Micro and macroeconomic determinants of profitability of conventional banks and stock performance using Tobin’s Q ratio: Evidence from the banking sector of Pakistan

The financial sector is the key player to enhance sustainable economic growth. Commercial banks play an important role to improve the performance of the financial sector of the economy and their profitability is closely connected to the soundness of the entire economy. The purpose of this study is to determine the internal determinants (bank-specific) and external determinants (macro-economic) of profitability. In this regard, the study adopted a quantitative research design by using the panel data of 17 commercial banks of Pakistan over the period of 2014-2018. Internal factors analyzed in this study were Liquidity, Size, and Capital Adequacy. While external factors were Gross Domestic Product (GDP) and Inflation. The data was analyzed by using simple OLS regression and Tobin’s Q ratio. The analysis showed that GDP has a significant impact on profitability. However, inflation has no impact on profitability. Tobin’s Q ratio of most of the banks is increasing which depicted their equilibrium position. Based on the findings, the study recommended some policies that will encourage banks to reduce credit risk and minimize their liquidity holdings. Moreover, the Government should take the proper initiatives to enhance the confidence of investors towards the stock market.


Introduction
Banks contribute significantly to the growth and development of the economy. Banks assist in the financial development of the country as well as provide various opportunities to people to make investment and saving plans through verified and guaranteed methods of investments (Sufian & Habibullah, 2009). Banks perform the duties of intermediary between the investors and end-users and facilitate them in different business activities.
The banking sector is represented as the hub of the financial sector with an 88% share in the last 10 years in Pakistan. The profitability of the banking sector contributes not only to economic growth but also helps to bear the external and negative financial shocks (Athanasoglou, Brissimis, & Delis, 2008). Rose (1999) described profitability as the after-tax net income usually measured by return on assets and return on equity. Profitability is the capability of the company to produce earnings. A profitable banking system not only contributes to the financial and economic stability of the country, but it also supports an economy to better respond to financial shocks. Therefore, investigating the micro and macroeconomic determinants of the profitability of conventional banks merits study on their own. For instance, the banking sector of Pakistan experienced significant transformation in the last two decades, shifted lending from the government to the private sector. This transformation impacts the profitability of commercial banks.
Therefore, this paper aims to research the determinants of commercial banks' profitability in Pakistan from 2014 to 2018. Our study contributes to the existing empirical literature in a couple of ways. First, our paper presents a joint analysis of bank profitability and stability by using both internal (microeconomic) and external (macroeconomic) determinants. Mirzaei et al. (2013) argue that the global banking industry has experienced substantial changes and structural reforms, specifically after the financial crisis of 2007/2008. Secondly past studies well-explored bank internal determinants of profitability and stability using a panel of different countries. This restricts policy and its generalizability to a specific country due to a change in the dynamics of the financial sector of a country. Moreover, past studies showed mixed results and produce a vague understanding of the determinants of profitability (Goddard et al., 2004;Ali, 2015;Sufian, 2010;Naceur and Omran, 2011). Thus, this research widening the scope and fills the gap by using internal and external determinants of bank profitability and stability in Pakistan to generalize the results Currently, there are 24 scheduled and cooperative banks (commercial banks) in Pakistan. Out of which, 17 conventional banks are listed on Pakistan Stock Exchange. Financial reports presented the financial results and related information to different stakeholders including investors, customers, and regulators. Financial reports also explain how the company performed over a specific time and help to make investment decisions. The relevant information is provided by such financial reporting activity for making important business decisions (Dubelaar, Sohal, & Savic, 2005) and also analyzes the current market situation of banks for investors that would be able to add the strategies to enhance the development of the banks.

1.1Research Objectives 1
To determine the impact of GDP on Return on Assets. 2 To determine the impact of Inflation on Return on Assets 3 To determine the impact of Liquidity on Return on Assets. 4 To determine the impact of Size on Return on Assets. 5 To determine the impact of Capital Adequacy on Return on Assets.

Research Questions 1
Does the macroeconomic factor GDP affect the bank's performance significantly? 2 Does the macroeconomic factor Inflation affect the bank's performance significantly? 3 Does the macroeconomic factor Liquidity affect the bank's performance significantly? 4 Does macroeconomic factor Size affect the bank's performance significantly? 5 Does macroeconomic factor Capital Adequacy affect the bank's performance significantly?

Scope of the study
The banking sector is a speedily growing industry in Pakistan. Abidi and Lodhi (2015) stated that commercial banks play an important role in the economic development of Pakistan. There is much competition in occupying a superior position in the financial system that every bank is trying to improve performance, and firm characteristics of manufacturing companies in Nigeria, a study was conducted by Egbunike and Okerekeoti (2018) by using multiple linear regressions to validate the hypothesis and found no significant effect for the exchange rate and interest rate but found a significant effect for inflation rate and GDP growth rate on ROA. Furthermore, the firm characteristics showed that firm size, liquidity and leverage were significant. Ali (2015) found that ROA and ROE were significantly affected by Asset Management, Assets Size, Liquidity, Asset Quality, Deposit, Operating Efficiency, Gearing Ratio, and Financial Risk (internal determinants) while (external determinants) Inflation and GDP are insignificantly affected the bank's profitability. Therefore, we propose that H2= Inflation has an impact on ROA of Conventional Banks

Relationship of Liquidity and the bank's performance
The liquidity of a bank is calculated by the proportion of liquid assets. This proportion demonstrates the ability of a bank to meet the payments as and when their investors and different providers of funds are required. The lower proportion will put the bank in trouble in gathering payments in the ideal time and subsequently its liquidity low. The lower proportion would imply that the bank won't easily get reserves or else it should bring about an incredibly high premium rate which will raise the expense of subsidizing and negatively affect the profitability. A very higher proportion will show the abundance of inactive liquid assets. Therefore, a higher proportion levels forecast the sign of trouble, and consequently, the proper investigation takes place (Rao & Lakew, 2012). Curak, Poposki, and Pepur (2012) analyze the industry-specific, bank-specific, and macroeconomic determinants of profitability with a sample of 16 banks in the Macedonian banking system over the period 2005-2010. They found that liquidity risk, operating expense, and solvency risk have significant negative effect on ROA. Vieira (2010) found an insignificant positive association between profitability and liquidity in the short run. Petria, Capraru and Ihnatov (2015) investigated the main determinants of bank's profitability in EU27 over the period 2004-2011. They selected panel level fixed effects to conclude the result and found that management efficiency, credit, liquidity risk, the diversification of business and economic growth affects a bank's profitability, both on ROAE and ROAA. They also found a positive effect of competition on bank's profitability. Albulescu and Ionescu (2018) conducted a study in which they have focused on the internal determinants of the banks' profitability in South and Central American countries and performed panel data analysis. They found that the liquidity, bank capitalization, and interest rate margins have a positive impact on the profitability of the banks, while the non-interest expense and nonperforming loans have a negative impact on profitability.
Hence, we propose that H3= Liquidity has an impact on ROA of Conventional Banks Boyd and Runkle (1993) indicated that the size of a bank is frequently connected with the idea of economies of scale. It is clarified in "Economic Theory" that if an industry is exposed to economies of scale, the firm could be increasingly proficient to deliver at low cost. Normally, bank size or economies of scale are identified positively with profitability. To contrast large banks and little banks, large banks are expected to appreciate economies of scale, they can deliver a huge number of items economically and productively. In this manner, huge banks are ready to produce a higher rate of return as compare to little banks. Furthermore, Antoun, Coskun, and Georgiezski (2018) conducted a study to investigate the industry-specific, bank-specific, and macroeconomic determinants of the financial performance of banks in Eastern and Central European countries over the period 2009-2014. They used the fixed-effect panel regression method and found that the earnings of banks and asset quality are affected negatively by the www.ijbed.org A Journal of the Centre for Business & Economic Research (CBER) 78 size, and affected positively by the inflation and business mix. Akhtar, Ali and Sadaqat (2011) examined the profitability of commercial banks over the period 2006-2009 in Pakistan and found that NPLs ratio, gearing ratio and asset management have a significant effect on the profitability of commercial banks. So, we propose that H4= Size has an impact on ROA of Conventional Banks

Relationship of Capital Adequacy and bank's performance
The capital adequacy ratio is an essential proportion to decide the strength of the capital. It is determined as the ratio of equity to total assets of the Company (Abel & Le Roux, 2016)& (Anbar & Alper, 2011). A positive association was found between the capital adequacy and profitability of the commercial banks (Ebenezer, Omar, & Kamil, 2017). Alshatti (2016) examined the basic determinants that influenced the profitability of the commercial banks over the period 2005-2014, by applying a balanced panel data set of 13 banks in Jordan. He found that the determinants of Capital adequacy, Leverage and Capitalization positively affect the productivity of banks as estimated by ROA. Furthermore, there is a positive outcome of Capitalization and Leverage when estimated by ROE. In the same way, Antoun et al. (2018) stated that liquidity and capital adequacy are negatively affected by size and positively affected by economic growth and bank concentration. The result analyzed that independent variables i.e. Funding Costing, Nonperforming loans, Liquidity, and Administrative expenses negatively affected the ROA, while positively affected by Non-fund based services, GDP and Capital Adequacy (Nisar, Susheng, Jaleel, & Ke, 2015). Mohiuddin (2017) conducted a study in Bangladesh for 2009-2012 and found that spread ratio, noninterest income and profit per employee have a positive relationship but operating expenses ratio and capital adequacy has a considerable negative association with ROA.
So, we propose that H5= Capital Adequacy has an impact on ROA of Conventional Bank

Research Methodology and Conceptual Framework 3.1 Conceptual Framework
The study proposed that among the Macroeconomic factors, Inflation and GDP are positively associated with Bank's performance. We further proposed that Bank's liquidity, size, and capital adequacy have a positive impact on the Bank's performance. In this model, ROA is used as a proxy to measure Bank's performance.

Research Methodology 3.2.1 Research design
The research design of this study is quantitative based on post positivist paradigm. The rationale for choosing quantitative research design was to identify the determinants of profitability of banks which can be understood using quantifiable facts obtained by adopting quantitative data collection and analysis methods (Shah and Corley, 2006). Moreover, quantitative research is used to understand the relationship between the variables to verify or nullify hypothesis (Creswell, 2002;Feilzer, 2010).
Independent variables of the study are inflation, GDP, Capital Adequacy, liquidity, and firm size, whereas dependent variables are the bank's performance which is represented as ROA i.e., Return on Assets.

Data Source
The information of monetary factors (dependent and independent factors) is gathered from auxiliary sources which incorporate State Bank of Pakistan Reports, distributed Final Reports or fiscal summaries of banks on their websites, Pakistan Statistics Bureau reports and Economic Survey of Pakistan reports.

Target Population
Currently, there are 24 scheduled and cooperative banks (commercial banks) in Pakistan (SBP, 2019). Out of which 17 conventional banks are working in Pakistan and listed on the Stock Exchange.

Sample Size
The sample size consists of the panel data of seventeen conventional banks, for five years, (2013-17). There were 85 observations for testing to make our research accurate.

Sampling Technique
The judgmental sample technique was used for gathering the data to test the hypothesis and in analyzing the data of conventional banks.

Transformation of Variables
This study utilized the log variable change condition to satisfy the supposition of panel regression analysis. It is one of the significant solutions for disposing of heteroscedasticity issues in the data of panel analysis.

Data Analysis and Discussion
In this study, we used Eviews9 for statistical analysis, as it is a robust software for analyzing economic data. Furthermore, we used Tobin's Q to provide investors with more accurate and effective information for their decision-making process.  Table 1 provides the OLS regression of the given model. In the given case, the value of probability (F-statistics) is > 0.05 which indicates that the overall model is right. The adjusted R 2 value showed that explanatory power is 42%. The t statistics and its probability show the significance of the individual variable. According to the given analysis, liquidity has an insignificant impact on ROA (p>0.05). Capital adequacy ratio has a significant positive effect on ROA (t=2.6. p<0.05). Inflation has insignificant impact on ROA (t=1.5, p>0.05). GDP is significantly but negatively associated with ROA (t=-3.22, p<0.05), and size have a positive significant impact on ROA (t=3.5, p<0.05).

Hausman Test
Hausman test is used to find the best method between the random effect and fixed effect. The value of P is greater than 0.05. Hence, it is suggested that the random effect model is more suitable than the fixed-effect model.

Stock Performance (Tobin's Q)
In financial aspects, the greater value of Tobin's Q from 1 shows that firm is worthier than its stated cost of assets. It shows that the profits made by the firm will be greater than the cost of the firm's asset. Therefore, additional investment in the firm will be made sense. In another case, the lower value of Tobin's Q from 1 means that market value is lower than its stated value of assets which ultimately means that it will have cost more when replacing the firm's assets than the firm's actual worth of assets. Hence, it is better for a firm to sell its assets rather than to put assets in use. The ideal state will be when the firm will be in an equilibrium state when Tobin's Q ratio is equal to the one (Bond & Cummins, 2004).
Tobin's Q is usually calculated as Market value / Total Assets value and the common practice is also to assume equivalence of the liabilities market and book value yielding. So, Tobin's Q = Equity market value+ Liabilities Book value/ Equity book value+ Liabilities Book value Where Equity market value= Market price per share* total number of shares And Equity book value= Total Assets-Total liabilities

Discriminate Zone
Tobin's Q>1 explains that the stock is overvalued. It shows that stock is expensive as compared to the cost of assets.
Tobin's Q<1 explains that the stock is undervalued. It shows that market value is less than the cost of assets.
Tobin's Q=1 denotes fairness of stock value. Hence, market value is reflected exclusively as the cost of assets.

Relationship of Liquidity and the bank's performance
This study found an insignificant negative effect of liquidity on ROA. Results are consistent with various studies (Eichengreen & Gibson, 2001 ;Bourke, 1989Molyneux & Thornton, 1992&Goddard, Molyneux, & Wilson, 2004. Similarly, Idris et al. (2011) analyzed the determinants of the profitability of nine Islamic banking institutions in Malaysia. The researchers found no association between the liquidity and the profitability of Malaysian banks. On the other hand, the result is found inconsistent with the findings of Haron (2004) that empirically validate a positive relationship between liquidity and profitability. According to Eichengreen and Gibson (2001), we might expect greater profitability with the tied-up of a smaller amount of funds in liquid investments. Therefore, it is very easy to understand the inverse relationship association between the liquidity and profitability.

Relationship of Size and bank's performance
This study found that bank size has a significant positive impact on profitability. The research findings of Wasiuzzaman & Tarmizi, (2010) and Bashir, (2003)

Relationship of capital adequacy ratio and bank's performance
This study found that the capital adequacy ratio has a positive and significant impact on profitability. Capital adequacy plays a vital role in the financial institutions of developing countries because it provides more strength and increases safety for depositors in bad macroeconomic circumstances (Sufian, 2009 ;Trujillo-Ponce, 2013 ;Anbar & Alper, 2011). If more assets are created with the capital, interest expense will be decrease and profitability will be increased (Molyneux & Thornton, 1992). The results are widely supported and consistent with previous studies that banks become more stable, profitable, and can deal with financial stresses and losses; Trujillo-Ponce, 2013 ;Athanasoglou Panayiotis, 2008 ;Anbar & Alper, 2011 ;Zhang & Daly, 2013).

Relationship of GDP and bank's performance
The study found that GDP has a significant negative impact on the profitability of conventional banks of Pakistan. Pakistan is suffering from various economic crises. Therefore, much time is needed to decrease the shocks of the economy. Therefore, the results exhibit the negative impact of GDP on profitability. Also, we have seen that there is not much variation found in Gross Domestic Product (GDP) in the last ten years. Therefore, it is negatively associated with profitability. The result is found consistent with the research conclusion of the study conducted by Sufian (2011).

Tobin's Q results
According to the calculations of Tobin's Q, it is found that Tobin's Q value of banks AKBL, NBP, HBL, HMB, SMBL, JSBL, BOK, ABL, UBL, BAHL, SNBL is increasing gradually and moving from undervaluing to equilibrium and approximately nearer to one. The ratio of MCB bank is devalued in the years 2014-2017 but increased in the year 2018. The ratio of bank SCBPL is undervalued in trending years but increasing gradually. The ratios of banks FABL, BOP, BAFL decreasing gradually in years of analysis, but nearer to one. The ratio of bank SBL is drastically devaluing in year's analysis. The stock is going from overvaluing towards undervaluing which shows a bad situation for this bank. It is to be considered that the average value of Tobin's Q of many banks is in an equilibrium position. Investors must take a look towards certain stock market conditions and can sell the shares of banks whose prices are undervalued.

Limitations and further studies
This study focused on liquidity, capital adequacy, size, GDP, and inflation that work as determinants of profitability of conventional banks. Researchers can expand this research by analyzing the impact of other financial and economic indicators on the profitability of Islamic banking obtained from financial statements. The researchers can also calculate the Tobin's Q ratio by taking the Islamic banks of Pakistan. Furthermore, they can include bank-specific variables like net interest margin, and net profit margin, to analyze their effect on the profitability of the banking sector. In

Managerial and policy implications
This study is an endeavor to assist the investors by providing them information on the current stock market situation through which they can invest in the future or sells shares from the unwanted banks. The study shows the stock value of most conventional banks is moving from undervaluing to overvalue. Based on the findings, the study has policy implications that will encourage banks to reduce credit risk and minimize their liquidity holdings. In addition to this, the Government should take such initiatives that enhance the confidence of investors towards the stock market. Moreover, the government should develop such policies that facilitate banks to increases the capital base and number of assets to enhance their profitability.

Conclusion
The purpose of this study is to analyze the profitability of 17 commercial banks based on bankspecific and macroeconomic indicators as follows: Capital adequacy, liquidity, size, GDP, and inflation for the period of 2014-2018. The results showed that capital adequacy and bank size have a positive impact on a bank's profitability while liquidy has an insignificant impact on ROA. Among the macroeconomic indicators. The study found that GDP has a significant negative impact on the profitability of conventional banks of Pakistan. In the light of Tobin's Q calculation, it was found that the average value of Tobin's Q of many banks is in an equilibrium position. The research finding aid policymakers and investors to design such strategies that would consequently enhance the profitability and stability of the banks.