Abstract:
The study examined the causality between bank profitability and stability of commercial banks (CBs) in Tanzania using panel data covering 10 years (2006-15). Bank profitability was measured using Return on Assets (ROA) and Return on Equity (ROE) while stability was measured using Z-score and the ratio of Non-performing loans to total loans (NPL/TL). The study included 22 banks and employed Granger Causality Test in Heterogeneous Panels as a method of analysis. The findings revealed that there is a positive bidirectional relationship between ROE and Z-score in large and small banks. This implies that banks in Tanzania should strive to increase both ROE and Z-score since they cause each other. The study also found that ROE does granger cause the ratio of NPL/TL in small and large banks while the ratio of NPL/TL was found to granger cause ROA and ROE in small banks. This might be implying that loans are almost the only source of income for small banks that is why NPL/TL do cause their profitability. Hence, the study recommends that, small banks should be keener on how to manage their loans and should expand their activities to earn more non-interest income which would ensure their stability even when their loan portfolios are not performing well. The findings concerning ROA and Z-score indicated that there is a bidirectional relationship between ROA and Z-score in small banks. These findings imply that the profitability and stability in small banks do cause each other. Thus, the study recommends that the management of small banks should aim to accomplish both simultaneously as they cause each other.
