Impact of Intrest Rate on Profitbility of Banks

The Impact of Interest rates on Banks Profitability in Pakistan

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Abstract

The main purpose of my study is to find out the impact of interest rates on profitability of the Pakistani banks. We take data of six major banks for the period of 2004-2012. We analyzed the financial statements for six major banks of Pakistan for the period of 2004 - 2012. The efficiency of banking sector was considered as a qualification for macroeconomic constancy, monetary policy implementation and economic growth. Interest spread of banking industry of Pakistan has risen from 2006 onwards. At the end increased in interest rates discourage the investment on the other hand decreased in interest rates discourage the savings. We select the variables on the basis of The changes in interest rate ultimately discourages the savings and investment on the one hand, and raises concern on the effectiveness of bank lending channel of monetary policy on the other. Variable were found, based on earlier studies. In this model independent variables are interest rates and Loan and Advances and Earning Assets has been chosen. Regression model is tested to determine the interest rate fluctuations have a significant impact on banks profitability and expected result would be that there is a significant effect of interest rate changes on bank profitability.


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1. Introduction 1.1: Banking industry of Pakistan Over the years, banking system in Pakistan shown enormous growth and potential. The performance and stability indicators showed significant improvement in the profitability of banking system. After enormous amount of growth now banking sector facing some though pressures from 2008. Such as liquidity crunch and solvency problem have significant impact on the performance of banking sector and economy. The financial institution could have managed the situation without any trouble if they have sufficient amount of liquidity available to fulfill their obligation. Since, they are operating in a very tight market conditions. They are forced to pay attractive rates to depositors to attract liquidity. Although the State Bank of Pakistan reduced the Cash Reserve Requirement (CRR) and Statutory Liquidity Requirement (SLR) on demand and Time Liabilities to ease the liquidity in the market. The stability of the banking system is conditional upon the stability of overall economy. A stable macroeconomic environment contributes to effective and efficient growth of saving and investment decision. Appropriate macroeconomic measures should support the functioning of the banking system more specifically in the areas of financial stabilization, transparent fiscal policy and monetary policy. The major contributor role of effective and efficient growth in the economy is played by the State Bank of Pakistan and provides guideline to the financial institution to play their role in the development by mobilizing the resources of the economy and facilitating the investors.


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The success of a bank also depends on the ability to forecast and avoid risk, to cover the losses brought about by the arisen risk. Profit is the important requirement of a competitive banking institution and the cheapest source of funds. It is essential to see it not simply as a result, but also a necessity for successful banking in a growing competition on financial market. These important facts together are the reason for this to focus on the current topical issue of banks profitability. Which are influencing on banks effectiveness and efficiency to manage their portfolio such as assets and liabilities in aiming at to achieve profitability and identify the areas where it might have possible room for raising the bank profitability? Banks assets are grouped into two categories - earning assets and non earning assets. Earning assets means those on which banks earns interest income and non earning assets means those which are used for the purpose of reserve requirement, fixed assets to run day to day operational activities. In this study we have focused on earning assets. This includes Placements, lending to financial institution, investment in securities and loan & advances. These assets are the major source of income for bank. Therefore, it is apparent that average income generation ability of these assets has a decisive influence on the banks profitability.

As financial intermediary, banks play a vital role in the operation of most economic development. The efficiency of financial intermediation can also affect the economic growth. Banks are different from other firms in that they provide financial services, the reward to which is an interest rate, and the most of the funding are financed by the deposits or borrowing, the expense of which is also an interest rate. Interest margin, the difference between what a bank has earned on its earning assets and what is paid to depositor. It has been on upward trend during the last decade. An increase in the spread would affect the depositor or the borrower or both stand


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loose at same time. The lack of alternate avenues of financial intermediation aggravates the adverse impact of spread. For example, if the State Bank of Pakistan based on the monetary policy change the interest rate. The change in interest rate influences the cost of capital that in turn affects the level of consumption and investment decision. If the increase in the spread is due to decrease the rate to depositors then this discourage the saving, and alternatively if due to increase the rate it would have adverse impact on investment. Therefore, these changes in the interest rate have important implication on the economy. Banks are more sensitive to interest rate changes than most of the other institutions. The effect of interest rate changes on banks profitability has been an important issue for banking system. It has been argued that bank exposure to interest rate risk perhaps the most important issue in participating the saving and investment crises. 1.2: Problem Statement The quickly changes in interest rate have significant impact on the economy. The impact of interest rates changes affect individual level and corporate level. Interest rate volatility discourages the saving & investment decision and also affects the development and growth of the economy.

1.3: Research Question

What are the affects of interest rate movement on banks profitability?


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1.4: Objective

The aim of this study is to evaluate and analyze the impact of interest rate changes on banks profitability based on the following variables. 

Interest rate



Balances with other banks - Deposit accounts



Lending to Financial Institution



Investments



Loan & Advances

Research Scope and Limitation

The scope of this study provides valuable insight to the factors that affecting the interest rate movements and its impact on banks profitability. There are some limitations in this research. Such as; 

The basis for calculation of income is KIBOR rate. The Pakistan banking system starts practicing KIBOR rate as benchmark from 2003 onward. Therefore, the study period is 2004 - 2012.



The sample size consists of Pakistan six major banks. This covers the 47% market share of the Pakistan banking industry.


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Research Structure

This research structure based on five chapters as follows: 

Introduction about Pakistan banking sector and their role in the economy.



The literature review provides theoretical background of the research and cites author those who have previously researched on the topic of impact of interest rate changes on banks profitability.



Interest rate policy implication on banks performance and economy.

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The methodology chapter includes adopted data sources, collection and interpretation.



The conclusion and recommendation section provides the final logical analysis.

LITERATURE REVIEW The study of Khawaja. M. Din, (2009) showed that “large banking organizations (1978 assets greater than $2 billion) are well hedged against interest rate fluctuations”. The large banks made necessary adjustment to avoid interest rate fluctuation by revising the repayment schedule rate as per the agreement with customer to minimize their interest rate risk. The some of the borrower pay quarterly, half yearly and annual payments. So, as per the agreement schedule bank revise the rates which minimize the risk of bank.

When market rate change, the large banking organization made necessary adjustments to avoid interest rate volatility in revenue and cost. The mostly organization have mismatched balance sheet such as they borrow from customer and financial institution at shorter period or maturity


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and give lending to customer and financial institution at longer period. It would create mismatch between assets and liabilities. Therefore, banks are exposing to interest rate risk and liquidity risk. To avoid the liquidity risk the banks develop relationship with financial institution to overcome their liquidity problem on immediate basis and for interest rate they minimize the risk by revising the interest rate of the contract as per the agreement. The study of Zarruk,Emilio and Madura (1998) showed that “a key variable in the financial system is the spread between lending and deposit interest rates. When it is too large, it is generally regarded as a considerable impediment to the expansion and development of financial intermediation, as it discourages potential savers with low returns on deposits and limits financing for potential borrowers, thus reducing feasible investment opportunities and therefore the growth potential of the economy”. The key point of financial institution is the spread between Loan and deposits rate differences. When the lending rate is high and deposits rate is low then which results in higher the profitability for the financial institution but on the other hand it will discourage the depositor. Because the depositors getting low return on their savings and also discouraging for the borrowers because the financial institution charging high interest rate. If the financial institution doing the same then it would reducing the saving confidence on depositor and borrower will try to avoid to borrow from financial institution. Which resulting in reducing the investments opportunities because the saving money not contributing to the economy. Financial system of developing countries showing larger spread difference as compare to the developed countries. Based on the balance sheet and profit & loss information the author derived two data base. Data base was developed on basis of quarterly from 1974-1988 and on the other hand of monthly from 1991-1996. In the period 1974-1980 the spread between loan and deposits increasing steadily and then start decreasing during the period 1981-1988 reached to 19 percent


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and again decreased during the period of 1991-1996. The evidence provided by the author clearly suggested that in the period of 1974-1980 spread increased and then during the 19811990 significantly decreased. This showed that the loan quality during the period remained stable and reserve ratio requirement decreased and consistent spreads and cost lower the productivity of the state bank. A study of Maisal, Robert (1978) showed that “financial markets is the degree and rapidity with which financial institution react to new information and shift funds among asset and liability classes so as to equalize marginal cost and returns. Many analysts assume that markets are efficient, that transaction and information costs are negligible or unimportant, and that borrowing and lending hedging and arbitrage are simple and available at or close to risk free rates. As a result, they believe that they can successfully predict the results of all types of markets actions and reactions without concern for institutional forces”. The financial markets are so efficient that they get rapidly information and on the basis of information they are making quick decision regarding the fund management such as assets, liability, cost and income. When all the information readily available then it reduces the cost and increase efficiency of transaction such as hedging and arbitrage without taking any risk on the basis of available information analyst predict their results of any market without considering the forces. The study conducted by author on the basis of cost and revenue of cross section banks during the period 1962-1975 estimation made on the basis of net rate of income and cost of book value of assets. The net rate is the difference between the gross revenue from assets minus cost of asset and rates are net of servicing, processing and overhead cost. The result showed that major shift occurred during the period of 1970-1975. Net returns of assets considerably differ when computed on the basis of average.


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The study of Hassan,Iftikhar and Sudipto Sarkar (2010) showed the “differences in interest margins and bank profitability reflect a variety of determinants: bank characteristics, macroeconomic conditions, explicit and implicit bank taxation, deposit insurance regulation, overall financial structure, and underlying legal and institutional indicators. A larger ratio of bank assets to gross domestic product and a lower market concentration ratio lead to lower margins and profits, controlling for differences in bank activity, leverage, and the macroeconomic environment. Foreign banks have higher margins and profits than domestic banks in developing countries, while the opposite holds in industrial countries. Also, there is evidence that the corporate tax burden is fully passed onto bank customers, while higher reserve requirements are not, especially in developing countries”. The study showed that variation between spreads and profitability comprised of various determinants, such as economic conditions, regulations and financial structure. As the banks have a high ratio of asset with respect to gross domestic product and have small profit margin and banks profits because of debts and economic conditions. Foreign banks usually have greater margin of profits as compare to the local or domestic bank in the developing countries and different outcome for industrial countries. This study also evidence that corporate tax had a direct burden on the bank customer because bank transfer the tax burden to their customer while reserve requirement of central bank doesn't not have a significant effect on banks. The data collected at the level of banks for 80 institutes and period comprised of 1990-2005 on the size and decomposition of banks spreads and profits. Regression technique had been used to find out the determinate of interest rate spreads and banks profitability. Taxation and regulation have big impact on bank customer and overall bank position. The banking system varies from country to country around the world in size and composition and structure. All banks have different influence of macroeconomic


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conditions, regulation and market conditions. Several countries data had been used for analysis to find out the bank characteristics and conditions which affect the banks performance such as interest margins and profitability. Some variable have positive relationship with each other and some of them have a negative relationship with each other i.e. reserve ratio to profitability. The study of Samuelson Paul A, (1945) showed that the “banking system as a whole is not really hurt by an increase in the whole complex of interest rates. It is left tremendously better off by such a change. If a bank were a university, nobody would doubt that it would be made better off by an increase in the interest rate. At worst, it could continue to hold all existing gilt-edge securities to maturity and be no worse off. As these matured, the proceeds could be invested at higher rates with a resulting increase in income. It would be better off in the sense that ceteris paribus it could hire more teachers per year, spend more money on buildings and stadia, and engage in more research. The only exception would be in the limiting and unrealistic case where all its money was invested in perpetuities. But even here it would be no worse off. In every other case it would be better off”. The increase in the interest rates usually not affects the performance of bank, its actual effect on the borrower. When the interest rate increases then borrower will bear the effect of increase interest rate. But it would not affect the bank performance .The reason is that the bank pay low return to depositors and charge more to borrower as interest rate increases. So, both depositor and borrower will bear the cost. In this article author taken the example of university. If this loan given to the university it certainly impact on the university performance because of increase in the interest rates. As the interest rates increases it would become more costly for the university and difficult to pay to the bank on time. The increase in the interest rates would not hurt university as its decreases capital value. This change would have a better impact on university.


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The study of Coleman George W, (1945) showed that the “banking system would recover these losses over a period of time, the length depending upon the maturity distribution. During that period, it would be "frozen in" to a given maturity pattern. The earnings of the banking system upon the existing portfolio would increase. He states that "immediately after interest rates have risen and capital values have scaled down, all parts of the portfolio, old as well as new, began to earn the higher rates”. The rise in the interest rates bank can come up with some loss on the portfolio such as investing in the securities of longer period. The bank can recover this cost over the period of time and get desired returns and also increase in the capital of the bank. When the investment is carried at cost then it would amortize cost. It means banks amortize the investments over the period of agreement until it becomes zero. When the interest rate rise it would have immediate effect and bank re-prices the portfolio on the current interest rate and gets benefit of the opportunity. The objective of the study to find that increase in interest rate would not a sufficient impact on banks. Its directly influence on the saver or borrower. Which ultimately result in decrease in saving and investment? The management of bank continuously monitoring and updating their portfolio policies to minimize such risk. The study of Khawaja, Musleh, (2007) showed that “Interest spread of the Pakistan's banking industry has been on the rise for the last two years. The increase in interest spread discourages savings and investments on the one hand, and raises concerns on the effectiveness of bank lending channel of monetary policy on the other”. The interest rate spreads in banking sector on the upward move. When the interest rate increases it discourages the depositor and borrower, such as saving and investments. Banks giving low returns to depositors which results in discouragement and getting high return from borrower by charging high interest rates inclusive of spreads. Spreads are much high in Pakistan. When spreads taken into account ultimately the


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interest increase and banks gets high returns on lending and investments. The depositor not has any other option to save his money and also the strict requirement of SBP capital requirement. The industry has rapidly merger and acquisition. This results in decrease in the option for saving. In this study author used data of 29 banks. Variant model had been used to check variables relationship. The results showed that inelasticity in deposits supply have positive impact on interest rate spreads. To lower the spread margin central bank play a vital role to reduce the spread and other alternative would be the financial intermediary which lower the spreads. The study of Chirwa, Montfort, (2004) highlighted the importance of “financial liberalization in facilitating economic development and growth. While there is no complete agreement on the removal of financial repression, usually characterized by control of interest rates, imposition of credit ceilings, and credit rationing, leads to significant amelioration of growth prospects, the dominant view is that financial liberalization and growth usually go together”. Financial liberalization had a great influence on improving the economy and increasing growth. There is no certain agreement made on the financial repression. The management made certain tool and polices to control the interest rate impact on credits. Such as by applying tool of checking limits and there purpose of credit extension. The good control over the interest rate would have a significant on the performance of economy and growth of the country. Financial liberalization and growth of the economy work to gather and run head to head and boost the development of economy. The determinants of markup spread and bank profit have been used in the model. The portfolio bank is trying to maximize their good portfolio. This maximizes the profitability of the banks. Bank usually made feasible choice of assets and liabilities with respective tenor interest rate. This study used monthly panel data from banking system between 1989-1999.the findings of that study showed that the after liberalization the interest rate significantly increased. The


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main cause of that increase was the increase in nonfinancial cost, provision for doubtful debts, taxation and variation in the inflation rates. The study of Marisel Peter, (2002) showed that in the “world of endogenous money, the central bank's role in monetary policy is reduced to the setting of a very short term official rate of interest, which indicates the price at which it will make liquidity available to the banking system. However; it is changes in market rates that affect behavior; and so the ability of the central bank to influence anything at all depends, first, on the interaction between official and market rates. In this paper, we use a vector autogressive error correction model to explore the response to changes in the central bank rate of three short-term market rates that have been featured previously in this journal in debates about the demand for endogenous money”. The main responsibility of the state bank is to control or reduce the rates which affect the price and liquidity of the banking system and affect the availability of liquidity of the banking organizations. The fluctuation in the market interest rates will affect the function of the banking system and as well as the behavior of the consumer and economy. In this study autoregressive correction model had been used by the author to find out the responses of interest rates changes and its effect. When spread between Corporate - Government bond increases then the market assume that the risk on the bond increases. When they see then they try to predict the coming slowdown and recession in the economy. After testing they have found that it would have a positive effect on the economy. They have used the Autoregressive model to test the fluctuation in prices and interest rates. The result of the paper showed that the short term interest rates have a significant impact on the banking system as compare to the long term interest rates. Short term interest rates were the major instrument of the monetary policy of the central bank. In monetary


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policy central bank advice the interest rates which would affect the banking system as well as the overall economic activities of the country. The study of Samuel, Laura (2006) showed that “macroeconomic imbalances are generally associated with high bank spreads. Instability in the macro economy is likely to increase the probability of default by bank debtors. For example exchange rate instability and high and variable inflation can constrain corporation, households' ability to meet their loan obligations, if it adversely affects their balance sheets. Balance sheet data were utilized for estimating the determinants of bank spreads. Both ex ante and ex post measures of spreads were used. The evidence proved that spreads in Barbados are higher than predicted by its macroeconomic environment”. Macroeconomic stability is associated with bank spreads. If the spreads are too much high. Then it will increase the bad debts and capital control also affects the spreads. Capital control directly effect on spreads by decreasing the return on fix income instruments. But also affect the spreads by decreasing the return on deposits. Bank size and market concentration not affect the spreads. It is often note that larger banks able to diversify their portfolio face lower defaults. To control the interest rate fluctuation central bank uses the tool of monetary policy. Financial sector efficiency increases when countries introducing market based instrument of

Interest Rate Implications and Policy Response

The mechanism of monetary policy is to bring discipline and efficiency in the financial sector, developing a conducive environment for economic growth. The central bank pursuing a tight monetary policy past few years. There are several objective of monetary policy to inflation, government borrowing and interest rate. In Pakistan, rising inflation and interest rate are the most


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common phenomenon. Rising lending rates harms the economy and consumer. It is a fact that high lending rates are regularly linked to high inflation.

The changes in interest rates affect consumption and savings decisions of households, corporate level and also affect the output and investment decision throughout the economy. The central bank set the interest rate at which bank lends money to financial institution and consumer. This measure will help in controlling the monetary pressure associated with the economy.

Decrease in interest rates

As a general rule, the decrease in interest rate is best for the economic environment. When consumer can afford to borrow funds because they don't have to pay high interest rate on borrow funds. The benefit from low rate includes: 1). House loans 2) Personal loans 3) Credit Cards 4) Auto loans and 5).Investment in Stock Market. Interest rate as a means of controlling economic growth. When the economy grows rapid pace then it will experience inflation. Prices rise to a high level and no one can afford changes in real interest rate. Which affects the public demand for goods and services due to altering the availability of bank loans? For example a low real interest rate decreases the borrowing cost; that leads to the investment spending and encourage people to spend in various forms consumer durables.

Low interest rate will provide corporate level opportunity to take new capital investment spending and increase the firm confidence by make heavy investment in growing sector and generating heavy revenue. Which result in stabilizing the economy and providing employment opportunities? The other aspect of low interest rate will decrease the default risk of counter party. It means that people have more disposable income to pay their borrow funds and take saving


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decisions. Cause depreciation in the exchange rate and increase demand for domestic producers those who sell goods and services global markets. The rise in the growth of exports will increase the aggregate demand and boost the economy and increases the factor incomes of those in work. This should lead to an increase in the level of national income.

Increase in interest rates

The increase in rate will increase the cost of property which results in different of property. Conversely, fall in the interest rate increase the demand and increase pressure on mortgage prices. This will increase the spending associated with mortgage buying and increase in prices will increase the total wealth.

The increase in interest rate opening the door of increasing non performing loans. Despite of heavy provision made by the banks. As inefficient and corrupt borrower try to find out and easy exit way to avoid repayment. This problem is going to be worse due to low recovery rate of bad debts.

Methodology

Data Collection Technique

There are two types of sources available for data collection i.e. primary and secondary data. In this research secondary data have been used. Secondary data is gathered from journal articles and electronic media. The annual financial information extracted from selected financial institution web site. Such as annual statements and six month average KIBOR rates.


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Sample Size

This study period consist of nine years from (2004-2012). The main reason for short study period was the amendments in practice. Before, 2003 banking industry used the PKRV rates. After changes the benchmark rate, the banks start practicing KIBOR rate as benchmark to find out the profitability. Pakistan's six major banks selected from total population thirty four of the banking industry. These six major banks cover 47% market share of Pakistan banking industry. The selection of six banks is made on the basis of total assets for the period ended December 31, 2012. Characteristics of Variables;

Dependent Variable

Interest income: is defined as the income earned on earning assets. Such as deposits with other banks, lending to financial institution, investments and loan & advances at the prevailing interest rate.

Independent Variable 

Interest rate: in simple term as cost of borrowing. In this research six month average KIBOR rate used for the analysis.



Balances with other banks - deposit accounts: Banks place excess liquidity with different financial institution in order to earn profit. These placements have no fixed maturity period.

The Impact of Interest rates on Banks Profitability in Pakistan 

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Lending to financial institution: Bank places excess funds with different banks to earned profit. These placements have fixed maturity period.



Investment: is defined as bank purchase the certificates from issuer by providing financial assistance. When borrower repay the borrow funds then bank sell the certificate to the borrower.



Loan & Advances: is defined as funds provide the customer to full fill their commitment and obligations.

Analysis Plan

In this section, the researcher discuses the time series methodologies that will be used in analyzing the data set. The following test are expected to be employed, Regression Analysis to check model is significant or not, J.B test to check the normality of residuals and GoldQuandt Test for checking the Hetroscadisticity.

Econometric Model

The data were analyzed by using regression model to find out the relationship between bank profitability and interest rates, balances with other banks - deposit accounts, lending to financial institution, investments and loan & advances. InI =α+β1 IR+ β2 BWOB + β3 LF +β4 INV+b5LA+℮

InI= Interest Income

IR= Interest Rate


BWOB= Balances with other banks - deposit accounts

LF= Lending to Financial Institution

INV= Investments

LA= Loan & Advances

Data Analysis and Findings

The data analysis and its findings based on the statistical analysis.

Test the Normality of the Residuals To test the normality of the residuals, we apply the JB Test Ho: Residuals follow the normal distribution H1: Residuals does not follow the normal distribution Test Statistic

Where S: Skewness and K is Kurtosis S= (Mean –mode)/S.D or

m3/ (m2)^3/2

K= m4/(m2)^2 , where m stand for moments about means

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m2= 4.028, m3= -2.457, m4= 33.65 Skewness= -0.3039, kurtosis = 2.074, JB=0.46 Critical Value of Chi-square = 39.33 Conclusion: As calculated value of JB does not fall in Critical Region, so, Ho can’t be rejected, residuals follow the normal distribution Test the Hetroscadisticity: To test the hetrosadisticity we apply the Goldfeld-Quandt Test Ho: There is no hetroscadisticity (Homoescadisticity) H1: There is hetroscadisticity As per steps, the data divided in two parts Omitting central 10 observations, RSS1= 29 (Residual sum of squares of 1st 25 observations) RSS2= 77 (Residual sum of squares of 2nd 25 observations) n=60, C=10 d.f=22

=2.66

Critical value of F at 5% level of significance, F0.05(22,22) =2.07


Conclusion: Calculated value falls in C.R , so reject Ho and conclude that there is hetroscadisticity

Now we can regress the following operation

We take log on both side of econometrics Model log(InI) =α+β1 log IR+ β2log BWOB + β3 logLF +β4log INV+b5logLA+Ut

Hypothesis Testing

H1: There is no significant relation between interest rate and interest income

Ho1: There is significant relation between interest rate and interest income

H2: There is no significant relation between balances with other banks - deposit accounts and interest income

Ho2: There is significant relation between balances with other banks - deposit accounts and interest income

H3: There is no significant relation between lending to financial institution and interest income

Ho3: There is significant relation between lending to financial institution and interest income

H4: There is no significant relation between loan & advances and interest income

Ho4: There is significant relation between loan & advances and interest income

H5: There is no significant relation between investments and interest income.

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Ho5: There is significant relation between investments and interest income

SUMMARY OUTPUT Regression Statistics Multiple R R Square Adjusted R Square Standard Error Observations

0.97 0.94 0.84 3.48 54

ANOVA df Regression Residual Total

Intercept Interest Rate Balances With other Banks-BWOB Lending to financial Institution Loan & Advances Investment

SS MS F 583.749 116.7499 9.661914 36.250 12.08352 620

5 53 58

Coefficients -9.031 1.838 -0.358 0.088 0.021 0.054

Standard Error 9.949 1.247 1.024 0.328 0.054 0.039

Significance F 0.004

t Stat -0.908 1.474 -0.349 0.267 0.389 1.382

P-value 0.431 0.023 0.750 0.807 0.023 0.001

Result of H1: The significant value of interest rate is .023 which is less then 0.05.We reject the null hypothesis. This means that the interest rate have a significant relation with interest income.

Result of H2: The significant value of Balances with other Banks is 0.75 which is greater than 0.05.We accept the null hypothesis. This means that Balances with other Banks have no significant relation with interest income.


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Result of H3: The significant value of Lending to financial institution is 0.807 which is greater than 0.05.We accept the null hypothesis. This means that lending to financial institution have no significant relation with interest income.

Result of H4: The significant value of Loan & Advances is 0.023 which is less than 0.05.We reject the null hypothesis. This means that Loan & Advances have a significant relation with interest income.

Result of H5: The significant value of Investments is 0.001 which is less than 0.05.We reject the null hypothesis. This means that Loan & Advances have a significant relation with interest income.


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Conclusion

The objective of this paper is to evaluate the impact of interest rate changes on banks profitability. The bank interest income is significantly affected by the interest rate, investments and loan & advances. The regression technique also proves these findings. This means that profitability of banks dependant on interest rate that is the tool of monetary policy. Interest income, investments and loan & advances are significantly related to the interest rate. Interest income is highly associated with interest rate.

Specifically, in a higher interest rate environment, an increase in lending rates usually larger than the increase in deposit rates, which result in pushing up the bank, spreads. On the other side, in a lower interest rate scenario, the opposite likely to be happen. When interest rate increases, lending rates tend to adjust more quickly as compare to deposit rates. While, in a declining situation deposit rates adjust faster than lending rates.

It is feared that further increase in the interest rate will slow the growth of advances and increase in the bad debts. The Paid up capital requirement of Rs. 7 billion until 2010 by the SBP also encourage further consolidation in the banking sector. It used for decrease the impact of risk, conservative growth in advances and deposits, bringing downward advances to deposits ratio. But the major concern is the interest rate movement which damaging in great deal. It will very difficult for individual to save money and made investment in the economy.


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References State Bank of Pakistan (2011). “Efficiency of Financial Intermediation: An Analysis of Banking Spreads.” Financial Stability Review (FSR), the State Khawaja, M. and M. Din (2009). “Determinants of Interest Spread in Pakistan.” The Pakistan Development Review, 46: 129-143. Theory and Empirical Evidence.” Journal of Financial and Quantitative Analysis, 16: 581-602. Hasan, Ifterkhar, and Sudipto Sarkar. 2010. Banks’ Option to Lend, Interest Rate Sensitivity, and Credit Availability. Review of Derivatives Research 5:213–50. Rahila Munir, Rehmat Ullah Awan & Zakir Hussain (2008). Investment, Savings, Interest Rate and Bank Credit to the Private Sector Nexus in Pakistan. International Journal of Marketing Studies. Zarruk, Emilio, and Jeff Madura. 1998. Optimal Bank Interest Margin under Capital Regulation and Deposit Insurance. Journal of Financial and Quantitative Analysis 27, no. 1:143–49. Saunders, A. and L. Schumacher (2000). “The Determinants of Bank Interest Margins: An International Study.” Journal of Money and Finance, 19: 813832 Barajas, A., R. Steiner, and N. Salazar (1999). “Interest Spreads in Banking in Colombia, 1974-96.” IMF Staff Papers, 46 (2): 196-224. http://www.mcb.com.pk/uploads/FCG/docs/MCB%20Half%20Yearly%20Result http://www.bankalfalah.com/cltp-content/uploads/2013/02/BALAnnualReport.pdf http://www.abl.com/services/downloads/?cat_id=1 http://www.hbl.com/investor-relations-annual-reports-.php http://www.standardchartered.com.pk/pk/_documents/SCB-Annual-Reporthttp://www.askaribank.com.pk/financial_report.php


Heider, F. & Hoerova, M. & Holthausen, C., 2009.Liquidity Hoarding and Interbank Market Spreads: The Role of Counterparty Risk Tilburg University, Center for Economic Research.

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Impact of Intrest Rate on Profitbility of Banks

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