THE RELATIONSHIP BETWEEN BANK PORTFOLIOS AND THEIR COSTS AND EARNINGS : AN ECONOMIC ANALYSIS OF COMMERCIAL BANKS IN SINGAPORE

Abstract

The aim of this study is to carry out a cost analysis of banking operations with the view to estimate the net contribution to profits of sources and uses of' funds for bank types and sizes and between time periods, and to identify the causal factors so as to assist bank management to arrive at optimal operating policies. Banks are assumed to be profit-motivated such that the rates of return are important determinants of its portfolio. The framework is statistical cost analysis in which net rates of return are imputed by regressing net profits after tax on deposits (demand, fixed and savings), borrowings, loans, securities and bills. Four hypotheses were tested on a sample of 32 banks for the period 1965 - 1967: 1. The composition of a bank's portfolio is an important determinant of its profits. R2 was more than 40% in all cases except 1967. 2/3. Differences in the relationship between bank profits and portfolio exist between bank types i.e. domestic and foreign; and between bank sizes i.e. large and small. The rationale is that differences in portfolio composition, and hence in costs and earnings, arise from characteristics associated with type and size of bank. Specifically, domestic and foreign banks differ in the importance of borrowings and time deposits as sources of funds and in bills and securities as uses of funds. These are reflected in costs and earnings so that although gross earnings were higher at foreign banks because of higher returns from international trade finance, yet due to higher salary and borrowing costs, their net profits were lower. Similarly, large and small banks differed in the importance of borrowings, bills and securities, Although large banks' gross earnings were lower yet economies of scale especially in salaries gave them an advantage in net earnings, Generally, bank type exerts a greater influence on portfolio structure whilst size bears more heavily on costs. 4. Differences exist among individual years. Hypotheses 2-4 were accepted at the 5% level of significance. No attempts have been made to assess the influence of other factors e.g. differential pricing, luck, variations in managerial capacity, in deposit supply and loan demand, market structure and vicissitudes of the economy. The signs of the net rates of return generally conformed to a priori expectations and estimates were significant at the 10% level except for demand deposits and securities. The empirical results reveal a consistently higher yield obtainable from bills. Hence higher gross earnings at foreign and small banks are attributable mainly to their larger bill portfolios. High net cost of borrowing relative to net rates of return on earning assets was the prime reason for banks especially foreign and small ones, which relied heavily on borrowed funds, incurring negative net profits.