Intra- and extra-bank determinants of Latin American Banks' profitability

- We study the intra- and extra-bank drivers of profitability of Latin American banks.
- There is an inverse U-shaped relationship between capital ratios and profitability.
- There is a negative relationship between revenue diversification and profitability.
- There is a negative impact of financial development on banks' profitability.
- More competition should be promoted in the Latin American banking industry.

Using data on commercial banks in seven Latin American countries from 1995 to 2012, we find evidence of several major relationships involving bank profitability, including: 1) an inverse U-shaped relationship between banks' capital ratios and profitability, 2) a positive relationship between asset diversification (e.g. security trading, hedge funds, foreign exchange, assurance, etc.) and profitability, 3) a negative relationship between revenue diversification (e.g. interests, fees, commissions, etc.) and profitability, 4) a positive relationship between market concentration and profitability, and 5) improvements in the legal and regulatory system are associated with a negative impact on banks' profitability. This paper contributes to the literature by assessing these relationships using data on Latin American banks and by estimating their models using a system GMM approach that addresses issues arising from endogenous independent variables and heterogeneity among individual banks.