Bank profitability and inflation: the case of China

Purpose The purpose of this paper is to evaluate the determinants of bank profitability in China. It examines the effects of inflation on bank profitability, while controlling for comprehensive bank‐specific and industry‐specific variables. Design/methodology/approach The sample comprises a total of 101 banks (five state‐owned banks, 12 joint‐stock commercial banks and 84 city commercial banks). The period under consideration extends from 2003‐2009. The two step generalized methods of moments (GMM) estimators are applied. Findings Empirical results exhibit that there is a positive relationship between bank profitability, cost efficiency, banking sector development, stock market development and inflation in China. The authors report that low profitability can be explained by higher volume of non‐traditional activity and higher taxation. Moreover, the authors confirm that there is a competitive environment in the Chinese banking industry. Furthermore, the authors propose policy actions that should be taken to improve bank profitability in China. Research limitations/implications Further research can be conducted by investigating the profitability of numerous branches of all national banks and its determinants. Practical implications The findings of the current study have considerable policy relevance. First, Chinese banks should emphasize the improvement of labour management and training skills, the purpose of which is to increase their productivity and boost the profitability. Furthermore, the government should gradually continue to open the banking and stock market, as the development of the financial sector is helpful in increasing the banks' profitability in China. Originality/value Particular emphasis will be placed on the investigation into the effect of inflation on bank profitability while controlling for most comprehensive internal and external factors.