Financial Stability Report No1 20 December 2010 - Banka Qendrore ...

Financial Stability ReportNumber 1Return on Average Equity (ROAE) (Figure 15). The increase in ROAA and ROAE wasmainly a result of the increase in the profits of the three largest banks in the economy.Box 1. Decomposition of factors contributing to the change of ROAEReturn on Average Equity (ROAE) represents an important indicator that measures the profitabilityof the banking sector. After three years of continuous decline, in June 2010 it was noticed an increaseof this indicator compared to previous year. The factors that have affected the change in ROAE canmainly be decomposed through the following formula, which presents ROAE as a product of fourdifferent factors.Profit Margin Risk Adjusted Profit Risk level LeverageThe increase of the ROAE is driven by higher profit margin before tax implying that the bankingsector income is increasing fasterFigure 20. Factors contributing to the change ofthan expenditures. Therefore, theROAEincrease of profit due to the higherprofit margin is considered to have4.0%20.0%positive implications for the2.0%resilience of the banking sector. The0.0%15.0%-2.0%banking sector resilience is affected10.0%positively also when the increase ofROAE results from the higher level ofrisk adjusted profit, which implies-4.0%-6.0%-8.0%5.0%-10.0%0.0%that banking profit is increasing at aJune 2007 June 2008 June 2009 June 2010higher rate compared to the increaseProfit margin before taxRisk-weighted profitRisk levelLeverage rateof risk-werighted assets. On the otherROE (right axis)hand, the increase of ROAE as aresult of a higher risk level has Source: CBK (2010)negative implications for the banking sector sustainability, indicating that the composition of bankingsector assets is changing in favour of assets that bear higher risk levels. Banking sector resiliencemay be negatively affected also if its profitability increases as a result of higher leverage rate, whichimplies that banking sector assets are increasing at a higher rate compared to the increase of capital,meaning that less capital in proportion to total assets will be available as a cushion against potentiallosses.Figure 20 presents the main contributors to the change of ROAE for the Kosovo’s banking sector. Theincrease of ROAE in June 2010 appears to have resulted mainly from the increase of profit margin,thus reflecting the decrease of banking expenditures during this period. Profit margin was the mostimportant determinant for the profitability of Kosovo’s banking sector also in year 2009, when ROAErecorded a decline. Another factor that contributed to the increase of ROAE in June 2010 was theincrease of leverage, indicating that assets have increased faster than the capital. On the other hand,the risk factor had a negative impact on the profitability of the banking sector. This reflects the lowergrowth rate of risk-weighted assets due to the lower growth rate of loans that represent the maincomponent of risk-weighted assets. The lower rate of credit growth has had a negative impact on theprofitability of the sector, but is considered to have decreased the level of risk taken by banks.| 35