Use of more than one independent variable in the analysis may cause of multicollinearity problem. The multicollinearity is measured by tolerance and variance of inflation factor (VIF). Tolerance is the proportion of variation in the dependent variable not explained by the model. The tolerance and VIF value showed that there is not much multicollinearity problem among independent variables. Which showed that overall model is good.
4.2: Multiple Regression Analysis Assumptions
4.2.1: Normality of error term distribution
The normality is checked by normal probability plots. In the method, the normal distribution made a 45 degree straight line, and plotted residual are compared with the diagonal. As presented in the figure 4.1 the values of the residual fall along the straight line with not much difference. The figure concludes that the residual structure is normal.
Figure 4.1: Normal P-P Plot of Regression Standardized Residual
Another method used to check the normality by histogram. The shape of the histogram in figure 4.2 showed that the figure closed to the shape of normal curve.
Figure 4.2: Histogram
4.2.2: Linearity of the phenomenon measured
The linearity of the relationship between dependent variable and independent variable represented the degree to which the change in the dependent variable is associated with independent variable. The figure 4.3 did not reflect any nonlinear pattern to the residual. Which shown that the overall relationship between variables is linear.
Figure 4.3: Scatter Plot - Interest Income
Figure 4.4: Partial Regression Plot - Interest Income and Interest Rate
Figure 4.5: Partial Regression Plot - Interest Income, Loan and Advances
4.2.3: Constant variance of error term
The residual plots also showed that the presence of equal variance. This fulfilled the assumption of multiple regression model.
5.2.4: Independent of the error terms
In regression each predicted value was independent of any other prediction. There were no sequenced by any variable from residual plot.
4.3: Reliability and Validity
4.3.1: Reliability
The reliability is defined as the degree to which the observed values measure the true values, error free and consistent. The overall results were in line with the practices applicable in Pakistan. But the difference is appeared when the results of Pakistan compared with international practices. In high interest rate environment Pakistan banking getting high returns on the other hand the at global level interest rate were low. That clearly indicates the major differences in returns at Pakistan and international level.
4.3.2: Validity
The validity is defined as the degree to which the measure is accurately represents what it is supposed to. The instrument has been used to predict the variation explained by the independent variable in interest income. The regression model used in the analysis and all the assumption has been fulfilled.
4.4: Hypothesis Testing
H1: There is a significant and positive impact of interest rate on interest income.
Result: Since the significant value of interest rate is 0.000, which was less than 0.050 and regression coefficient value 852.617 was also positive. That means interest rate had a significant and positive impact on interest income. That accepts the hypothesis H1. The reason for significant and positive impact was that rate increases and interest income increases.
H2: There is a significant and positive impact of balances with other banks - deposit accounts on interest income.
Result: Since the significant value of balances with other banks- deposit accounts is 0.209, which was greater than 0.050 and regression coefficient value 0.057 was also negative. That means balances with other banks - deposit accounts had no significant and positive impact on interest income. That rejects the hypothesis H2. The reason for no significant and positive impact was balances with other banks cover only the small portion of the banks earning assets.
H3: There is a significant and positive impact of lending to financial institution on interest income.
Result: Since the significant value of lending to financial institution is 0.917, which was greater than 0.050 and regression coefficient value 0.003 was also negative. That means lending to financial institution had no significant and positive impact on interest income. That rejects the hypothesis H3. The reason for no significant and positive impact was lending to financial institution cover only the small portion of the banks earning assets.
H4: There is a significant and positive impact of investments on interest income.
Result: Since the significant value of investments is 0.186, which was greater than 0.050 and regression coefficient value 0.079 was also positive. That means investment have no significant but had positive impact on interest income. That rejects the hypothesis H4. The reason for no significant but positive impact was that interest income not much dependent on investment. If the investment increases then interest income also increases but in small proportion.
H5: There is a significant and positive impact of loan and advances on interest income.
Result: Since the significant value of loan and advances is 0.000, which was less than 0.050 and regression coefficient value 0.118 was also positive. That means loan and advances have a significant and positive impact on interest income. That accepts the hypothesis H5. The reason for significant and positive impact was that as the portfolio increases the interest income increases.
Table 4.6: Hypothesis Assessment Summary
Hypothesis
Independent Variables
t value
sig.
Comments
There is a significant and positive impact of interest rate on interest income.
Interest Rate
6.474
0.000
Accepted - since there was a significant and positive impact of interest rate on interest income.
There is a significant and positive impact of balances with other banks - deposit accounts on interest income.
Balances with other banks - deposit accounts
-1.270
0.209
Rejected - since there was an insignificant and negative impact of balances with other banks- deposit accounts on interest income.
There is a significant and positive impact of lending to financial institutions on interest income.
Lending to Financial Institution
-0.105
0.917
Rejected - since there was an insignificant and negative impact of lending to financial institutions on interest income.
There is a significant and positive impact of investments on interest income.
Investments
1.338
0.186
Rejected - since there was an insignificant and positive impact of investments on interest income.
There is a significant and positive impact of loan and advances on interest income.
Loan and Advances
28.368
0.000
Accepted - since there was a significant and positive impact of loan and advances on interest income.
Dependent Variable : Interest Income
Sig. Value: (0.05)
4.5: Chapter Summary
The chapter included the results, interpretation, assumption in the multiple regression and hypothesis tested. The overall results are positive and significant.
CHAPTER FIVE
DISCUSSIONS, IMPLICATIONS, FUTURE RESEARCH AND CONCLUSIONS
5.1: Conclusion
The objective of the study was to evaluate the impact of interest rate changes on banks profitability. The interest rate and loan and advances had a significant and positive impact on interest income. In the context of Pakistan interest rate and loan and advances had major impact on the banks interest income. The other significantly important variable was the loan and advances. As the portfolio of the loan and advances increases the banks interest income increases. Both the independent variable was directly related to interest income. The statistical result also showed that both the variable has significant and positive impact on the banks interest income. The regression technique also proved these findings. That means that profitability of bank dependant on interest rate, loan and advances.
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 loan and advances 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 then lending rates. Banks were more sensitive to interest rat risk as compare to the other financial institution.
It is feared that further increase in the interest rate would slow the growth of advances and increase in the bad debts. Short term interest rate changes was a serious issue among shareholders, managers and analysts and most of the banks represent no serious threat on long term interest rate. That would affect the performance and credit rating of financial institution. 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 was the interest rate movement which damaging in great deal. It would be very difficult for individual to save money and made investment in the economy.
The findings clearly suggested that main determinant of banks profitability are interest rate, loan and advances. The only way to increase banks profitability by way of having good quality portfolio in terms of assets, check and balance system developed to monitor closely such default risk and interest rate risk. Usually Banks have different polices in place to monitor the customer credit worthness in the form of KYC, AML, watch list, credit rating and electronic credit information bearue (ECIB). Banking was about how to managing its risk and return. Success in banking system is dependent on how well organization manages its risk and return. The nature of banks business was to identify, evaluate and manage risk effective and efficiently.
5.2: Discussions and limitations
There were some limitations in the research. Such as;
The basis for calculation of interest income was KIBOR rate. The Pakistan banking system started practicing KIBOR rate as benchmark from 2002 onward. Therefore, the study period is 2003 - 2008.
The sample size consists of ten major banks in Pakistan. That covered 76% market share of the Pakistan banking industry.
5.3: Implications and Recommendation
5.3.1: Implications
The mechanism of monetary policy was to bring discipline and efficiency in the financial sector and developing a favorable environment for economic growth. The central bank pursued a tight monetary policy from past few years. There are several objective of monetary policy to control inflation, government borrowing and interest rate. In Pakistan, rising inflation and interest rate was the most 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 institutions and consumer. This measure will help in controlling the monetary pressure associated with the economy.
5.3.1.1: 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 customers don't have to pay high interest rate on borrow funds. Interest rate used as a tool for controlling the 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. That affects the public demand for goods and services due to altering the availability of bank loans. 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 provide corporate level opportunity to take new capital investment spending and increase the firm confidence by making heavy investment in growing sector and generating heavy revenue. That result in stabilizing the economy and providing employment opportunities. The other aspect of low interest rate was that it will decrease the default risk of counter party. It means that people have more disposable income to pay their borrow funds and take saving 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 would increase the aggregate demand.
5.3.1.2: Increase in interest rates
The increased in rate will increase the cost of property. Conversely, fall in the interest rate increase the demand and increase pressure on mortgage prices. That would increase the spending associated with mortgage buying and increase in prices had increase the total wealth. The increase in interest rate opens the door for increasing non performing loans. Despite the fact that heavy amount of provisioned made by the banks. Inefficient and corrupt borrowers try to find out an easy exit way to avoid repayment. That problem was going to be worsted due to low recovery rate of bad debts.
5.3.2: Recommendations
The banks can decrease their risk with out involvement of funds by developing their focus on non interest income.
Bank must take conscious measure about capital adequacy ratio and abrupt changes in the interest rate.
The central bank should play their role in standardization of interest spreads.
There has been a gap of 5 to 8 percent between what the banks in Pakistan were paying to the deposit holders and what charging to borrowers, which was not in line with the international level. Banks management should required to logically focus on improving the quality of their banks profitability by providing better return to depositors and charge less interest rate to borrowers for the development of economy.
APPENDICES
Appendix A - Data Sheet
Period
2003
2004
2005
2006
2007
2008
Interest Rate
2.4588
3.3384
8.1853
9.9159
10.1640
12.8018
S.No
Bank
Year
Interest Income
Balances with Other Banks - Deposit Accounts
Lending to FI's
Investments
Loan and Advances
01
ABL
2003
4,984.607
1,607.460
15,361.240
40,972.690
49,986.980
02
ABL
2004
5,244.710
1,183.920
16,175.000
57,631.300
69,948.840
03
ABL
2005
9,846.657
2,329.190
5,777.380
45,068.120
119,506.010
04
ABL
2006
17,215.507
460.830
19,050.240
47,274.640
151,705.420
05
ABL
2007
21,201.422
-
18,419.240
84,209.830
178,524.360
06
ABL
2008
30,570.540
-
15,793.180
86,560.780
223,639.780
07
AB
2003
4,373.715
2,370.460
5,770.840
20,421.220
46,341.070
08
AB
2004
4,487.206
4,194.420
2,324.840
16,602.370
71,718.490
09
AB
2005
8,780.698
4,949.270
10,172.240
24,447.030
88,395.860
10
AB
2006
12,596.921
6,019.030
8,392.950
27,094.960
102,724.880
11
AB
2007
15,143.241
2,697.120
14,444.140
39,196.290
108,188.770
12
AB
2008
18,393.313
2,847.660
4,479.750
37,077.250
139,830.970
13
BAF
2003
4,033.380
138.920
7,437.730
28,603.260
50,372.330
14
BAF
2004
5,620.203
1,195.210
-
35,346.540
90,291.460
15
BAF
2005
12,246.811
7,714.610
27,050.490
57,445.250
120,416.990
16
BAF
2006
21,191.470
9,929.260
12,456.650
57,152.550
152,235.780
17
BAF
2007
25,783.871
14,695.660
3,452.060
88,568.460
175,678.810
S.No
Bank
Year
Interest Income
Balances with Other Banks - Deposit Accounts
Lending to FI's
Investments
Loan and Advances
18
BAF
2008
31,046.583
12,815.470
3,315.500
77,655.480
198,811.850
19
BAH
2003
2,403.489
303.650
469.630
14,109.220
35,543.980
20
BAH
2004
2,432.106
3,952.270
2,471.000
14,413.790
47,536.980
21
BAH
2005
4,935.626
377.170
3,352.750
19,502.320
55,526.000
22
BAH
2006
7,857.745
536.820
6,578.800
20,949.460
71,036.210
23
BAH
2007
9,945.872
262.700
4,112.430
35,240.220
79,446.700
24
BAH
2008
14,604.237
2,513.210
295.400
48,360.340
101,422.780
25
HBL
2003
19,049.914
17,049.800
22,595.490
158,870.810
216,380.740
26
HBL
2004
18,198.725
28,962.540
3,755.040
132,354.980
292,398.010
27
HBL
2005
32,343.206
27,558.480
12,272.250
107,678.120
350,424.900
28
HBL
2006
43,685.740
29,301.390
6,550.130
120,077.020
371,364.540
29
HBL
2007
50,481.021
22,865.310
1,628.130
178,463.740
403,478.900
30
HBL
2008
63,305.033
35,810.250
6,193.790
146,668.940
484,451.900
31
HMB
2003
2,684.887
195.090
3,896.280
17,958.900
32,637.090
32
HMB
2004
2,783.812
1,695.490
4,132.230
15,559.830
40,599.290
33
HMB
2005
4,358.556
381.790
5,462.580
22,003.310
44,039.160
34
HMB
2006
7,289.123
4,665.010
5,447.110
39,252.460
84,142.090
35
HMB
2007
11,983.551
2,175.450
3,989.250
61,656.770
91,044.060
36
HMB
2008
15,873.445
1,537.310
98.180
55,347.780
110,391.360
37
MCB
2003
10,569.994
290.360
10,430.450
125,635.810
104,011.100
38
MCB
2004
9,083.863
3,972.120
10,965.300
66,220.990
144,010.170
39
MCB
2005
17,756.232
548.150
9,998.830
68,261.030
188,139.680
40
MCB
2006
25,778.061
2,531.000
21,081.800
62,178.080
206,847.500
S.No
Bank
Year
Interest Income
Balances with Other Banks - Deposit Accounts
Lending to FI's
Investments
Loan and Advances
41
MCB
2007
31,786.595
571.810
1,051.370
111,816.630
229,732.870
42
MCB
2008
40,043.824
696.010
4,100.080
102,168.650
273,222.330
43
NBP
2003
19,452.317
19,979.670
29,937.860
168,280.530
188,958.770
44
NBP
2004
20,947.333
47,412.390
10,511.320
146,984.970
250,494.740
45
NBP
2005
33,692.665
28,068.920
16,282.940
120,471.490
299,422.810
46
NBP
2006
43,788.628
39,662.610
23,012.730
114,093.350
348,370.460
47
NBP
2007
50,569.481
30,356.200
21,464.600
180,431.770
374,732.030
48
NBP
2008
60,942.798
35,021.680
17,176.030
167,708.330
457,828.030
49
NIB
2003
172.372
-
347.580
951.960
6,791.960
50
NIB
2004
803.542
118.860
1,812.910
1,329.410
12,349.390
51
NIB
2005
1,716.917
1,400.000
2,270.000
5,205.170
20,181.320
52
NIB
2006
3,499.278
1,100.000
2,600.000
6,677.110
31,874.850
53
NIB
2007
6,999.888
535.720
4,753.110
40,593.510
92,586.340
54
NIB
2008
15,201.691
-
12,459.620
37,663.870
97,322.480
55
UBL
2003
9,269.494
17,959.120
23,096.030
53,841.740
114,897.000
56
UBL
2004
9,660.563
22,801.880
16,262.500
52,906.600
166,488.950
57
UBL
2005
20,687.373
13,262.180
17,867.550
61,236.540
239,613.350
58
UBL
2006
33,627.533
18,164.960
29,572.070
65,571.650
282,322.910
59
UBL
2007
41,045.543
2,583.690
24,781.720
115,967.140
334,120.160
60
UBL
2008
52,253.361
3,056.020
22,805.340
126,129.800
410,665.880
Appendix B - Banks included in the study with legend
S.No
Legend
Bank
1
AB
Askari Bank Limited
2
ABL
Allied Bank Limited
3
BAF
Bank Al Falah Limited
4
BAH
Bank Al Habib Limited
5
HBL
Habib Bank Limited
6
HMB
Habib Metropolitan Bank Limited
7
MCB
MCB Bank Limited
8
NBP
National Bank of Pakistan
9
NIB
NIB Bank Limited
10
UBL
United Bank Limited
Appendix C - SPSS Results
Table 4.1: Descriptive Statistics
Mean
Std. Deviation
N
Interest Income
18,772.105
16,092.870
60
Interest Rate
7.811
3.766
60
Deposits with other Banks
9,089.759
12,244.525
60
Lending to FI's
10,296.928
8,376.489
60
Investments
68,035.369
49,741.048
60
Loan and Advances
165,419.474
122,548.000
60
Table 4.2: Correlations
Interest Income
Interest Rate
Deposits with other Banks
Lending to FI's
Investments
Loan and Advances
Pearson Correlation
Interest Income
1.000
0.581
0.617
0.363
0.811
0.961
Interest Rate
0.581
1.000
0.031
0.024
0.201
0.436
Deposits with other Banks
0.617
0.031
1.000
0.318
0.703
0.723
Lending to FI's
0.363
0.024
0.318
1.000
0.431
0.412
Investments
0.811
0.201
0.703
0.431
1.000
0.862
Loan and Advances
0.961
0.436
0.723
0.412
0.862
1.000
Sig. (1-tailed)
Interest Income
.
0.000
0.000
0.002
0.000
0.000
Interest Rate
0.000
.
0.408
0.429
0.062
0.000
Deposits with other Banks
0.000
0.408
.
0.007
0.000
0.000
Lending to FI's
0.002
0.429
0.007
.
0.000
0.001
Investments
0.000
0.062
0.000
0.000
.
0.000
Loan and Advances
0.000
0.000
0.000
0.001
0.000
.
N
Interest Income
60
60
60
60
60
60
Interest Rate
60
60
60
60
60
60
Deposits with other Banks
60
60
60
60
60
60
Lending to FI's
60
60
60
60
60
60
Investments
60
60
60
60
60
60
Loan and Advances
60
60
60
60
60
60
Table 4.3: Model Summary
Model
R
R Square
Adjusted R Square
Std. Error of the Estimate
1
.961a
0.924
0.923
4,477.355
2
.978b
0.956
0.955
3,428.556
Table 4.4: ANOVA
Model
Sum of Squares
df
Mean Square
F
Sig.
1
Regression
14,120,000,000
1
14,120,000,000
704
.000a
Residual
1,163,000,000
58
20,050,000
Total
15,280,000,000
59
2
Regression
14,610,000,000
2
7,305,000,000
621
.000b
Residual
670,000,000
57
11,750,000
Total
15,280,000,000
59
Table 4.5: Interest Income
Model
Unstandardized Coefficients
Standardized Coefficients
t
Sig.
Collinearity Statistics
B
Std. Error
Beta
Tolerance
VIF
1
(Constant)
-2107.823
976.321
-2.159
0.035
Loan and Advances
0.126
0.005
0.961
26.537
0.000
1.000
1.000
2
(Constant)
-6878.423
1049.738
-6.553
0.000
Loan and Advances
0.115
0.004
0.874
28.368
0.000
0.810
1.235
Interest Rate
852.617
131.700
0.200
6.474
0.000
0.810
1.235
Table 4.6: Excluded Variables
Model
Beta In
t
Sig.
Partial Correlation
Collinearity Statistics
Tolerance
VIF
Minimum Tolerance
1
Interest Rate
.200a
6.474
0.000
0.651
0.810
1.235
0.810
Deposits with other Banks
-.164a
-3.404
0.001
-0.411
0.477
2.096
0.477
Lending to FI's
-.041a
-1.024
0.310
-0.134
0.830
1.205
0.830
Investments
-.068a
-0.957
0.343
-0.126
0.258
3.883
0.258
2
Deposits with other Banks
-.057b
-1.270
0.209
-0.167
0.377
2.652
0.306
Lending to FI's
-.003b
-0.105
0.917
-0.014
0.800
1.250
0.648
Investments
.079b
1.338
0.186
0.176
0.220
4.549
0.186
Figure 4.1: Normal P-P Plot of Regression Standardized Residual
Figure 4.2: Histogram
Figure 4.3: Scatter Plot - Interest Income
Figure 4.4: Partial Regression Plot - Interest Income and Interest Rate
Figure 4.5: Partial Regression Plot - Interest Income, Loan and Advances
