impact of interest rate changes on bank profitability

Impact of Interest Rate Changes on the Bank Profitability Term Report Submitted to

Sir Maqbool ur Rehman Submitted By

Mujtaba Haider (12713) Dated: 12/29/2014

2 Impact of Interest Rate Changes on Bank Profitability

Table of Content

S.No Topics Pg. No 01 Preface 03

02 Abstract & Introduction 04

03 Literature Review 05

04 Research Question & Methodology 16

05 Pearson Correlation & Results 17

06 Conclusion 18


Preface

By the Grace of Almighty Allah and guidance of my teacher Sir Maqbool ur Rehman I have been able to

finish this report. The objective of this report was to evaluate Interest rate changes on the profitability of

Commercial Banks in Pakistan. I have done literature Review of 10 research papers on this topic. I have

carried out Pearson Correlation Method to see the relation of interest rate with the bank profitability. I

took Bank profitability of MCB & Askari Bank and Interest rate from the year 2008 to 2012 through

Pearson correlation method.

Best Regards, Mujtaba Haider (12713) BS Economics & Finance Institute of Business management, Karachi


Abstract:

The Core objective of this paper is to analyze the impact of interest rate changes on the profitability of the banks in Pakistan. For this I have taken Two banks namely Muslim Commercial Bank (MCB) and Askari Bank LTD as a sample. I have taken their after tax profits from the year 2008 till 2012 and Interest rates between stipulated period. For analyzing the impact of these two variables I have used Pearson Correlation method.

Introduction:

Banking sector of Pakistan has revealed massive growth and potential over the years. There is a considerable expansion in the profitability of banking sector demonstrated by performance and

stability indicators. Mainly in operations of economic development bank as financial intermediary, plays an important role and their efficiency can also influence the economic

growth. As banks provide financial services to its customers and as a reward banks charge interest .Conversely most funds are provided by depositors and they also receive interest. The

difference among the banks earnings on its assets and payments to depositors is called interest margin. During the last decade there has been an increasing trend. The borrower or depositor

or both would be affected by an increase in the spread. The shortage of alternative opportunities of financial intermediation intensifies the bad impact of spread. For example, based on monetary policy if the state bank of Pakistan changes interest rate then the changes in the interest rate will influence the cost of capital and as a result the investment decision and level of consumption will be affected. When the interest rates to depositors decrease and due to that if spread increases then it will

discourage the savings and on the other hand, if interest rate to depositor increases then it will badly affect the investment. That‟s why there are important implications of these changes in the interest rate on the economy. In the banking system the impact of interest rate changes on the profitability has

been a significant issue. As compared to other institutions banks are more sensitive to the changes in the interest rate. In participating, the investment crisis and saving the experience of

bank to interest rate risk has been argued the significant issue. Interest is the fees paid to the lender for giving up his or her consumption. Interest act as an incentive for those who sacrifice their consumption and lend money to others if interest rate has been eliminated from the whole frame work than no one would lend the amount of money available. When borrower

borrows the amount he or she pays interest as a fees of utilizing the funds.


Literature

Reviews


Particular

Description

Topic

MARKET INTEREST RATE FLUCTUATIONS IMPACT ON THE PROFITABILTY OF

COMMERCIAL BANKS

Author

EUPHEMIA IFEOMA GODSPOWER-AKPOMIEMIE

Journal

Publication Year

Objective/Research Question

Objective is to examine the interest rate sensitivity

of commercial banks’ interest profitability (Net Interest Margin) and net worth

Variable Studied

Interest rate (Independent Variable) Bank Profitability (Dependent Variable)

Sample Size

The sampled banks are fourteen commercial banks

and one investment bank in South Africa

Research Methodology

A software package stata 10.0 was used to conduct the hypothesis testing, trend, and correlation analysis.

Findings

Interest rate (repo rate) changes have a positive effect on the profit (net interest margin) of commercial banks in South Africa. Small commercial banks actually experience increase in profitability (net interest margin) both absolutely and relative to big banks in periods of rising interest rates..


Particular

Description

Topic

Profitability and interest rates differentials in Tunisian Banking

Author

Hichem Ben-Khedhiri The University of Reading Business School

Journal

Publication Year

-


This study explores the key determinants of bank

profitability and differentials in interest margins for deposit banks during the period 1996-2003

Variable Studied

Bank profitability and differentials in interest margins

Sample Size

Bank profits and Interest margins for

deposit banks during the period 1996-2003


Dealership model and the micro-model, this paper implements both parametric and non-

parametric tests and panel data analysis .

Findings

Regression analysis showed that the Interest rate margin have a significant effect on cost of the bank and cost of the bank effect profits.


Particular

Description

Topic

The Determinants Of European Bank Profitability

Author

Christos K. Staikouras,

Athens University of Economics and Business

Journal

International Business & Economics Research Journal Volume 3, Number 6

Publication Year


This paper reviews the literature on bank performance studies and classifies the bank

profitability determinants.

Variable Studied

Interest rates & Bank Profitability

Sample Size

Balamce sheet & Income data for the period 1992-1999 & Interest Rate


We construct OLS and fixed effects models Regression & Corelation

Findings

. The estimation results suggest that the profitability of European banks is influenced not only by factors related to their management decisions but also to

changes in the external macroeconomic environment. The level of interest rates have a positive effect, while the variability of the interest rates and the growth of GDP rates negative


Particular

Description

Topic

Impact of Interest Rate Changes on the

Profitability of four Major Commercial Banks in Pakistan

Author

Waseem Ahmad Khan

Journal

International Journal of Accounting and Financial Reporting ISSN 2162-3082 2014, Vol. 4, No. 1

Publication Year

2014


To examine the impact of interest rate changes on the profitability of commercial

banks in Pakistan

Variable Studied

Bank Profits & Interest Rate

Sample Size

Bank Statement from 2008 to 2012


Pearson correlation method is used in this study

Findings

Result it is found that there is strong and positive correlation between interest rate and commercial banks‟ profitability. It means if the value of interest rate is increases/decreases then as result value of banks‟ profitability will also increases/decreases.


Particular

Description

Topic

Impact of Low Interest rate environment on

Bank profitability

Author

Hesna Genay

Vice President & Monetary & Financial Policy Adviser FED

Journal

Publication Year

July 2014


What is the impact of low interest rate

environment on Bank profitability.

Variable Studied

NIMs & Bank Profitabilities

Sample Size


Parsimonious model

Findings

Interest rates do affect the Banks profitability. Higher interest rate increase the profitability of Banks but low interest rate can also positively

affect the profitability of Banks.


Particular

Description

Topic

The Profitability of Financial Institution

Author

Journal

Publication Year


To find out what affects the profitability of Financial institution specifically Interest rate.

Variable Studied

Dependent ROA, NI and NII and Interest rate as Independent

Sample Size

Profits from annual reports of commercial banks of Pakistan for 5 years 2004-2008


Regression analysis

Findings

Interest rate fluctuation has adversely related with commercial bank profitability

Reference:

http://www.essay.uk.com/free-finance-essays/the-profitability-of-financial-institution.php#ixzz3N2dA0A9y


Particular

Description

Topic

Market Interest rate and Commercial Bank

profitability

Author

Dahlia Daley

Journal

American Charter of Economics & Finance

Volume No.1

Publication Year

June 2012


Examine the impact of Interest rate on Bank

profitability

Variable Studied

Interest Rates and Profitabilities of Comercial

Bank

Sample Size

2000 till 2008 Two commercial Bank profits and

Interest rates


Modification of Falannery’s Model

Findings

Interest rate has a Small impact on Bank

profitability


Particular

Description

Topic

Profitability and the Yield Curve

Author

Piergiorgio

Journal

Bank of England Working Paper No.452

Publication Year

June 2012


To Examine link between Interest Rate and

Profitability

Variable Studied

Interest rates and Bank profits

Sample Size


Regression and Coorelation

Findings

Systematic effect of interest rate on Bank profitability. Increase in short term interest rate depresses income wheare as increase in long run interest rate increases income.


Particular

Description

Topic

Interest rate risk

Author

Enzo Scannella

Journal

Business System Review

Publication Year

June 06, 2013


To analyze interest rate volitality impact on

Profits

Variable Studied

Interest rate Bank assets and Bank profitability

Sample Size


Asset Price approach

Maturity & Duration Model

Findings

Interest have positive and Negative impact on Bank Profitability


Particular

Description

Topic

Interest Rate Risk and Bank Profitability

Case of Turkey

Author

Kursat Aydogan

Journal

Central Bank of Republic Turkey

Publication Year

September 1991


Paper Examines the interest rate Risk Exposure

of the Commercial Bank of Turkey

Variable Studied

Interest Rates & Bank Profitability , Liabilities

Sample Size

Interest rate and bank profits


Findings

Short term rise interest rates are profitable.


Research Question

What is an impact of changes in interest rate on the profitability of Banks in Pakistan?

If we further simplify this question we will end up getting two further questions:

What impact will be on the profitability of commercial banks if interest rate increases?

What impact will be on the profitability of commercial banks if interest rate decreases?

Methodology

Data: I have obtained data from the authentic source which includes the official websites of the Banks and State Bank of Pakistan. Data includes after tax profits of two banks which includes MCB and Askari bank from the year 2008 till 2012 and interest rate of the same years which were prevailed in the market.

Year MCB Profits Askari Bank profits Interest Rates

2008 15,323,227,000 386,225,00 0 13

2009 15,495,297,00 1,107,793,000 12.5

2010 16,873,175,000 943,177,000 14

2011 19,424,906,000 1,627,698,000 12

2012 20,940,696,000 1,255,362,000 9.5

The above table has been displays the annual profits of the two Banks and the Interest rates.


Pearson Correlation method: A correlation is a number within the range -1 and + 1 that measures the degree of association between two variables call them X and Y. The association between these two variables could be positive or negative. If the correlation is positive between two variables; it means that there is a direct relationship between them (if the value of one variable(X) is increased/decreased then the value of second variable(Y) will also be increased/decreased). Contrary to this, if the correlation is negative between two variables (X and Y), then it means that there is an inverse relationship between the two variables (if the value of one variable(X) is increased/decreased then the value of second variable(Y) will be decreased/increased). Researchers employed Pearson correlation method to measure degree of association among interest rate and commercial banks profitability in Pakistan and tried to find out some extent of association among these variables.

Correlations

MCB Profits

Askari Bank

profits Interest Rates

MCB Profits Pearson Correlation 1 .580 -.846

Sig. (2-tailed) .606 .154

N 4 3 4

Askari Bank profits Pearson Correlation .580 1 -.426

Sig. (2-tailed) .606 .574

N 3 4 4

Interest Rates Pearson Correlation -.846 -.426 1

Sig. (2-tailed) .154 .574

N 4 4 5

Result:

The Result shows that there is an inverse relationship between interest rate and bank profitability. This means that when Bank interest rate increases it decreases the Banks’s profitability. This result is different from what is suggested in the literature. The reason behind this is that the banking sector in Pakistan is having a very huge banking spread and any changes in interest rates are easily absorbed by this spread. Moreover banks are earning profits from investment also, so their income is not too h eavily dependent on interest margin.


Conclusion:

Interest rate considerably affects the bank‟s interest income. These findings are proved

through Pearson correlation technique. It means banks‟ income by interest is extremely related

to interest rates that show the bank‟s profitability is dependent on the monetary policy tool

known as interest rate. when interest rate is high, usually rise in lending rate is higher than the

deposit rates which as a result increases the bank spread. But on the other side when interest

rates are low then rise in deposit rate is higher than the lending rates. As compare to deposit

rates, the rates of lending are adjusted more rapidly when interest rates increase. Whereas

when interest rate decreases then the deposit rates are adjusted more rapidly as compare to

lending rates.

References:

Official website of MCB Bank

Official website of Askari Bank

State Bank of Pakistan Website

All the articles reviewed (Saved in the folder)

impact of interest rate changes on bank profitability

Economy & Finance