IMPACT OF INTEREST RATE ON BANK PROFITABILITY

1-INTRODUCTION
The interest rate swaps market has experienced tremendous growth since what is commonly regarded as the rst swap was executed in 1981. The growth in the market since then manifests itself not only in the vast increase in the notional outstanding of interest rate swaps but also in the varied users and uses of swaps. The purpose of this chapter is to provide a broad overview of the swaps market. We will focus on products and conventions in the market. The Banking sector acts as the life blood of modern trade and commerce to provide them with a major source of finance. This increasing phenomenon of globalization has made the concept of efficiency more important both for the non-financial and financial institutions and banks are the part of them. Banks largely depends on competitive marketing strategy that determines their success and growth. The modalities of the banking business have changed a lot in the new millennium compared to the way they used to be in the years bygone. The financial system of Pakistan is dominated by the commercial banks. The financial history of the country significantly altered in early 1970s with nationalization of domestic banks and growth of public sector development finance institutions. By the end of 1980s, it became quite clear that the national socio-economic objectives could not be achieved by nationalization.

The public sector in banking and non-bank financial institutions was liable for financial inefficiency, deteriorating quality of assets and growing threats of downfall of financial institutions. By the end of 1990, public sectors share in the banking industry was almost 90 percent in total assets, while the rest belonged to foreign banks, as domestic private banks did not exist at that time. Besides this high shares existed for deposits, advances and investments. The structure of banking system in Pakistan underwent significant changes after 1997 when the banking supervision process was aligned with international best practices. Privatization of public sector banks and the ongoing process of merger/consolidation brought visible changes in the ownership, structure, and concentration in the banking sector (State Bank of Pakistan, 2009). The Pakistani banking system since it has a completely diversified banking structure presents an interesting case. A quick look at net income before tax over total assets of all banks (operating throughout the time period under study) yield very low profitability levels (Ramlall, 2009). The Figure1 shows the determinants of banks profitability which are usually dichotomized into internal and external factors.

Determinants of Banks Profitability

The objective of this study is to find out the relationship between internal and external factors on Banks profitability in top 15 banks of Pakistan. Based on the objective, the present study seeks to test the following hypothesis: H1: There is a direct relationship between internal factors and banks profitability. *Internal factors are more important for the performance of Banks]. H1a: There is a direct relationship between SIZE and banks profitability. H1b: There is a direct relationship between CAPITAL and banks profitability H c 1: There is a direct relationship between LOAN and banks profitability. H d 1: There is a direct relationship between DEPOSITS and banks profitability. H2: There is a direct relationship between external factors and banks profitability *External factors are more important for the performance of Banks]. H a 2: There is a direct relationship between GDP and banks profitability. H b 2: There is a direct relationship between INF and banks profitability H c 2: There is a direct relationship between MC and banks profitability.

2-RESEARCH OBJECTIVE
The objectives of a research project summarize what is to be achieved by the study. These objectives should be closely related to the research problem. The general objective of a study states what researchers expect to achieve by the study in general terms. It is possible (and advisable) to break down a general objective into smaller, logically connected parts. These are normally referred to as specific objectives. Specific objectives should systematically address the various research questions. They should specify what you will do in your study, where and for what purpose.

3-PROBLEM STATEMENT
The problem statement for this research is: Why banks profitability is impacted by the changes in interest rate There could be several reasons behind it. In this research we will find out the possible grounds, those give an upward or downward movement to the profitability of banks with respect to the alteration in interest rate in economy.

4-SCOPE OF RESEARCH
Scope of this research may raise different questions. As I discussed in introduction of this project that the objective of this study is to find out the relationship between internal and external factors on Banks profitability in top 15 banks of Pakistan. The scope is that this report will give a proper procedure that how to analyze and gather the data and how to make the decisions with the findings of factors are influencing negatively or positively.

5-JUSTIFICATION OF RESEARCH
In the initial stage I would notice and examine the influence and impact of various economic factors on the interest rate. After the research on these phenomena banks will get to know that how these variables are influencing.. I will analyze the result which will be generated by going through different research papers. As we know that the criteria of the research is the ASSOCIATIONAL. In associational the two variables are dependent to each other. In my research interest rate and banks profitability are correlated with each other. In the next stages of my research I have generated the results and relationship between the dependents and independents variables. In the next chapters, stages or we can say in the

next sections. In my research I believed that some of the independent variables do influence negative impact on the banks profitability and I also believe that some dependent variables do influence a positive impact on the banks profitability.

6-LITERATURE REVIEW
This section provides the overview of previous studies reviewed related to the determinants of the profitability of banks with respect to interest rate. Some studies were country specific and few of them considered panel of countries for reviewing the determinants of profitability. From the last four decades there is a lot of research, analysis and interpretation has been done on the profitability of banking sector in relationship of interest rate. Now we will discuss different studies regarding my topic of research. Researchers conclude that foreign banks have higher profitability than domestic banks in developing countries, while the opposite holds in developed countries. Nevertheless, their overall results show support for the positive relationship between the capital ratio and financial performance. Another study by Abreu and Mendes (2002) on commercial bank interest margins and Profitability, for banks from four different EU countries for the period of 1986-1999 investigates the influences of bank-specific variables along with other variables on profitability of banks. They found that well-capitalized banks have low bankruptcy costs and higher interest margins on assets. Regarding bank-specific variables, the net interest margin reacts positively to operating costs and the loan-to-asset ratio has a positive impact on interest margins and profitability. In his study of the determinants of the Tunisian banking industry profitability for 10 banks in Tunisia for the period 1980-2000, Naceur (2003) notices that high net interest margin and profitability are likely to be associated with banks with high amount of capital and large overheads. Further he also noticed that other determinants such as loans has positive and bank size has negative impact on profitability. Bashir and Hassan (2003) and Staikouras and Wood (2003) show that a higher loan ratio actually impacts profits negatively. Goddard, et al. (2004) use panel and cross-sectional regressions to estimate growth and profit equations for a sample of banks for five European countries over the 1990s. The growth regressions suggest that, as banks become larger in relative terms; their growth performance tends to increase further, with little or no sign of mean reversion in growth. Berger (1987) finds positive causation in both direction between capital and profitability. Another panel study by Athanasoglou et al. (2006,a) on determinants of bank profitability in the South eastern European region, considering the credit institutions for the period 1988-2002, suggested some implementation of the findings. They found that all bank specific determinants (the internal factors) have significant affect on banks profitability. No positive result was found between banking reforms and profitability and macroeconomic determinants shows mixed affect. According to the research by Amor et al. (2006) on the commercial banks industry of the

OECD (Organization for Economic Co-operation and Development) countries shows that a higher leverage ratio helps to get better profitability. Similarly, lower overheads ratio also improve profitability by reducing the type of costs, which is generally considered a signal of efficiency. 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.

7-METHODOLOGY
This section mainly focuses on designing a comprehensive methodology in resemblance of proposed research study. Though, research is undertaken to get findings about a topic by taking into consideration some facts, experiences, concepts, hypotheses, principles and laws. A well designed research defines the problem clearly, takes on proper technique, discourses objective evidence, argues logically and provides valuable inferences which provides the researcher with practical insight of complete study. It is critically important to carefully select the appropriate methodology for research by considering purpose of study, research questions and available resource. The process of research design leads the research towards accomplishing concrete research. If researcher makes the best selection and uses this step appropriately he or she can get much valid results. Research Design The quantitative technique is applied when researcher is intended to measure the collected data statistically. This technique explain already existed facts testing the proposed theory while latter technique explores some other aspects of study formulating of a new theory Sample . I have selected the whole data on the yearly basis and I have also selected some dependent macro-economic variables in terms of the percentages. Sources of Data There were different resources used in terms of collecting secondary data. In this regard, the required data was gathered from books, peer-reviewed articles and magazines. I collected this data from different sources they are as follows: Commercial Banks Business Recorder

Pakistan Economic Survey State Bank of Pakistan Annual report

Statistical Representation H0:2 = 0 H1:2 0 Hypothesis H0= 0; the stock market is influence by the macro economic factors H1 0; the stock market is not influence by the macro economic factors Variables Independent Variable Dependent Variable