Abstract
The study aims to investigate the impact of determinants of financial distress on financial sustainability of Ethiopian commercial banks. The balanced panel data of 12 commercial banks of Ethiopia have been taken for the study from 2011 to 2017. The research deploys Ordinary Least Square (OLS) Regression Model. The indicators of financial distress are bank’s specific internals and macro-economic factors. The proxies of financial sustainability are Return on Assets, Return on Equity, Financial Stability Index and Bank Soundness. The findings reveal that the Absolute Liquidity Risk and Net Income Growth are found to be positive and significant and Solvency Risk negative and significant in relation to Return on Assets. Asset Quality is found to be positive and significant and Solvency Risk negative and significant with respect to Return on Equity. The Asset Quality and Net Income Risk are positive and significant and Solvency Risk is negative and significant with relation to the Financial Stability Index. Absolute Liquidity Risk and Liquidity Risk are positive and significant and Credit Risk negative and significant with Bank Soundness. Free Cash Flow and Net Income Growth are essential for enhancing Return on Assets and Bank Soundness, and managing equity within the prudential norms could bring forth short-term financial sustainability of commercial banks. By lowering provisioning of loan loss, Growth in Net Interest Income and managing Solvency Risk could ensure financial stability to the banks, which in turn leads to financial sustainability. The study reveals that financial sustainability of banks is insulated from the exposures of systematic risks originating from macroeconomic factors.
Highlights
The financial soundness of a country depends on a robust financial system that comprises a set of financial institutions, efficient financial markets, tradeable financial instruments and, after all, customer centric financial services
The Return on Assets and Bank Soundness representing short-term financial sustainability of banks reveal that the contribution of consistent income growth year after year, management of absolute free cash to meet the demand of depositors and maintaining minimum equity capital as per the prudential norms of the Central Bank have a tremendous effect on the Return on Assets growth
While absolute free cash could be adequately kept to reduce probability of financial distress vis-a-vis bank failure, total cash and bank balance should be kept minimum by deploying the surplus cash in securing loan portfolio having low default risk that maximizes the chance of bank soundness, which in turn accelerates the financial sustainability of commercial banks
Summary
The financial soundness of a country depends on a robust financial system that comprises a set of financial institutions, efficient financial markets, tradeable financial instruments and, after all, customer centric financial services. The nature and extent of financial crisis in the financial system depend on understanding the impact and likelihood of systemic risk (Allen et al, 2006). Bank distress poses as a reflection of systemic risk that acts as stumbling block on the economy or financial system as a whole (Bernanke, 2009). The financial institutions like banks and insurance companies act as mediation from savers to investors and channelize the cash flow from surplus to deficit economy and constantly thrive for balanced regional growth of a nation.
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