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The Relationship Between Political Risk, Credit Risk and Profitability in the South African Banking Sector DANIEL MOKATSANYANE (

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The Relationship Between Political Risk, Credit Risk and Profitability in the South African Banking Sector DANIEL MOKATSANYANE ( The relationship between political risk, credit risk and profitability in the South African banking sector DANIEL MOKATSANYANE (Student no: 22466223) Dissertation submitted in partial fulfilment of the requirements for the degree MASTER OF COMMERCE (RISK MANAGEMENT) in the School of Economic Sciences in the Faculty of Economic Sciences & IT at the NORTH-WEST UNIVERSITY (Vaal Triangle Campus) Supervisor: Dr D Viljoen Co-supervisor: Dr PF Muzindutsi November 2016 The relationship between political risk, credit risk and profitability in the South African banking sector. Page DECLARATION I, Daniel Mokatsanyane, student number 22466223 hereby declare that this dissertation is my own original work and has been submitted in partial fulfilment for the degree, Masters of Commerce in Risk Management at North West University (Vaal Triangle Campus), and that it will not be presented at any other university for a similar or any other degree. …………………………………….. .……/……./.…... Mr Daniel Mokatsanyane Date The relationship between political risk, credit risk and profitability in the South African banking sector. Page i ACKNOWLEDGMENT I would like to express my sincere gratitude to: God, for his undeserved favour, knowledge, wisdom, and understanding from above; My supervisor, Dr Diana Viljoen, and my co-supervisor, Dr Paul-Francois Muzindutsi, for your ongoing guidance and support, without which this dissertation would not have been possible; My family for their love and support. Mr and Mrs Mzizi; to you I will forever be thankful, and Mr and Mrs Mofokeng, Mrs Masike, Dr Zolela Ngcwabe and the clan, you showed me that family is beyond blood; My sister, Dikeledi Evelyn Mokatsanyane, and the rest of the Mokatsanyane and Phelane fraternity, thank you for your love and support; My brothers, Siyamcela Moses Sambatha and Ayanda Phesheya Mdluli, for your inspiration, love and respect – but most importantly, for the enduring friendship; My associate and brother, Thomas Habanabakize, thank you for all the encouragement and support; The North-West University (Vaal Triangle Campus) for the financial support; The faculty members and fellow students of the School of Economic Sciences, for their encouragement, assistance and support; Janine Jubber, for the exceptional final language and grammatical editing; Last, but not least, to my father, Mr Lebode Wessells Mokatsanyane, and my grandmother, Mrs Masamoele Martha Mokatsanyane, for their care, love, and sacrifices they made while contributing towards my education. You have both been pillars of strength, and for this, I will always be grateful and humbled. The relationship between political risk, credit risk and profitability in the South African banking sector. Page ii DEDICATION I dedicate this project to: My late mother, Matebello Moselantja Jeanette Mokatsanyane; My grandmother, Mrs Masamoele Martha Mokatsanyane; and Lastly, to Nomsa Mzizi, Ndumiso Mzizi, Thandiwe Mzizi, Kabelo Mofokeng, and Nosolomzi Ngcwabe. I have mastered the art of obedience and found answers to the question ‘why’. I have set an example for you, and encourage you never to cease studying and improving the quality of your life by acquiring knowledge. Therefore, please receive my plea not to disappoint those following you. The relationship between political risk, credit risk and profitability in the South African banking sector. Page iii ABSTRACT As the cornerstone of every economic structure, the financial system is one of the most important key elements in the economic development and economic growth of every country. The structure of the financial system comprises various financial markets and financial institutions, including banks. Due to their critical role in promoting economic growth, financial stability and capital formation, banks are viewed as among the largest and most vital types of financial institutions. However, due to their nature and functionality, banks are exposed to a number of risks. Studies have indicated that political risk and credit risk are the two oldest and most perilous risks faced by banks globally, as they influence banks’ capital, investment and profitability structure. This study employed quantitative research to analyse the relationship between political risk, credit risk and profitability in the South African banking sector, which is the study’s primary objective. The secondary data of four large banks, namely Absa, FirstRand, Nedbank and Standard Bank from 2001 to 2015 was collected. Data included return on equity (ROE), return on assets (ROA), net interest margin (NIM) and earnings per share (EPS) as the proxies for profitability. Two independent variables, credit risk, denoted by non-performing loans ratio (NPLR), and political risk denoted by political risk index (PRI) were used in the study. Lastly, bank size; operating expenses; economic activity; gross domestic product; and inflation and interest rate, were used as control variables. The profitability variables were obtained from the INET BFA dataset and the respective banks’ official websites. Political risk data was provided by ICRG, while South African macroeconomic variables were obtained from the South African Reserve Bank (SARB) and Statistics South Africa (Stats SA). The statistical tests and econometric models used to analyse the data included trend analysis, descriptive statistics, a correlation (multicollinearity) test and a unit root test. The panel pooled mean group (PMG) model, based on the Autoregressive Distributed Lag (ARDL) approach, was employed to test the cointegration among variables, and the error correction model (ECM) was used to determine the adjustment of the system to the equilibrium. The findings of the study revealed that both political and credit risk has a significant relationship with profitability. Moreover, the analysis of other variables indicated that bank size has a negative effect on South African banks’ profitability, while operating expenses The relationship between political risk, credit risk and profitability in the South African banking sector. Page iv indicate a positive and significant effect. The analysis of GDP growth and inflation exhibited a positive effect on profitability. These findings are an indication that bank profitability is not only influenced by political and credit risk alone, but by bank size, operating expenses, GDP growth and inflation among other factors. Therefore, in an attempt to provide a meaningful explanation of the movements in profitability, banks’ management should combine political risk, credit risk and bank size, operating expenses, GDP growth and inflation, in order to improve profitability management. Key words: political risk, credit risk, profitability, ARDL, South Africa. The relationship between political risk, credit risk and profitability in the South African banking sector. Page v TABLE OF CONTENTS DEDICATION....................................................................................................................... III ABSTRACT ........................................................................................................................... IV TABLE OF CONTENTS ..................................................................................................... VI LIST OF FIGURES ........................................................................................................... XIV LIST OF TABLES ............................................................................................................. XIV LIST OF ACRONYMS ....................................................................................................... XV CHAPTER 1: INTRODUCTION ........................................................................................... 1 1.1 BACKGROUND OF THE STUDY .................................................................................. 1 1.2 PROBLEM STATEMENT ............................................................................................... 6 1.3 OBJECTIVES OF THE STUDY ...................................................................................... 7 1.3.1 Primary objectives ......................................................................................................... 7 1.3.2 Theoretical objectives ................................................................................................... 7 1.3.3 Empirical objectives ...................................................................................................... 7 1.4 RESEARCH DESIGN AND METHODOLOGY ........................................................... 7 1.4.1 Literature review: political risk, credit risk and profitability ........................................ 8 1.4.2 Empirical study ............................................................................................................. 8 1.4.2.1 Population and sampling ........................................................................................ 8 1.4.2.2 Data source and description of variables ................................................................ 8 1.4.3 Data analysis ................................................................................................................. 9 1.5 ETHICAL CONSIDERATION ...................................................................................... 10 The relationship between political risk, credit risk and profitability in the South African banking sector. Page vi 1.6 CHAPTER CLASSIFICATION....................................................................................
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