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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
3 Impact of Interest Rate Changes on Bank Profitability
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
4 Impact of Interest Rate Changes on Bank Profitability
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.
5 Impact of Interest Rate Changes on Bank Profitability
Literature
Reviews
6 Impact of Interest Rate Changes on Bank Profitability
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..
7 Impact of Interest Rate Changes on Bank Profitability
Particular
Description
Topic
Profitability and interest rates differentials in Tunisian Banking
Author
Hichem Ben-Khedhiri The University of Reading Business School
Journal
Publication Year
-
Objective/Research Question
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
Research Methodology
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.
8 Impact of Interest Rate Changes on Bank Profitability
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
Objective/Research Question
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
Research Methodology
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
9 Impact of Interest Rate Changes on Bank Profitability
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
Objective/Research Question
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
Research Methodology
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.
10 Impact of Interest Rate Changes on Bank Profitability
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
Objective/Research Question
What is the impact of low interest rate
environment on Bank profitability.
Variable Studied
NIMs & Bank Profitabilities
Sample Size
Research Methodology
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.
11 Impact of Interest Rate Changes on Bank Profitability
Particular
Description
Topic
The Profitability of Financial Institution
Author
Journal
Publication Year
Objective/Research Question
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
Research Methodology
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
12 Impact of Interest Rate Changes on Bank Profitability
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
Objective/Research Question
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
Research Methodology
Modification of Falannery’s Model
Findings
Interest rate has a Small impact on Bank
profitability
13 Impact of Interest Rate Changes 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
Objective/Research Question
To Examine link between Interest Rate and
Profitability
Variable Studied
Interest rates and Bank profits
Sample Size
Research Methodology
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.
14 Impact of Interest Rate Changes on Bank Profitability
Particular
Description
Topic
Interest rate risk
Author
Enzo Scannella
Journal
Business System Review
Publication Year
June 06, 2013
Objective/Research Question
To analyze interest rate volitality impact on
Profits
Variable Studied
Interest rate Bank assets and Bank profitability
Sample Size
Research Methodology
Asset Price approach
Maturity & Duration Model
Findings
Interest have positive and Negative impact on Bank Profitability
15 Impact of Interest Rate Changes 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
Objective/Research Question
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
Research Methodology
Findings
Short term rise interest rates are profitable.
16 Impact of Interest Rate Changes on Bank Profitability
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.
17 Impact of Interest Rate Changes on Bank Profitability
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.
18 Impact of Interest Rate Changes on Bank Profitability
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)