Factors affecting the profitability of commercial banks in Ilocos Norte

 Rojelyn Marie Sotelo Bagain

Divine Word College of Laoag – Graduate School

Abstract

Commercial banks play a critical role in economic development by mobilizing savings, facilitating payments, extending credit to businesses and households, and contributing to financial stability. The profitability of commercial banks is a critical indicator of their financial health and sustainability, which in turn impacts the overall stability and growth of the regional economy as well as the national economy. Thus, this article discusses the key internal and external factors affecting the profitability of commercial banks and is anchored with different economic theories, which include Agency Theory, Risk Management Theory, Structure–Conduct–Performance (SCP) Theory, Trade-off Theory, and Macroeconomic Theory.

Keywords:

Commercial Banks; Profitability; Internal Factor; External Factors; Agency Theory; Risk Management Theory; Structure–Conduct–Performance (SCP) Theory; Trade-off Theory; Macroeconomic Theory.

Introduction

A commercial bank is a financial institution that accepts deposits, provides loans for individuals and businesses, and offers other services like checking accounts, certificates of deposit, and foreign exchange services. In the Philippines, banking continues to be fundamental for growth, especially in provinces where financial inclusion, investment, and local business development hinge on access to banking services. Ilocos Norte, as a growing province in Region I, has seen increasing economic activity and investment, contributing significantly to the Gross Regional Domestic Product.

However, profitability remains a continuing concern in the banking sector, influenced by both internal (bank‐specific) and external (macroeconomic, regulatory, market) factors. Most importantly that there are several changes occurring in the Philippine banking sector, because of its adaptation to new conditions such as the deregulation of the national markets and the level of competitiveness internationally. At the national level, the Bangko Sentral ng Pilipinas is actively pushing for reforms to accelerate the development of the domestic capital market as an alternative funding source for the economy. Since it is reported that about 98% of the local companies in the Philippines are supplied by the banks, while 2% comes from the capital market. This reform may have capital implications on banking profitability due to increasing market competition. Understanding the factors that affect the profitability of these banks is essential not only for bank management but also for policymakers, investors, and stakeholders who seek to enhance the banking sector’s performance and contribution to economic development (Hinlo, 2025).

Profitability of Commercial Banks

This article focuses on analysing key internal and external factors affecting the profitability of commercial banks. Internal factors typically include bank-specific determinants such as bank size, capital adequacy, asset quality, operational efficiency, loan portfolio composition, and liquidity management. External or macroeconomic factors encompass economic growth, inflation rate, money supply, government regulations, and competitive pressures within the banking industry.

Prior studies in the Philippine banking context have shown that bank efficiency, money supply growth, bank size, and liquidity significantly affect banking profitability, while other studies in similar developing regions highlight the importance of capital adequacy and asset quality as primary profitability drivers. And these are being anchored with different theories.

Agency Theory explores the relationship between principals (e.g., shareholders or owners) and agents (e.g., managers or bank officers), where the agents are supposed to act in the best interest of the principals leading to information asymmetry and potential inefficiencies, impacting profitability through increased monitoring costs, risk-taking (moral hazard), and suboptimal decisions, mitigated by strong governance, incentives, and regulation to align actions with shareholder wealth. (Sukendri et al., 2024)

Meanwhile, risk management theory in banking posits that effectively identifying, assessing, and mitigating risks (credit, liquidity, market, operational) is crucial for sustainable profitability, as these risks directly impact performance, while also influencing risk-taking behavior, creating a complex interplay where good management can boost returns but excessive profitability might paradoxfully encourage riskier ventures, aiming to balance growth with stability. (Babulo & Viswanadham, 2021)

On the other hand, the Structure–Conduct–Performance (SCP) framework is used to examine how the market structure of commercial banks and their operational conduct affect financial performance. Through this model, the study identifies both structural (e.g., competition, market size) and conduct-related (e.g., pricing, credit policy) determinants of profitability.

Moreover, Trade-Off Theory serves as a theoretical foundation for examining how capital structure decisions affect bank profitability. According to the theory, banks must balance the benefits of leverage (e.g., tax shields, increased lending capacity) against the potential costs of financial distress and regulatory non-compliance. In the context of commercial banks in Ilocos Norte, understanding this balance can help explain variations in profitability across institutions with different capital adequacy levels.

This study is also grounded in macroeconomic theories, which explain how large-scale economic factors affect firm-level performance. According to Keynesian and monetarist perspectives, variables such as GDP growth, inflation, interest rates, and unemployment significantly influence the behaviour of borrowers and the operational environment of banks. In the context of Ilocos Norte, where local economic conditions are closely tied to agricultural production, tourism, and remittances, these macroeconomic forces are expected to have a direct impact on bank profitability.

Factors affecting profitability

The profitability of commercial banks is shaped by a complex interaction of internal (bank-specific) and external (environmental) factors, and these relationships can be clearly explained through established financial and economic theories.

From an internal perspective, factors such as management efficiency, asset quality, capital adequacy, liquidity management, cost control, and risk-taking behaviour play a decisive role in determining bank profitability. Agency Theory highlights how conflicts between shareholders, managers, and depositors can reduce profitability when managerial decisions prioritize personal interests over value maximization. Strong corporate governance, performance-based incentives, and effective monitoring mechanisms help mitigate agency costs and improve profitability. In line with Risk Management Theory, prudent credit risk, market risk, and operational risk management enhance profitability by reducing non-performing loans, stabilizing earnings, and preserving capital. Banks that balance risk and return effectively tend to achieve more sustainable profits.

Capital structure decisions are also critical. Trade-off Theory explains that banks aim to optimize their capital mix by balancing the tax benefits of debt against the costs of financial distress. Adequate capitalization strengthens confidence, reduces funding costs, and enhances resilience, thereby positively influencing profitability, although excessive capital may dilute returns.

From an external perspective, market structure, competition, and macroeconomic conditions significantly influence bank performance. The Structure–Conduct–Performance (SCP) Theory suggests that banks operating in more concentrated markets can exercise market power, set favourable pricing for loans and deposits, and earn higher profits. However, excessive concentration may reduce efficiency and innovation over time. Meanwhile, Macroeconomic Theory emphasizes that economic growth, inflation, interest rates, and monetary policy directly affect banks’ profitability by influencing credit demand, loan quality, and net interest margins. Favourable macroeconomic conditions generally support higher profitability, while economic downturns increase credit risk and compress margins.

Conclusion

Overall, commercial bank profitability is not determined by a single factor or theory but by the dynamic interaction between internal managerial decisions and external economic and market forces. Banks that align effective governance (Agency Theory), sound risk practices (Risk Management Theory), optimal capital structures (Trade-off Theory), competitive strategies (SCP Theory), and adaptability to macroeconomic conditions (Macroeconomic Theory) are better positioned to achieve sustainable and resilient profitability.

References

Babulo, A. A., & Viswanadham, P. (2021). The effect of risk management practice on the financial performance of Ethiopian commercial banks. INNOVATIONS, 530003. https://journal-innovations.com/assets/uploads/doc/4600c-1294-1311.23640.pdf

 

Hinlo, J. E.  (2025). Determinants of banking profitability in the Philippines. Usep. https://www.academia.edu/65281585/Determinants_of_Banking_Profitability_in_the_Philippines

Sukendri, N., Muktiyanto, A., Geraldina, I., & Safitri, J. (2024). Agency Theory in Banking: Balancing incentives and mitigating moral hazard in the Principal-Agent dilemma.

 

R, M. R. &. R. J. P. (2017). The Impact of Credit Risk and Capital Adequacy on the Profitability of Rural Banks in the Philippines.  Pakistan Journal of Life and Social Sciences, 22–22, 22877–22887. https://www.pjlss.edu.pk/pdf_files/2024_2/22877-22887.pdf

PAMATMAT, R. J. (2021). Determinants of bank group profitability in the Philippines from 2008 to 2019: A panel data regression approach. Philippine Management Review 2021, 28, 81–110. https://pmr.upd.edu.ph/index.php/pmr/article/download/357/356/

 

Mahmud, K., Mallik, A., Imtiaz, M. F., & Tabassum, N. (2016b). The Bank-Specific Factors Affecting the Profitability of Commercial Banks in Bangladesh: A Panel Data Analysis. International Journal of Managerial Studies and Research, 4(7). https://doi.org/10.20431/2349-0349.0407008

 

 

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