitability. Based on datasets covering 60 conventional banks in Canada, Japan, and
Western Europe for the 1971–1977 period, Short (1979) investigated the impact of the
concentration variable on bank performance. The results of linear modelling indicated that
larger banks were more likely to obtain cheaper capital and were therefore likely to be more
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profitable. In addition, higher concentrations of banks gave rise to higher profitability.

Bourke (1989) used an even larger dataset, covering 90 banks selected from 12 European and
North American countries for the 1972–1981 period. According to the results of linear
modelling, bank size, capital adequacy, liquidity ratios, and interest rates were all positively
associated with bank profitability.

The relatively large number of empirical studies, using various statistical methods, of internal
and external determinants of bank profitability following these two pieces of research can be
divided into country-specific and multi-country studies. Several country-specific studies
treated bank profitability in European countries. In Greece, Mamatzakis and Remoundos
(2003) and Athanasoglou et al. (2008) examined the impact of organization-specific and
environmental variables on bank profitability using relatively small samples covering the
1990s. Dietrich and Wanzenried (2011) studied profitability determinants in a sample of 372
commercial banks in Switzerland from 1999 to 2009, dividing the study period into pre-crisis
(1999–2006) and financial crisis (2007–2009) periods. Moreover, Trujillo-Ponce (2013)
examined potential determinants of profitability of 89 Spanish banks over the 1999–2009
period, and Garcia and Martins (2016) analysed the impact of internal and external
determinants on three measures of profitability in 27 universal banks in Portugal from 2002
to 2011. Empirical studies have also been conducted in other European countries, for
example, Macedonia (Poposka and Trpkoski, 2013).

Of the studies conducted outside Europe, Saona (2011) investigated the impact of
organization-specific and environmental variables on profitability in 11,777 US banks over
the 1995–2007 period, and Chronopoulos et al. (2015) analysed the determinants of
profitability using an even larger sample, 17,500 US commercial banks, over the 1984–2010
period. The studies in Bangladesh are based on smaller samples. Sufian and Habibullah

6
 (2009) examined the performance of 37 commercial banks between 1997 and 2004, and
Rahman et al. (2015) studied 25 banks, investigating the impact of several independent
variables on three measures of profitability over the 2006–2013 period. Studies have also
examined countries such as China (Garcia-Herrero et al., 2009), Japan (Liu and Wilson,
2010), Kenya (Ongore and Kusa, 2013), Korea (Sufian, 2011), Malaysia (Devinaga, 2010),
Nigeria (Osuagwu, 2014), Syria (Al-Jafari and Alchami, 2014), Tunisia (Naceur and Goaied,
2008; Ameur and Mhiri, 2013), and Turkey (Macit, 2012; Ayaydin and Karakaya, 2014).
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Multi-country studies in the European Union have focused on either six or seven larger
countries (Goddard et al., 2004a,b), two smaller countries (Burgstaller and Cocca, 2010), or a
group of seven neighbouring countries (Athanasoglou et al., 2006). For example, Goddard et
al. (2004a) investigated the relationship between profitability and growth in European banks
in five countries for the 1992–1998 period, and Goddard et al. (2004b) focused on
determinants of profitability and growth in 665 banks operating in the six largest European
countries in the mid-1990s. More recently, Menicucci and Paolucci (2016) focused on 35 top
European banks in various countries for the 2009–2013 period. Among the more
comprehensive studies, Demirgüç-Kunt and Huizinga (1999) empirically examined 988
banks operating in 80 countries by exploring the relationship between organizational-level
and macroeconomic variables, respectively, and bank profitability for the 1988–1995 period.
Dietrich and Wanzenried (2014) analysed the impact of organization-specific, industry-
specific, and macroeconomic characteristics on the profitability of 10,165 commercial banks
across 118 countries over the years 1998–2012.

The above studies have reported mixed results, in line with the particularities of the different
analysed socio-economic contexts, macroeconomic conditions, emphasized determinants,
applied statistical methods, and study periods. However, several common organizational-
level determinants can be recognized among those found to explain bank profitability. In
accordance with the purpose of this study and given the available data, four organizational-
level variables – growth, lagged profitability, size, and capital adequacy – are investigated.
Regardless of industry, growth and size are considered common determinants of profitability,
and since profitability is a common way of assessing business performance, previous years’
performance is a determinant of current profitability (Cassis et al., 2016). In the banking
sector, capital adequacy is by tradition considered a profitability determinant (Short, 1979;
Bourke, 1989). In addition, a macroeconomic control variable, economic growth, is included

7
 in the study. Hypotheses about the relationship between these determinants and bank
profitability are developed below.

Theoretically, higher revenue growth creates more opportunities to obtain resources that
bolster competitive advantage, resulting in improved performance in terms of profitability
(Goddard et al., 2004a; Yazdanfar and Öhman, 2015). However, empirical findings regarding
the relationship between organizational-level growth and profitability are not consistent
(Bottazzi et al., 2010). Several studies of various individual countries (Athanasoglou et al.,
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2008; Dietrich and Wanzenried, 2011; Chronopoulos et al., 2015; Garcia and Martins, 2016)
as well as multi-country studies (Dietrich and Wanzenried, 2014) have found empirical
evidence for a positive and significant relationship between growth measured in various ways
and profitability. Others have found a negative and significant relationship between the
variables (Goddard et al., 2004a) or no relationship between growth and profitability
(Trujillo-Ponce, 2013). Based on theoretical assumptions and the most common results of
previous empirical studies, the following hypothesis is formulated:

H1. Growth is positively related to bank profitability.

The persistence of bank profits can be explained by the fact that banks tend to retain their
competitive advantages in terms of, for example, market share, product innovation, and
process innovation over time (Berger et al., 2000). The impact of lagged profitability, as a
proxy variable for the persistent effect of past profitability on current profitability, is
emphasized by several previous studies. Although Al-Jafari and Alchami (2014) found the
opposite association, most previous studies suggest a positive and significant association
between lagged and current profitability (Dietrich and Wanzenried, 2011; Ameur and Mhiri,
2013; Trujillo-Ponce, 2013; Ayaydin and Karakaya, 2014; Chronopoulos et al., 2015).
Accordingly, the second hypothesis is as follows:

H2. Lagged profitability is positively related to bank profitability.

Capital adequacy has not only been emphasized in bank regulation (Chey, 2014; De Moraes
and De Mendonça, 2017), but also is regarded as an important determinant of bank
profitability (e.g. Trujillo-Ponce, 2013). This could be because banks with high capital
adequacy ratios are more likely to borrow less capital and to have lower risk and higher

8
 creditworthiness than other banks, which reduces their costs related to funding and thereby
increases their profitability. Theoretically, a positive relationship between the capital
adequacy ratio and profitability should therefore be expected. Moreover, banks with high
capital adequacy ratios tend to use their capital more efficiently than do other banks (Naceur
and Goaied, 2001; Chiaramonte and Casu, 2017).

Several empirical studies of various individual countries (Mamatzakis and Remoundos, 2003;
Athanasoglou et al., 2008; Dietrich and Wanzenried, 2011; Rahman et al., 2015) as well as
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multi-country studies (Demirgüç-Kunt and Huizinga, 1999; Goddard et al., 2004b) suggest a
positive relationship between the capital adequacy ratio and profitability, and Garcia and
Martins (2016) found that capital adequacy had this impact on bank profitability over both
the pre-crisis (2002–2007) and financial crisis (2008–2011) periods. Other studies (Ali et al.,
2011; Saona, 2011; Chronopoulos et al., 2015) report a negative relationship. Moreover,
Trujillo-Ponce (2013) found different relationships between the capital adequacy ratio and
profitability in Spain depending on whether return on assets or return on equity was used to
measure profitability. Dietrich and Wanzenried (2014) found that capital adequacy had a
statistically significant influence on bank profitability in high-income countries, but not in
other countries. Taken together, theoretical assumptions and most empirical results justify the
third hypothesis, as follows:

H3. Capital adequacy is positively related to bank profitability.

Associated with economies of scale, bank size has been identified as an important
determinant of profitability (Naceur and Goaied, 2008). The larger the bank, the better its
opportunities to obtain resources that provide competitive advantages through portfolio
diversification, investing opportunities, reputation, and access to equity capital and external
financing (Aggarwal and Jacques, 2001). Large banks can also exploit economies of scale to
reduce their cost of activity (Goddard et al., 2004a). However, increasing size beyond a
certain level may give rise to bureaucracy and scale inefficiencies (Naceur and Goaied,
2008).

Previous studies have found both positive (e.g. Mamatzakis and Remoundos, 2003;
Athanasoglou et al., 2008; Sufian and Habibullah, 2009; Dietrich and Wanzenried, 2011,
2014; Chronopoulos et al., 2015; Menicucci and Paolucci, 2016) and negative (Naceur and

9
 Omran, 2011; Saona, 2011) relationships between size and profitability, while Trujillo-Ponce
(2013) found no relationship between the two variables. The multi-country study by Dietrich
and Wanzenried (2014) indicated a positive and significant coefficient for the relationship
between the size variable and bank profitability in low- and middle-income countries. Based
on theoretical assumptions and the most common empirical results from previous research,
the fourth hypothesis is as follows:

H4. Size is positively related to bank profitability.

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In their historical overview, Larsson et al. (2016) stated that general economic conditions,
especially financial crises, affect the development of the financial sector, and that the
development of the national economy influences bank profitability. However, the empirical
picture is not absolutely clear. For example, while a Greek study by Athanasoglou et al.
(2008) found that macroeconomic variables, such as central bank interest rate, inflation, GDP
development, and taxation, significantly affected profitability in the sampled banks, another
Greek study, Mamatzakis and Remoundos (2003), found no significant link between CPI or
real interest rate and bank profitability. According to Garcia and Martins (2016), some
macroeconomic variables had a significant impact on Portuguese banks’ profitability, while
other variables did not.

Several previous studies have examined economic growth as a determinant of bank

profitability (e.g. Athanasoglou et al., 2008; Dietrich and Wanzenried, 2011; Goddard et al.,
2011; Sufian, 2011; Sufian and Noor, 2012; Kiganda, 2014; Tan, 2016). Although the
empirical results are somewhat mixed, in agreement with previous studies in the USA,
finding that commercial bank profits tended to increase during periods of faster economic
growth and decline during periods of slow growth (Chronopoulos et al., 2015), and,
especially, in the European context (e.g. Athanasoglou et al., 2008; Dietrich and Wanzenried,
2011), the fifth hypothesis is as follows:

H5. Economic growth is positively related to bank profitability.

4. Variable selection, data sample, and model specification

4.1 Variable selection

10
 Previous empirical studies have used different measures of profitability: Athanasoglou et al.
(2008) and Scott and Arias (2011), for example, used return on assets (ROA), whereas
Mamatzakis and Remoundos (2003), Goddard et al. (2004a,b), Sufian and Habibullah (2009),
Macit (2012), Trujillo-Ponce (2013), Rahman et al. (2015), and Garcia and Martins (2016)
used ROA in combination with return on equity (ROE) and/or net interest margin. The
present study employs return on assets (ROA) as a proxy for bank profitability.

As mentioned, this study examines organization- or bank-level determinants directly related

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to managerial decisions, and investigates the variables growth, lagged profitability, capital
adequacy, and size. Previous studies have measured firm growth in distinct ways in terms of,
for example, the percentage change in revenues, total assets, or loans (e.g. Goddard et al.,
2004a,b; Burgstaller and Cocca, 2010). The present study uses annual revenue change as the
measure of growth. Following several previous studies, the variable lagged profitability is
defined as profitability in the previous year (Athanasoglou et al., 2008; Dietrich and
Wanzenried, 2011; Ameur and Mhiri, 2013; Trujillo-Ponce, 2013; Ayaydin and Karakaya,
2014; Chronopoulos et al., 2015). Capital adequacy has usually been measured by the ratio of
equity to total assets (Bourke, 1989; Demirgüç-Kunt and Huizinga, 1999; Naceur and
Goaied, 2001; Goddard et al., 2004b; Dietrich and Wanzenried, 2011), and the present study
follows this practice. Several measures such as annual revenue, total assets, and market share
can be used as proxies for bank size (e.g. Devinaga, 2010; Dietrich and Wanzenried, 2011).
To capture the advantages associated with economies of scale, the present study uses the
natural logarithm of annual revenue as a proxy for size.

For control purposes, the study also investigates a macroeconomic determinant, i.e. economic
growth. Several studies focusing on macroeconomic variables have used GDP, inflation, and
interest rate as determinants of bank profitability (e.g. Sufian and Habibullah, 2009; Goddard
et al., 2011; Kiganda, 2014). In agreement with Athanasoglou et al. (2008) and Dietrich and
Wanzenried (2011), the present study measures economic growth in terms of annual change
in GDP.

4.2 Data sample

The present study examines Swedish commercial banks using data collected from annual
reports, including income statements and balance sheets. Panel data based on financial
statements often suffer from missing data and outliers. To resolve this problem, cases with

11
 missing data and banks for which under ten years of data were available were excluded. Due
to data availability, the final dataset covers 20 commercial banks over the 10-year period
from 2005 to 2014, leading to 200 observations. The banks in the sample are: Collector Bank,
ICA Banken, Ikano Bank, Landshypotek Bank, Länsförsäkringar, Nordax Bank, Nordea,
OKQ8 Bank, Resurs Bank, Santander Consumer Bank, SBAB Bank, SEB, Skandiabanken,
Svenska Handelsbanken, Swedbank, Swedbank Sjuhärad, Tjustbygdens Sparbank,
Vimmerby Sparbank, Volvofinans Bank, and Ölands Bank. The sample was divided into
three sub-samples covering pre-crisis (2005–2006), crisis (2007–2009), and post-crisis
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(2010–2014) periods.

4.3 Model specification

Several statistical techniques, univariate as well as multivariate, were used in this study, i.e.
ordinary least squares (OLS), fixed-effects, and feasible generalized least squares (FGLS)
regressions. In line with Garcia and Martins (2016), OLS was used as a basic model, and in
line with Saona (2011), fixed-effects regression was used to control for the fixed effects of
the characteristics of the individual sampled banks on the dependent variable. The FGLS
model was applied to overcome problems related to possible heteroscedasticity, panel error
structure, and autoregressive error AR(1), the last of which is a common problem in cross-
sectional data (Wooldridge, 2002). None of the previous studies presented here has
implemented the latter model; however, other bank-related studies have used this model (e.g.
Arghyrou and Kontonikas, 2012).

The following OLS model (model 1) was developed to identify the variables that explain
bank profitability in the sample:

Profitabilityi,t = αt + β1Growthi,t + β2Lagged profitabilityi,t + β3Capital adequacyi,t + β4Sizei,t

+ µit

where

αt = constant

Profitabilityi,t = return on assets (ROA), measured as the bank’s book value of net profit after
taxes divided by total assets

12
 Growthi,t = the percentage change in revenue (book value)

Lagged profitabilityi,t = lagged return on assets (ROA), measured as the bank’s book value of
net profit after taxes divided by total assets

Capital adequacyi,t = ratio of equity to total assets (book value)

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Sizei,t = size of bank i at time t, measured as the natural logarithm of the bank’s book value of
total revenue

µi,t = error term

The parameters of the fixed-effects model (model 2) were similar to those of the OLS model
except for the term ηi, which represents the unobservable heterogeneity (individual effects)
specific to each entity. Accordingly, the fixed-effects model was as follows:

Profitabilityi,t = αt + β1Growthi,t + β2Lagged profitabilityi,t + β3Capital adequacyi,t + β4Sizei,t

+ µit + ηi

The variables included in the FGLS model (model 3) were similar to those included in the
OLS model (model 1).

To detect a possible relationship between the macroeconomic control variable and bank
profitability, GDP was included in the OLS and FLGS models. The new models (models 4
and 5) were identical and as follows:

Profitabilityi,t = αt + β1Growthi,t + β2Lagged profitabilityi,t + β3Capital adequacyi,t + β4Sizei,t

+ β5GDPi,t + µit

where

GDPi,t = the annual change of the GDP.

13
 5. Empirical results
5.1 Descriptive statistics
Table I summarizes the descriptive statistics of the variables included in the correlation and
regression analyses. Over the 2005–2014 period, the sampled banks’ profitability (i.e. ROA)
averaged approximately 2% annually with a standard deviation of almost 5%. The ratio of
revenue growth averaged approximately 11% annually with a standard deviation of more than
27%. Lagged profitability is similar to current profitability in terms of its mean and standard
deviation. The average capital asset ratio was 12% and its standard deviation was equally
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high. The mean of the natural logarithm of the bank’s book value of total revenue is higher
than its standard deviation. The standard deviation of economic growth (i.e. change in GDP)
varied during the study period and is higher than its mean value. Due to missing values, there
are some differences in the number of observations between the variables.

[Insert Table I about here]

5.2. Correlation analysis

Table II exhibits the results of the correlation analysis of the variables incorporated into the
OLS, fixed-effects, and FGLS models. The correlation coefficients indicate the direction and
magnitude of the associations between the variables. The independent variables growth,
lagged profitability, and capital adequacy are significantly and positively correlated with the
dependent variable ROA. The association between size and ROA is insignificant and
negative, whereas the association between GDP and ROA is insignificant and positive. In
general, the analyses indicate that the correlations between the independent variables are not
strong, suggesting that multicollinearity problems are not severe.

[Insert Table II about here]

5.3. Multiple regression analysis

Table III presents the results of the OLS, fixed-effects, and FGLS analyses. According to the
OLS model, there is a positive and significant relationship between three of the four
independent variables and profitability (ROA) at the 1% significance level. Banks with
higher growth rates, higher lagged profitability rates, and higher capital adequacy tend to be
more profitable than other banks. However, the results suggest that there is no relationship
between size and profitability. Notably, the same pattern emerges irrespective of whether the

14
 pre-crisis (2005–2006), crisis (2007–2009), or post-crisis (2010–2014) period is analysed.
This indicates that Swedish banks were relatively unaffected by the global financial crisis.

It can also be noted that the lagged profitability variable has the highest coefficient, and that
the adjusted R² value is approximately 67%. Table III also shows that the results of the fixed-
effects and FGLS regressions are essentially the same as the results of the OLS regressions.

[Insert Table III about here]

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Models 4 and 5 in Table IV indicate no relationship between the macroeconomic control

variable, economic growth, and bank profitability. It is also worth noting that the
relationships between the organizational-level variables growth, lagged profitability, capital
adequacy, and size, respectively, and profitability found in models 4 and 5 are consistent with
the results reported in models 1–3 in Table III.

[Insert Table IV about here]

Based on the results of the five models, it can be concluded that the coefficients of the
variables growth, lagged profitability, and capital adequacy are significant and positive, and
that H1, H2, and H3 are supported. However, H4 is rejected because the results do not
indicate a relationship between size and profitability, and H5 is rejected because the results in
Table IV do not indicate a relationship between economic growth and bank profitability. The
diagnostic tests of the OLS, fixed-effects, and FGLS models, i.e. the VIF, F, Wald, and
Hausman tests, support the robustness of the results. Moreover, the adjusted R² values are
high, indicating that the independent variables significantly explain the change in the
dependent variable.

6. Concluding discussion
This study examines four bank-level determinants of profitability in 20 Swedish commercial
banks over the 2005–2014 period, meaning that the overall results take account of the pre-
crisis, crisis, and post-crisis periods (cf. Dietrich and Wanzenried, 2011; Garcia and Martins,
2016). The empirical findings suggest that the variables representing growth, lagged
profitability, and capital adequacy significantly influence current bank profitability. However,
bank size and economic growth (the control variable), are not related to bank profitability.

15
 This finding regarding the macroeconomic variable is in contrast to the results of several
previous studies but partly in line with those of Mamatzakis and Remoundos (2003) and
Garcia and Martins (2016).

Although the generalization of bank profitability findings from different countries is

hazardous due to country-specific context differences (Mac an Bhaird and Lucey, 2014;
Larsson et al., 2016), the positive relationship found between growth and profitability is
consistent with, for example, the findings of Short (1979), Bourke (1989), Dietrich and
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Wanzenried (2014), and Chronopoulos et al. (2015). The positive relationship between
lagged profitability and current profitability is in agreement with the findings of
Athanasoglou et al. (2008), Dietrich and Wanzenried (2011), and Trujillo-Ponce (2013), and
the positive association between capital adequacy and profitability corroborates the findings
of, for example, Demirgüç-Kunt and Huizinga (1999), Goddard et al. (2004b), Rahman et al.
(2015), and Garcia and Martins (2016).

The banking sector arguably plays a significant role in financing various economic activities
(Levine, 1998; Frexias and Rochet, 2008). This seems to be particularly true in a bank-based
financial system such as Sweden’s, where the government has been keen to protect the
domestic banks during crises (Engwall, 1997). According to the resource-based theory, the
results indicate that a resource composition giving greater competitive advantage measured in
terms of revenue growth, higher lagged profitability, better access to liquidity, and lower risk
(i.e. capital adequacy) gives rise to higher current profitability (cf. Barney, 2001). The finding
that the selected bank-level explanatory variables significantly explain the change in bank
profitability supports previous findings from other countries (e.g. Papadopoulos, 2004;
Kosmidou et al., 2006; Rahman et al., 2015) that organizational-level variables are highly
important in explaining bank performance.

In agreement with Trujillo-Ponce (2013) but in disagreement with, for example, Bourke
(1989), Sufian and Habibullah (2009), Dietrich and Wanzenried (2011), and Menicucci and
Paolucci (2016), the present study finds no relationship between size and profitability. A
possible explanation suggested by Naceur and Goaied (2008) is that an increase in bank size
beyond a certain level may give rise to bureaucracy and scale inefficiencies. Another possible
explanation is, as argued by Saona (2011), that the use of advanced technology is more
important for a bank than is its size per se. It is also possible that the lack of a relationship

16
 between size and profitability is related to Sweden’s status as a bank-based country, and to
Swedish commercial banks’ dominant role in financing the business community, as reported
by Larsson and Wallerstedt (2015). According to Larsson et al. (2016), it is also likely that a
bank-based financial system produces more diversified banks than does a market-based
financial system. The relationship orientation, which makes customers loyal to their banks
(Strandberg et al., 2015), seems to affect the profitability of the four banks dominating the
Swedish market and the smaller banks in a similar way.
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The present findings are of particular interest as they derive from a bank-based country,
which differs from European countries, such as Italy and Spain, that suffered heavily from the
global financial crisis. The findings indicate that organizational-level determinants explain a
considerable part of Swedish banks’ profitability, suggesting that more attention could be
paid to organizational-level determinants as a basis for the managerial and regulatory policies
of banks. From a managerial perspective, one implication is that banks can achieve high
profitability following low risk-growth strategies, so the findings could help bank managers
assess and review their strategies for large as well as small banks, thereby improving
managerial performance. Previous studies (Chiaramonte and Casu, 2017) have found that
capital and liquidity ratios are important in ensuring soundness in large banks.

Perhaps even more importantly, regulators may benefit from the present findings in several
ways. On one hand, in line with several studies from other countries, the findings suggest that
the bank regulatory requirements imposed in the wake of the global financial crisis – in order
to increase banks’ capital buffers and protect them from losses, thereby increasing financial
stability – have been successful in that banks with higher capital adequacy tend to be more
profitable than other banks. This relationship between capital adequacy and bank profitability
seems to have held before, during, and after the studied financial crisis period, at least for
banks in a country such as Sweden that emerged from the global financial crisis reasonably
stable (cf. Nordlund and Lundström, 2011). On the other hand, the regulatory requirements
imposed on banks seem to have been less successful considering that smaller banks may now
have difficulties amassing the financial resources necessary to meet the new regulatory
requirements (Klomp and De Haan, 2011). In line with previous findings from Spain
(Trujillo-Ponce, 2013), the present study suggests that smaller banks can be as profitable as
larger banks, although larger banks may more easily obtain cheaper capital. This indicates not
only that both smaller and larger banks can use their unique resources to achieve sustained

17
 competitive advantage (cf. Rangone, 1999), but also that the existence of smaller banks
stimulates competition in the banking sector to the advantage of bank customers. At the same
time, increased regulation may hinder smaller banks from becoming major players in the
bank market, which would tend to lead to decreased competition and therefore inferior
conditions for companies and individuals needing to borrow money.

Moreover, given that bank profitability is stressed as a significant factor promoting economic
growth (Ongore and Kusa, 2013; Osuagwu, 2014; Larsson et al., 2016), it must be considered
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that bank profitability may change over time as a result of changed regulation (Chronopoulos
et al., 2015), and that banks in general have been forced to spend significant amounts of
money to meet international regulatory requirements (Goodhart, 2011). Thus, regulation may
decrease banks’ profitability.

Like any research, the present study has certain limitations, suggesting that the findings
should be treated carefully. Due to data limitations, only four organizational-level
determinants were investigated. Moreover, only 20 commercial banks were examined and
over a limited time period. Further research could productively use unbalanced panel data to
incorporate a larger number of banks, particularly recently established ones. Comparisons
between the Nordic countries are also suggested, preferably over a long time period covering
the pre-crisis, crisis, and post-crisis periods. In the same vein, comparative studies classifying
countries in terms of environmental factors (e.g. Dietrich and Wanzenried, 2014) are
encouraged. Considering the contrasting finding of the present study that economic growth is
not associated with bank profitability and the US finding of Chronopoulos et al. (2015) that
economic growth may affect bank profitability over time, growth rate, exchange rate,
inflation, and other macroeconomic factors could be used as independent variables in future
studies of bank profitability to give a more comprehensive picture of the phenomenon.

Acknowledgement

The authors of this article have not made their research dataset openly available. Any enquiries
regarding the dataset can be directed to the corresponding author.

18
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About the Authors

Peter Öhman (PhD) is Professor of Business Administration at Mid Sweden University and
the Centre for Research on Economic Relations. His research focuses on accounting,
auditing, and banking.

Darush Yazdanfar (PhD) is Associate Professor of Business Administration at Mid Sweden

University and Centre for Research on Economic Relations. His research focuses corporate
finance, the stock market, risk management, and entrepreneurial finance.

24
 Organizational-level profitability determinants in commercial banks: Swedish evidence

Table I. Descriptive statistics for the 2005–2014 period.

Profitability Lagged Capital GDP

(ROA) Growth profitability adequacy Size growth
Mean 0.0213 0.1083 0.0219 0.1218 24.0551 0.0173
Std. dev. 0.0480 0.2726 0.0504 0.1257 2.4401 3.0165
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Min –0.0123 –0.5837 –0.0123 0.0048 18.5740 –0.0520

Max 0.5251 10.7163 0.5251 0.8338 28.3890 0.0600
n 200 194 180 200 200 200

Notes: Profitabilityi,t = return on assets (ROA), measured as the bank’s book value of net profit after taxes
divided by total assets; Growthi,t = the percentage change in revenue (book value); Lagged profitabilityi,t =
lagged return on assets (ROA), measured as the bank’s book value of net profit after taxes divided by total
assets; Capital adequacyi,t = ratio of equity to total assets (book value); Sizei,t = size of bank i at time t,
measured as the natural logarithm of the bank’s book value of total revenue; and GDPi,t = annual change in the
gross domestic product (GDP).
.
 Table II. Results of correlation analysis for the 2005–2014 period.

Profitability Lagged Capital GDP

(ROA) Growth profitability adequacy Size growth
ROA 1.0000
n 200
Growth 0.3044*** 1.0000
P-value 0.0000
n 194 194
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***
Lagged profitability 0.6609 –0.0005 1.0000
P-value 0.0000 0.9948
n 180 176 180
***
Capital adequacy 0.6589 0.1086 0.5552*** 1.0000
P-value 0.0000 0.1317 0.0000
n 200 194 180 200
Size –0.1122 –0.0188 –0.1175 –0.2363*** 1.0000
P-value 0.1137 0.7946 0.1163 0.0008
n 200 194 180 200 200
GDP growth
0.0200 0.0064 0.0040 0.0411 –0.0277 1.0000
P-value
0.7782 0.9284 0.9550 0.5633 0.7115
n
200 194 200 200 180 200

Notes: * p < 0.1, ** p <0.05, *** p < 0.01; Profitabilityi,t = return on assets (ROA), measured as the bank’s
book value of net profit after taxes divided by total assets; Growthi,t = the percentage change in revenue (book
value); Lagged profitabilityi,t = lagged return on assets (ROA), measured as the bank’s book value of net profit
after taxes divided by total assets; Capital adequacyi,t = ratio of equity to total assets (book value); Sizei,t = size
of bank i at time t, measured as the natural logarithm of the bank’s book value of total revenue; and GDPi,t =
annual change in the gross domestic product (GDP).

2
 Table III. Regression estimations of the OLS fixed-effects and FLGS models for the 2005–
2014 period.

Model OLS Model Fixed effects FLGS

(Model 1) (Model 2) (Model 3)

Dependent variable Profitability (ROA) Dependent variable Profitability (ROA) Profitability (ROA)

Constant –0.0305 Constant –0.1043 –0.0163

P-value (0.209) P-value (0.389) (0.084)
Std. err. 0.0242 Std. err. 0.1207 0.0095
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Growth 0.0480*** Growth 0.0272*** 0.0165***

P-value (0.000) P-value (0.001) (0.000)
Std. err. 0.0079 Std. err. 0.0083 0.0034

Lagged profitability 0.4013*** Lagged profitability 0.2157*** 0.5941***

P-value (0.000) P-value (0.000) (0.000)

Std. err. 0.0520 Std. err. 0.0576 0.0681
*** ***
Capital adequacy 0.1925 Capital adequacy 0.3215 0.0886***

P-value (0.000) P-value (0.000) (0.000)

Std. err. 0.0216 Std. err. 0.0307 0.0267
Size 0.0007 Size 0.0038 0.0006
P-value (0.518) P-value (0.508) (0.133)
Std. err. 0.0011 Std. err. 0.0058 0.0004
LM test 1016.09 Wald χ² 169.56
LM test (sig.) (0.000) Wald (sig.) (0.000)
Durbin–Watson 1.819 Hausman test χ² 57.47
VIF 1.26 Hausman test (sig.) (0.000)
F-value 91.82 F-value 60.40
F (sig.) (0.000) F (sig.) (0.000)
Root MSE 0.0289
Adj. R² 0.6749 Adj. R² 0.6823
n 176 n 176 176

Notes: * p <0.1, ** p < 0.05, *** p < 0.01; Profitabilityi,t = return on assets (ROA), measured as the bank’s
book value of net profit after taxes divided by total assets; Growthi,t = the percentage change in revenue (book
value); Lagged profitabilityi,t = lagged return on assets (ROA), measured as the bank’s book value of net profit
after taxes divided by total assets; Capital adequacyi,t = ratio of equity to total assets (book value); Sizei,t = size
of bank i at time t, measured as the natural logarithm of the bank’s book value of total revenue; LM test =
Lagrange multiplier test; and VIF = variance inflation factor.

3
 Table IV. Regression estimations of the OLS and FLGS models including the
macroeconomic GDP variable for the 2005–2014 period.

Model OLS (Model 4) Model FLGS (Model 5)

Dependent variable Profitability (ROA) Dependent variable Profitability (ROA)
Constant –0.0333 Constant –0.0054
P-value (0.171) P-value (0. 589)
Std. err. 0.0242 Std. err. 0.0099
Growth 0.0487*** Growth 0.0187***
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P-value (0.000) P-value (0.000)

Std. err. 0.0080 Std. err. 0.0041
Lagged profitability 0.4094*** Lagged profitability 0.6538***
P-value (0.000) P-value (0.000)
Std. err. 0.0525 Std. err. 0.0670
Capital adequacy 0.1901*** Capital adequacy 0.0597**
P-value (0.000) P-value (0.010)
Std. err. 0.0218 Std. err. 0.0231
Size 0.0008 Size 0.0001
P-value (0.472) P-value (0.764)
Std. err. 0.0011 Std. err. 0.0010
GDP growth 0.0007 GDP growth 0.0002
P-value (0.286) P-value (0.381)
Std. err. 0.0007 Std. err. 0.0099
LM test 1002.87 Wald χ² 191.16
LM test (sig.) (0.000) Wald (sig.) (0.000)
Durbin–Watson 2.095
VIF 1.230
F-value 73.07
F (sig.) (0.000)
Root MSE 0.0290
Adj. R² 0.6753
n 176 n 176

Notes: * p <0.1, ** p < 0.05, *** p < 0.01; Profitabilityi,t = return on assets (ROA), measured as the bank’s
book value of net profit after taxes divided by total assets; Growthi,t = the percentage change in revenue (book
value); Lagged profitabilityi,t = lagged return on assets (ROA), measured as the bank’s book value of net profit
after taxes divided by total assets; Capital adequacyi,t = ratio of equity to total assets (book value); Sizei,t = size
of bank i at time t, measured as the natural logarithm of the bank’s book value of total revenue, GDPi,t = annual
change in the gross domestic product (GDP); LM test = Lagrange multiplier test; and VIF = variance inflation
factor.