1

TESTING OF CAPITAL ASSET PRICING MODEL ON

PAKISTAN STOCK EXCHAGE LISTED COMPANIES

SUBMITTED TO:

DR. KASHIF HAMID

SUBMITTED BY:

ABU HURARA

2016-AG-5651

7TH SEMESTER

MBA (3.5YEARS)

COURSE N0: BM-721

COURSE TITLE: RESEARCH PROJECT

INSTITUTE OF BUSINESS MANAGEMENT SCIENCES (IBMS)

UNIVERSITY OF AGRICULTURE FAISALABAD

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 DECLERATION

I hereby declare that this submission is my own work and that, to the best of my
knowledge and belief, it contains no material previously published or written by another
person nor material which has been accepted for the award of any degree or diploma of
the university or other institute of higher learning, except where due acknowledgement
has been made in the text. We therefore, understand and transfer the copy rights for this
material to the institute of Business Management Sciences (IBMS) University Of
Agriculture Faisalabad (UAF). I also understand that if evidence of plagiarism is found in
my project the work may be cancelled and the degree revoked.

Signature

3
To,

The Controller Examinations,

University of Agriculture,

Faisalabad.

“We the Supervisory committee, certify that the contents and form of project submitted by
(Reg. No 2016-AG-5651) have been found satisfactory and recommend that it be
processed for evaluation by the external examiner (s) for the award of degree.”

Supervisory Committee:

1. Supervisor
(Dr. Kashif hamid))

2. Member
(Dr. Muhammad Nazim)

3. Member
(Mr. Asif Maqbool)

4
 Dedicated

To

The Sublime Love Of

My parents

Whose hands always raised in the prayer for me who are with me

To the feel the bud of their wishes and prayers,

Blooming into a flower.

5
 ACKNOWLEDGEMENT

All the praises and acclamations for Allah Almighty the benevolent that know mysteries
and secrets of universe and his Holy Prophet Muhammad (S.A.W) whose blessings
enabled me to pursue higher goals of life and whose teachings have served as beacon
for the humanity in the hours of despair and darkness.

I am heartily thankful to my supervisor whose encouragement, guidance and support from

the initial to final level enabled me to develop an understanding of the subject. He has left
no stone unreturned during supervision of this project. I would also like to acknowledge
my dear friends for their encouragement and corporation.

Last but not least, ordinary words of appreciation do not cover my parent’s true love and
their guidance at every corner of my life. Their keen interest, prayers and encouragement
have been a very strong support for me and enabled me to finish my project in time. I also
owe my thanks to all others who encouraged and helped me throughout my research
work. I am tried my level best to prepare this with high level of accuracy but no one claim
to perfect other than Allah Almighty.

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Contents:

CHAPTER TITLE PAGE

NO. NO.

1 Introduction 10
Objective of the study
Significance of study
2 Literature Review 20
Research gaps
3 Methodology 28
Definition
Types of data
Approaches of Data
Techniques
Hypothesis
Variables of the study
4 Interpretation of data 32
Data input
Data output
5 Results and Discussions 44

6 Conclusions 46
Further study
Limitations
Impact of the study
References 48

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Sr. No List of Figures Page
no.
1.1 Functions of commercial banks 11
1.2 Roles of commercial banks 11
1.3 Number of banks 14
1.4 Selected banks in project 15
1.5 Relationship of variables 17
1.6 Relationship of variables 18
3.1 Types of data 29
3.2 Approaches 30

Sr. No List of Tables Page

no.
3.1 Analyze 31
4.1 Data input 33
4.2 Model summery 34
4.3 Reliability Analysis 34
4.4 Statistic items 35
4.5 Variable items 36
4.6 Model Summery 36
4.7 Coefficients 37
4.8 Residual statistics 37
4.9 Variable items 39
4.10 Model Summery 39
4.11 Coefficient 40
4.12 Residual statistics 41
4.13 Variable items 41
4.14 Model Summery 42
4.15 Coefficient 42
4.16 Residual statistics 43

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 Abstract
The core objective of this project is to analyze the impact of interest rates changes on the
profitability of commercial banks being operated in Pakistan by examining the financial
statements of five major banks during 2011 to 2015. The efficiency of banking sector is
considered most important for economic growth, monetary policy implementation and
macro-economic stability. From the past few years, interest spread of banking sector of
Pakistan is rising. As a result, variations in the interest rate depress the savings and
investment and on the other hand it increases the efficiency of bank's lending. In this
research, interest rate is independent variable and bank profitability is a dependent
variable. It is measured by the Return on total Assets, Return on equity and Earning per
share. The main objective of the study is to examine the impact of interest rate changes
on the profitability of commercial banks in Pakistan, Correlation method is used in this
study. It is found that there is strong and positive correlation between interest rate and
commercial banks profitability with the help of Statistical package for social sciences
(SPSS).

Keywords: Return on total Assets, Earning per share, Return on equity, interest rate and
commercial banks.

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Chapter No.1

Introduction
1.1- Background of study:

A commercial bank is an institution that provides banking services for businesses.

Commercial banks provide savings and checking accounts for customers, but they
also provide loans, lines of credit, foreign exchange and payment and transactions
(Pritchard, 2009). While commercial banks' primary focus is on the business
customer, a large percentage of the customers they attract are private individuals as
well.

A commercial bank is authorized to serve the following functions:

 Receive deposits - take money in from individuals and businesses (called

depositors).

 Disburse payments - make payments upon the direction of its depositors, such
as honoring a check.

 Collections - a bank will act as your agent to collect funds from another bank
payable to you, such as when someone pays you by check drawn on an
account from a different bank.

 Invest funds in securities for a return.

 Safeguard money - banks are considered a safe place to store your wealth.

 Maintain and service savings and checking accounts of its depositors.

 Maintain custodial accounts - accounts controlled by one person but for the
benefit of another person, such as a trust account.

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Commercial Banks can also be playing a very major role in the economy. The people
are getting more services from the banks in daily basis and the commercial banks
provide the best facility regarding the cash. The banks can receive the deposits of
the customers and provide the funds also. Moreover, the commercial

Banks provide the services to the customers like online payments, accepting the
Utility bills, and so on. Moreover, the Commercial banks playing the very important
role in the enhancement of the economy. Commercial banks may offer other services
such as brokering insurance contracts, giving investment advice and so on.

The commercial banks help in overcoming and promoting economic development.

The role of a commercial bank in a developing country is discussed as under,

Figure: 1.1 Role Commercial Banks

Recieve
Deposits

Custodian Disburse
Accounts Payments
Commercial
banks

Maintain
Safeguard and
Money Service
Savings

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 Figure: 1.2 Functions of Commercial Banks

Financing
Consumer
Activities

Financing
Employment Financing
generating Agriculture
activities
Commercial
Banks

Help in Financing
Monetory Trade

Source: Chand (2007)

1.2:1- Financing Consumer Activities: People in underdeveloped countries being

poor and having low incomes do not possess sufficient financial resources to buy
durable consumer goods. The commercial banks advance loans to consumers for the
purchase of such items as houses, scooters, fans, refrigerators, etc. In this way, they
also help in raising the standard of living of the people in developing countries by
providing loans for consumptive activities.

1.2:2- Financing Agriculture: The commercial banks help the large agricultural
sector in developing countries in a number of ways. They provide loans to traders in
agricultural commodities. They open a network of branches in rural areas to provide
agricultural credit. They provide finance directly to agriculturists for the marketing
of their produce, for the mechanization of their farms, for providing irrigation
facilities, for developing land, etc.

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1.2:3- Help in Monetary Policy: The commercial banks help the economic
development of a country by faithfully following the monetary policy of the central
bank. In fact, the central bank depends upon the commercial banks for the success
of its policy of monetary management in keeping with requirements of a developing
economy.

1.2:4- Financing Trade: The commercial banks help in financing both internal and
external trade. The banks provide loans to retailers and wholesalers to stock goods
in which they deal. They also help in the movement of goods from one place to
another by providing all types of facilities such as discounting and accepting bills of
exchange, providing overdraft facilities, issuing drafts, etc. Moreover, they finance
both exports and imports of developing countries by providing foreign exchange
facilities to importers and exporters of goods.

1.2:5- Financing Employment Generating Activities:

The commercial banks finance employment generating activities in developing

countries. They provide loans for the education of young person’s studying in
engineering, medical and other vocational institutes of higher learning. They
advance loans to young entrepreneurs, medical and engineering graduates, and other
technically trained persons in establishing their own business. Such loan facilities
are being provided by a number of commercial banks in India. Thus the banks not
only help in human capital formation but also in increasing entrepreneurial activities
in developing countries.

There are many banks in Pakistan like, foreign bank, Public sector banks, Islamic
banks, specialized banks, Microfinance banks. All the banks are providing a lot of
services to the public and provide a lot of benefits to the people. Moreover, the
private banks helping more as compare to others.

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 Figure: 1.3

Specialized
Private Banks Islamic Banks
Bank
Bank AlHabib Meezan Bank
Zarai Taraqiati Bank
Bank Alfalah Dubai Islamic Bank

United Bank SME Bank Albarka Bank

Allied Bank UBL Islamic Banking

Industrial
MCB Development Bank HBL Islamic Banking

Source: Rodger (2007)

1.3- Research Questions:

 What is the impact of interest rate changes on the profitability of five major
commercial banks in Pakistan?
 Does the Interest Rate affect the ROE, ROTA, and EPS of Commercial Banking?
 How much change occurs due to the increase or decrease in the Interest rate?

Five Major Commercial Banks were chosen for the study. Which were Al Habib, Bank Al-
Falah, United Bank, Allied Bank, and MCB. These are the Commercial Banks in which I
have choose and now we analyze the fluctuations in the profitability and the investment
rather it will be increase or decrease though the fluctuation in interest rate.

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These are the Five Commercial Banks and now we see how the Interest rate affects the
profitability, investments of Banking Sector (Figure 1.4)

Figure: 1.4: List Of Banks

Bank Al-Habib

Bank Al-Falah

United bank

Allied Bank

MCB
1.5-
Interest Rate:
On the usage of funds, a certain sum of money paid or received is known as interest rate.
Creditor receives interest when he lent money and debtor pays interest when he borrows.
The amount of interest that a creditor receives is a percentage of the amount of money
he lent and in the same way, the amount of interest that a borrower pays is a percentage
of the total amount he borrowed*.

Anyone can make loan to someone and receive the interest or any institution like bank
can accept the deposits and pay the certain amount of interest. But, typically it is the job
of bank to provide the loans and accept the deposits. Here question arise that to provide
loans, from where bank obtain money? Banks encourage the public to deposit their
money by offering interest rates which motivate the public to make deposits by opening
their different accounts with the banks and banks use their funds for making loan to other
people*.

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Practically, when bank makes loan to a customer it charges higher rate but pays lower
rates to the depositor. With this difference of interest rates bank makes profit in return of
giving these services. To earn much profit bank charges higher interest rate as much as
it is possible and on the other hand pays lower rate as much as possible. However, to
attract the same borrower and depositor banks are competing to each other which
maintain the interest rates in comparable range*.

*Source: www.About.com, (Date accessed: 19/11/2017)

1.5:1- Increasing Effect:

When interest rate rises up, businesses have to pay more for borrowing. In other words
their cost of taking loan increases which decreases their profitability and due to decrease
in profitability market price of their share also decline. Moreover, a rise in interest rate
also decreases the worth of corporate bond. The interest rate that a bond pays to its
holder is not much attractive due to high interest rate*.

*Source: www. Accaglobal.com, (Date accessed: 19/11/2017)

For borrowing and saving there are various types of interest rates that bank offers. To set
the rate of interest that influence the lively of financial system, central bank plays a
significant role in this. The main source of commercial banks income is the interest
income by interest rate which is to some extent below or above the inter-bank loan rate.
Typically, central bank boosts up the rate of interest for many causes that may or may not
correct the intended issue. Inflation is from one of them. Rising interest rate encourages
the people to keep their funds with bank by offering hand sum saving interest income.
Rising interest rate and over spending cause stress on inflation. While on the other hand,
when interest rate goes up make borrowing more expensive which results into fall in
mortgage and investment. Ultimately, it influences the currency revaluation to increase
the value of money. Moreover, improved rate of interest may enhance the demand of
Government Issue bond*.

*Source: www. eHow.com, (Date accessed: 28/11/2017)

Example: If interest rate adds more than the amount you are paying, it possibly means
your debts increase although you are paying for debts. Interest rates are not same even
though they are more competitive. When a bank feel doubt that the debt will not be repaid
it will usually charge higher interest rate. Loans like credit cards are very expensive to
handle, so banks usually charge higher interest rates to them. Moreover, bank also
charges high interest rate to risky people*.

*Source: www. Accaglobal.com, (Date accessed: 27/11/2017)

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1.5:2- Decreasing Effect:
The decline in the interest rate as a common rule is most excellent for the economic
atmosphere because customers can easily pay for taking loan as they don’t have to pay
higher interest rate for taking the loans. In other words prices go up to higher point which
reduce the buying power of people which affect the demand of people for goods and
services because of the shifting accessibility of bank loans. But on the other hand when
interest rates are low the cost of borrowing decline which increase the buying power of
public and as result they tend to make investments and spend in different forms.

Lower interest rate also gives opportunity to businesses to take capital investment loan.
As result the economy become stable and employment opportunities in the country
increases. Another feature of lower interest rate.

When the Interest Rate is high then the profitability and investment should be reduced.
On the other hand, when the interest rate is low then the probability and the investment
should be increases.

Figure- 1.5: Relationship between Interest rate and profitability

Interest Rate

Profitability

Interest
Rate

Profitability

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The interest rate should be reducing the profitability of the banks. Firstly the interest rate
which is not to be the same as usually. It does change after three months and it will be
increase or decrease. If the interest rate will be increases then they will conduct the
negative impact on the profitability of commercial banks because banks charge the high
amount to borrowers.

The efficacy of financial intermediation can affect economic growth. Crucially, financial
intermediation affects the net return to savings and the gross return to investment. The
spread between these two returns mirrors bank interest margins, in addition to transaction
costs and taxes borne directly by savers and investors.

Thus bank interest spreads could be interpreted as an indicator of the efficiency of the
banking system. In this article we investigate how bank interest spreads are affected by
taxation, the structure of the financial system, and financial regulations, such as deposit
insurance (Levine, 1997).

The banks prefer high interest rates, and certainly their revenues are likely higher when
interest rates on loans and other investments are higher. However, banks must fund their
investments, and bank funding costs are also generally higher when market rates are
high. (Wheelock, 2016).

The impact of interest rate is much effect the profitability of banking sector because the
high amount should be paid by borrowers in return due to high interest rates.

To measure the effect of changes in bank’s profitability, it is mandatory to evaluate and

asses the overall fluctuations of interest rate on the economy and to depict the
implications of interest rate on cash flow. (English, 2002)

1.6- Objective of the study:

 To find out the impact of interest rate on the profitability of commercial banks.
 To see the effect of interest rate on return on equity.
 To see the effect of interest rate on return on total assets.

1.7- Significance of study:

 Commercial banks play the vital role in the economy. My purpose behind this study
is to evaluate the profitability of the five major commercial banks operating in
Pakistan for the period of 2011 to 2015.
 The key to understanding the relationship between the interest rates and
profitability in the commercial banks.
 To find the all over impact of interest rate on the ROA, ROE, And EPS.
 The benefit of this study to help the bankers in which the impact of fluctuations.
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Chapter no. 2

Literature Review
2.1-Introduction:
In this chapter of previous literature is discussed and research gap is identified.

A literature review is a text of a scholarly paper, which includes the current knowledge
including substantive findings, as well as theoretical and methodological contributions to
a particular topic. Literature reviews are secondary sources, and do not report new or
original experimental work. By Arlene Fink, (2005.)
2.2- Literature Review:
Gambacorta (2006) has done work to check the effect of change in interest rate on
commercial banks profitability in Pakistan. He has used secondary data and targets the
5 major commercial banks of Pakistan and then see the impact of interest rate on
profitability.

He stated that, when a debtor compensates to creditor with the amount of cash for the
utilization of creditors funds for a specific time period, is called interest rate. Creditors
charge the interest rate as percentage of the sum of funds lent. Similarly, the institutions
like bank for the utilization of money pays interest rate to the depositor.

Profitability of bank is described as income by interest or non-interest and after tax profits
which are computed as an amount of income (both interest & non-interest) after the
subtraction of provisions and operating costs.

Barajas (1999) has done the study to check the impact of interest rate and micro and
macro data used in the empirical work has extracted from the Central bank database. The
financial structure data did collected from the World Bank Indicators Database. The
sample includes the main deposit banks in Tunisia from 10 banks over the period 1980-
2000.

He advised that, the interest rate cause the some significant effects on commercial banks
profitability but the change in interest rate does create some negative factors as well.
Moreover, the spread of interest rate do not decline the overall profitability of banks and
the total performance is not based only on interest rate.

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Huizingha (1999) work see the specific determinants of interest margin and profitability
and used data of 80 countries and collect the data in 1988-1995.

He stated that, the foreign banks charge high interest rate with the high margin as
compare to the local institutions. Moreover, he advised the lower banking concentrations
conduct the lower profit as well as lower margin.

Khawaja (2009) investigate his study involves the interest rate and the profitability in
Pakistan. This study period consist of nine years from (2004-2012).Afterchanges the
benchmark rate, the banks start practicing KIBOR rate as benchmark to find out
the profitability. Pakistan 6 major banks selected from total population thirty four of the
banking industry.

He stated that, the interest rate causes very major effects in the profitability of the banks
as well as the customer needs. For the solution to avoid that risk or maximization the
profit the large banks made some 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. Moreover, the some borrowers quarterly, half quarterly or maybe
annual system and so that the banks can revise the same rate against interest that can
be increased the risk of banks.

Goaied (2008), carry out his study to check and examine the specific factors that can be
effect on the bank’s profitability in public and private sectors of Tunisia in 1980-2008. For
the better understanding of effects, the sample was divided into two categories.

1) Public sector banks: Comprises of four nationalized banks.

2) Private sector banks: Contains six private sector banks for the study.

He conducted that, capital ratio has positive and size has negative effect on profitability.
There exists little or zero effect of macro-economic components on the profitability of
banks in Tunisia. Moreover, the macro-economic factors have no any influence on
profitability of commercial banks.

Sufian (2011) has done his study during 1992-2003 in Korea on specific banks and
conducts the specific components as well as the macro-economic components that do
effect on profitability of commercial banks.

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He stated that, the liquidity and interest rate have a negative impact on profitability of
commercial banks in Korea. Moreover, Banks who focused more on diversification has
positive effect on profitability. Size depicted positive where as there is a negative effect
of financial crisis on the profitability Of Korean banks. Banks in Korea can also show more
profitable during the period of before-crisis as compared to after crisis.

Schumacher (2000) conduct the study in1988-1995 with 614 banks of Europe and US as
a sample size and more focused on the profitability and interest margin of commercial
banks.

He stated that, the interest rate changes have no any significant effect on profitability and
also conduct that the interest rate has any positive impact on banks profitability.
Moreover, he stated that the increase in interest rate should create more profit and
beneficial for the commercial banks in sense of investments, savings, reserves, and
capital.

Guru (2002) investigate his study at Malaysia during 1986-1995to identify the
determinants of successful deposit banks in order to provide practical guides for improved
profitability performance of these institutions. The sample size is 17 Malaysian
commercial banks.

He stated that efficient expenses management was one of the most significant in
explaining high bank profitability. Among the macro indicators, high interest ratio was
associated with low bank profitability and inflation was found to have a positive effect on
bank performance. Moreover, if the borrowers do pay high interest rate then it will effect
in the borrower behavior or intensions and then it will effect on the profitability of
commercial banks.

Ben-Naceur (2001) carry out his study involves the determinants of the Tunisian banks
performances during the period 1980-1995 at Tunisia.

He advised that the banks better performance and profit is not only conduct from the low
interest rates it’s also depend to improve the performance and those who have
successfully improved labor and capital productivity, those who have maintained a high
level of deposit accounts relative to their assets and finally, those who have been able to
reinforce their equity.

Anghazo (1997), investigate his study and he investigates the determinants of bank net
interest margins for example of US banks for the period1989-2003.

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He advised that the default risk, the opportunity cost of non-interest bearing reserves,
leverage and management efficiency are all positively associated with bank interest
spread. Moreover, he did find that the interest rate spreads have no any negative effects
on the profitability of commercial banks and no concerned with the efficiency of the banks.

Levin (1997) has done his research about the spread of interest rate in US banks for the
period of 1995.

He stated that the spreads of interest rate have fully influence the efficiency and
profitability of banks and the financial intermediation affects the net return to saving s and
the gross return to investment. The spread between these two returns bank interest
margins, Moreover the interest spread is the big challenge because it do not effect only
to the profitability but is can effect also to the investments, customers behaviors and
equity of banks.

Rocha (1986), conduct his work in 29 countries for the period of 1975-83 and summarizes
the role implicit and explicit taxes play in raising spreads.

He advised that the indirect relationship between the inflation and interest margin and he
can also done his work in bank cost, profit, inflation and economies of scale. He finds the
indirect between the inflation and interest rate.If the interest rate is reduced it is likely that
the inflation rate will rise because both people and businesses are able to borrow money
and therefore are willing to spend more. The demand will eventually start to overtake the
supply and this will cause prices to increase.

Anbar (2011) carry out his study to analyze the internal and external factors of the
commercial banks for the period of 2002-2010 in US.

He stated that the non-interest income and bank size have the positive impact on the
bank profitability. And on the other side of the external factors only the real interest rates
impact on the profitability of the commercial banks positively.

Nolle (1997) has done work for use the data from 19 industrial countries in 1993 and
examines the impact of return on equity, banking powers and profitability.

He stated that the bank powers, banks profitability, banking concentrations and the
changes in interest rate do not significantly affect the return on equity of banks. He can
also describe that the return on equity may be fall or rise by some other factors along with
the change in interest rate.

Besides that, the decline in equity of banks may be conduct in any other factor or reason-
it may be mismanagement and improper structure of banks.

22
Mendes (2002) conduct his studies the impact of interest rate of four different countries
for the period of 1998-99.

He stated that the well-capitalized banks have low bankruptcy costs and higher interest
margins on assets. Then net interest margin reacts positively to operating costs and the
loan-to-asset ratio has a positive impact on interest margins and profitability.

Al-Haschimi (2007) investigate the study about the determinants of bank net interest rate
margins in 10 SSA countries from the period of 2004-06.

He finds that credit risk and operating inefficiencies explain most of the variation in net
interest margins across the region. Macroeconomic risk has only limited effects on net
interest margin.

Alper (2011) carries out his study about the internal and external factors of banks
profitability of Turkey for the period of 2002-2010 in US.

He stated that the return on assets (ROA) and return on equity (ROE) both are the
dependent variables and the function of internal and external factors. The Profitability of
the commercial banks increases when the non interest income and asset size increases.
And real interest rate in the external factors has positive effect on profitability of banks.

Saira (2011) conduct her work about the profitability of 10 commercial banks in Pakistan
for the period of 2004-08.

She states that the internal factors have affected the profitability of banks. AnInternal
factor includes assets, loan, equity and deposits on the profitability of banks on dependent
variable called return on asset (ROA). Bank size or total assets does not lead any
profitability of commercial banks but equity and deposits have a significant influence on
the profitability of commercial banks.

Wanzenried (2011) He did his work in Switzerland amid 1999-2009 for 372 businesses
banks and checks the effect of profitability components. It was viewed as that from 1999-
2006 was pre-crisis time and 2007-2009 was well situation.

He stated that the averages of return on Assets and return on Equity and Net interest
margin have been used as profitability indicators as average values.

Moreover, he conducted that the negative effect of advanced financing expenses and
positive effect of diversification on banks profitability.

Samuelson (1945), has done his study on the impact of interest rate in Pakistan for the
period of 1944-45 of some commercial banks.
23
He stated that when interest rate increases it obviously effects to borrowers but it don’t
affect the banks performance. The borrowers tolerate the impact of high interest rate while
the performance of bank would not be affected by high interest rates. Because when
interest rates go upward then the bank charges more to borrower than the return it pays
to depositors. However, both the borrower and depositor tolerate the cost.

Musleh (2007) carry out his study in Pakistan from the period of 2003-06 to see the impact
of interest rate on profitability and investments.

He stated that the Increase in the interest rate depresses the borrowers and depositors,
like investment and saving. Banks by charging high interest rate gain high returns from
borrowers and discouraging the depositors by giving low return to them which results in
inclusive spreads. The interest rate spreads are high in Pakistan. Moreover, interest rate
increases when spreads are here then the high returns to banks on investments and
lending. And on the other hand, depositors have no other option to save their money
except on prevailing rates offered by the banks.

Laubach (2009) has done his study in Pakistan during the period of 2001-09 and conduct
the effect of interest rate from the commercial banks.

He stated that the change in interest rate not only effect the profitability of commercial
banks but also effect economic stability. Moreover, he stated that the competition among
the banks interest rate remains in a comparable range. For managing the significant
development interest rate is to be addressed a significant economic problem.

George (1945) He did his work from 6 commercial banks in Pakistan for the period of nine
years 2004-2012 and consults with the impact of interest rate on profitability.

He advised that the earnings of the banking system should depend upon the increase in
existing portfolios. Moreover he also stated that when the interest rates high and value of
capital down then all parts of the portfolio old as well as new began to earn the new rates.
When the interest rates high then the bank can come up with some loss on the portfolio
such as investing in the securities of longer period.

Moreover, 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.

2.3- Research gaps

 Mostly peoples see the fact of internal and external factor of the banks to find the
profitability but few numbers of researchers find the impact of change in interest
rate on banks performance and profitability.

24
  Mostly the researchers find the determinants of banks profitability but researcher
have done my work of impact of change in interest rate on the profitability.
 Internal and external factor affects the profitability but no one has used interest
rate as an independent variable, and I have use the interest rate as an independent
variable.
 Some researcher used the econometric model to find profitability, but I have
chosen three dependent variables who find the profitability.

Chapter No. 3

Methodology

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3.1: Methodology
Methodology is the systematic, theoretical analysis of the methods applied to a field of
study. It comprises the theoretical analysis of the body of methods and principles
associated with a branch of knowledge. Typically, it encompasses concepts such as
paradigm, theoretical model, phases and quantitative or qualitative techniques. (Kothari,
2004)

In the research project, the several methods as well as techniques are here.

3.2: Types of Data

There are two types of data that can be used as follow, Doyle's, (2017)

1. Primary data:
Primary data is original research that is obtained through first hand
investigation, its includes information collected from interviews, experiments,
Surveys, Questioner, Focus group and measurements.
2. Secondary data:
Secondary data is research that is widely available and obtained from
another party. Moreover, the Secondary data is the type of data which is usually
immediately available to the public at little or no cost.

However, there are a lot of methods which researcher can use for this like Regression,
Correlation etc, but researcher use Correlation to find the relationship between the
interest rate and the profitability of commercial banks.

3.3: Approaches of Data:

There are two types of approaches, Qualitative approach and quantitative approach. And
we used Quantitative approach for that study because this research is about analyzing

26
the impact of interest rate changes on the profitability of five commercial banks in
Pakistan.

Figure: 3.1 Quantitative Approach

•Quantitative analysis involves

using scientific or
Quantitative mathematical data to
understand a problem, such as
Approach analyzing surveys to predict
the change.

3.3- Secondary data collection sources:

Researcher collecting data from the official sites from commercial banks. These
commercial banks top 5 ranks in Pakistan on the basis of market share.

1. Bank Al-Habib*.

2. Bank Al-Falah

3. United Bank Limited*.

4. Allied Bank*.

5. MCB*.

(www.bankalhabib.com)

(www.bankalfalah.com)

(www.ubldirect.com)

(www.abl.com)

(www.mcb.com.pk)

3.4- Data Validity and Reliability:

27
The secondary data that researcher using, it has got from the official sites of commercial
banks and it is very valid data because the commercial banks financial statement is
prepare the qualified professionals. The data used in that study is provided with complete
references to ensure the validity and reliability of data.

3.5- Statistical Analysis:

This table indicates the profitability after tax of five major commercial banks in Pakistan.
This is different from what is suggested in the literature review. 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. So, the income is not too heavily
dependent on interest margin.

Table- 3.1 Profit after Tax

Banks Profit After tax

Years 2011 2012 2013 2014 2015

Bank 4,537,104 5,510,520 5,198,257 6,436,370 7,331,752

Al_Habib
Bank 3,503,130 4,556,121 4,675,950 5,640,851 7,522,810
Al_Falah
United Bank 14,854,785 19,247,439 19,730,771 24,024,803 27,009,626
Limited
Allied Bank 10,256,173 11,882,367 14,783,175 15,202,000 15,314,275

MCB 19,302,483 20,967,541 21,950,141 24,774,446 25,035,112

3.6- Research Hypothesis

Ho: The interest rate has a negative impact on profitability

28
H1: The interest rate has a positive impact on profitability

Ho: The interest rate has a negative impact on Return on total Assets.

H2: The interest rate has a positive impact on Return on total Assets.

Ho: The interest rate has a negative impact on Earnings per share.

H3: The interest rate has a positive impact on Earnings per share.

H0: The interest rate has a negative impact on Return on Equity.

H4: The interest rate has a positive impact on Return on Equity.

3.7- Research Variables:

The variables of this study is divided into two Parts-

29
3.7:1-Dependent Variables- It is something that depends on other factors. I-e
(Profitability)

3.7:2- Independent variables- An independent variable is exactly what it sounds like.

It is a variable that stands alone and isn't changed by the other variables you are trying
to measure. i.e. (Interest Rate)

Table-3.1 Relationship between dependent variable and Independent variables

The interest coverage ratio is used to

determine how easily a company can
Independent Interest coverage pay interest expenses on outstanding
Variable ratio debt. The ratio is calculated by
dividing a company's earnings
Interest Rate before interest and taxes (EBIT) by
the company's interest expenses for
the same period.
is a financial ratio that shows the
percentage of profit a company earns
Dependent Variables ROTA in relation to its overall resources. It is
commonly defined as net income
Profitability divided by total assets. Net income is
derived from the income statement of
the company and is the profit after
taxes
is a measure of profitability that
calculates how many dollars of profit a
ROE company generates with each dollar
of shareholders' equity. The formula
for ROE is: ROE = Net
Income/Shareholders' Equity. ROE is
sometimes called "return on net
worth.
(EPS) is the portion of a company's
profit allocated to each
EPS outstanding share of common stock.

Chapter No. 4

30
Interpretation of data
4.1- Introduction of Data:
In this chapter of Project the researcher describe independent variables are Interest rate
and dependent variables are ROE, ROTA, and EPS. After that researcher have done his
analysis in statistical package of social sciences and analyze the impact of independent
variables on dependent variables and find the reliability of data as well.

4.2- Data Input:

The table indicates the sum of ratios of five commercial banks in which involve all the
variables (Dependent and Independent variables) of 2011-2015. These percentages put
in the SPSS.

Table- 4.1 Ratio Analysis

ROA ROE EPS IC

Bank Al Habib 0.072510675 1.191172513 28.15 2.634653723
Al-Falah 0.06080418 0.82261442 18.88 1.88915479
united bank 0.146566 0.88849 82.16 3.537418
allied bank 0.126455 1.269519 62.07 3.637242
MCB 0.211726 0.144112 108.07 3.256855

4.3-Stistical package for social sciences:

SPSS Statistics is a software package used for logical batched and non-batched statistical analysis.
Long produced by SPSS Inc., it was acquired by IBM in 2009.

Moreover, researcher have done his finding in SPSS and find the Reliability, Regression analysis,
R square as well as Model summery of each variable findings.

Case Processing Summary

31
Case processing summery which involves the valid items, total items and excluded item
number.

Table-4.1 Case Processing Summary:

N %

Valid 5 100.0

Cases Excludeda 0 .0

Total 5 100.0
a. List wise deletion based on all variables in the procedure.

Reliability Statistics
Firstly find out the reliability of all the variables which involves the Dependent variables
as well as independent variables. Reliability is the overall consistency of a measure. A
measure is said to have a high reliability if it produces similar results under consistent
conditions. After find out the reliability it show the 34 % only which means that the
reliability id significantly among the variables.

Table-4.2 Reliability Statistics

Cronbach's Alpha N of Items

.046 4

Item-Total Statistics

32
After the reliability, now find out the total statistics which is involves all the variables and
this table indicates the scale mean. Scale variance if item deleted, total correlation
(correlated items) and alpha if item deleted. Scale mean indicates the return on total
Assets is 63.7202, total correlation is .988 which is relatively high, and cronbach alpha is
.022 which is low.

On the other side the return on equity, total correlation is negative which is -.625 and the
cronbach alpha is .048 which is average.

The earning per share total correlation is .384 and cronbach alpha is just .061 which is
low and the interest rate correlation is .771 and cronbach alpha is negative which .018 is
-. It is negative due to a negative average covariance among items,

After the reliability test, now I have done my regression analysis of each dependent
variable with the independent variable.

Table-4.3 Item-Total Statistics

Scale Mean if Scale Variance Corrected Item- Cronbach's
Item Deleted if Item Deleted Total Alpha if Item
Correlation Deleted

ROTA 63.7202 1399.023 .988 .022

ROE 62.9807 1424.336 -.625 .048
EPS 3.9779 .765 .384 .061
Interest coverage 60.8528 1361.489 .771 -.018
a. The value is negative due to a negative average covariance among
items. This violates reliability model assumptions. You may want to
check item coding.

33
4.4-

Regression Dependent Variable(ROTA)

Analysis
Independent Variable(Interest rate)

Variables Entered/Removed
Now the regression analysis which involves the return on total assets as a dependent
variable and use the enter method in regression analysis.
Enter Method:
Backward elimination (or backward deletion) is the reverse process. All the independent
variables are entered into the equation first and each one is deleted one at a time if they
do not contribute to the regression equation. Stepwise selection is considered a variation
of the previous two methods.

Table-4.4 Variables Entered/Removed

Model Variables Variables Method
Entered Removed

1 Interest coverage . Enter

a. Dependent Variable: ROTA
b. All requested variables entered.

34
Model Summary
Regression analysis is a statistical process for estimating the relationships among
variables. It includes many techniques for modeling and analyzing several variables,
when the focus is on the relationship between a dependent variable and one or more
independent variables.
Correlation is a statistic that measures the degree to which two securities move in relation
to each other. Correlations are used in advanced portfolio management. Correlation is
computed into what is known as the correlation coefficient, which has value that must fall
between -1 and 1.
Here it’s the findings of return on total assets which covariance is .704 and that is highly
co-related and the regression is .496 which means it is high. The adjusted regression is
.328.

Table-4.5 Model Summary

Model R R Square Adjusted R Std. Error of the Estimate
Square

.704 .496 .328 .04996

1

a. Predictors: (Constant), Interest coverage

b. Dependent Variable: ROTA

35
Coefficients

We are using the standardized coefficients as compare to the unstandardized

coefficients on the regression analysis of return on total asset as a dependent variable
and in which involve the beta term which is .704 and here the beta factor is high, and the
significance of independent variable is .184.

Table-4.6 Coefficients
Model Unstandardized Coefficients Standardized t Sig.
Coefficients

B Std. Error Beta

(Constant) -.052 .105 -.500 .652

1
Interest coverage .059 .034 .704 1.718 .184
a. Dependent Variable: ROTA

Residuals Statistics

The minimum predicted value is the .588 and maximum is the .1616 and the maximum
standard deviation is .04292. The minimum residual is relatively negative and the
minimum standard deviation predicted value is negative as well. The minimum standard
deviation residual value is negative also.

Table-4.8 Residuals Statistics

Minimum Maximum Mean Std. Deviation N

Predicted Value .0588 .1616 .1236 .04292 5

Residual -.03518 .07247 .00000 .04326 5
Std. Predicted Value -1.511 .886 .000 1.000 5
Std. Residual -.704 1.451 .000 .866 5
a. Dependent Variable: ROTA Table- 4.8

36
4.5-

Regression Dependent Variable(ROE)

Analysis
Independent Variable(Interest rate)

Variables Entered/Removed
Now the regression analysis which involves the return on equity as a dependent variable
and use the enter method in regression analysis.
Enter Method:
Backward elimination is the reverse process. All the independent variables are entered
into the equation first and each one is deleted one at a time if they do not contribute to
the regression equation. Stepwise selection is considered a variation of the previous two
methods.

Table-4.8 Variables Entered/Removed

Model Variables Entered Variables Method
Removed

1 Interest coverage . Enter

a. Dependent Variable: ROE
b. All requested variables entered

37
Model Summary
Regression analysis is a statistical process for estimating the relationships among
variables. It includes many techniques for modeling and analyzing several variables,
when the focus is on the relationship between a dependent variable and one or more
independent variables.
Correlation is a statistic that measures the degree to which two securities move in relation
to each other. Correlations are used in advanced portfolio management. Correlation is
computed into what is known as the correlation coefficient, which has value that must fall
between -1 and 1.
Here it’s the findings of return on total assets which covariance is .010 and that is highly
co-related and the regression is .000 which means it’s have no any impact on return on
equity. The adjusted regression is also negative which .333 is -.

Table-4.9 Model Summary

Model R R Square Adjusted R Std. Error of the
Square Estimate

1 .010 .000 -.333 .51379

a. Predictors: (Constant), Interest coverage
b. Dependent Variable: ROE

Coefficients
We are using the standardized coefficients as compare to the unstandardized
coefficients on the regression analysis of return on equity as a dependent variable and
in which involve the beta term is low which is .010 and here the beta factor is low, and
the significance of independent variable is .987.

Table-4.10 Coefficients
Model Unstandardized Coefficients Standardized t Sig.
Coefficients

B Std. Error Beta

(Constant) .845 1.078 .783 .491

1
Interest coverage .006 .352 .010 .017 .987
a. Dependent Variable: ROE

38
Residuals Statistics
The minimum predicted value is the .8564 and maximum is the .8672 and the minimum
standard deviation is negative which is -1.511. The minimum residual is relatively
negative and the maximum standard deviation predicted value is .886. The minimum
standard deviation residual value is negative also.

Table-4.11 Residuals Statistics

Minimum Maximum Mean Std. Deviation N

Predicted Value .8564 .8672 .8632 .00448 5

Residual -.72070 .40237 .00000 .44496 5
Std. Predicted Value -1.511 .886 .000 1.000 5
Std. Residual -1.403 .783 .000 .866 5
a. Dependent Variable: ROE

39
4.6-

Regression Dependent Variable(Earning per share)

Analysis
Independent Variable(Interest rate)

Variables Entered/Removed

Now the regression analysis which involves the earning per share as a dependent
variable and use the enter method in regression analysis.

Table-4.12 Variables Entered/Removed

Model Variables Variables Method
Entered Removed

1 Interest coverage . Enter

a. Dependent Variable: EPS
b. All requested variables entered.

4.6:1- Enter Method:

Backward elimination (or backward deletion) is the reverse process. All the independent
variables are entered into the equation first and each one is deleted one at a time if they
do not contribute to the regression equation. Stepwise selection is considered a variation
of the previous two methods.
Model Summary
Regression analysis is a statistical process for estimating the relationships among
variables. It includes many techniques for modeling and analyzing several variables,
when the focus is on the relationship between a dependent variable and one or more
independent variables.
Table-4.13 Model Summary
Model R R Square Adjusted R Square Std. Error of the Estimate

.765 .586 .448 27.58572

1

.a. Predictors: (Constant), Interest coverage

b. Dependent Variable: EPS

40
 Coefficients

Correlation is a statistic that measures the degree to which two securities move in relation
to each other. Correlations are used in advanced portfolio management. Correlation is
computed into what is known as the correlation coefficient, which has value that must fall
between -1 and 1.
Here it’s the findings of earning per share which correlation is .765 and that is highly co-
related and the regression is .586 which means its high any impact on earnings per share.
The adjusted regression is positive which .448 is.

We are using the standardized coefficients as compare to the unstandardized

coefficients on the regression analysis of earning per share as a dependent variable and
in which involve the beta term is high which is .765 and here the beta factor is high, and
the significance of independent variable is .132.

Table-4.14 Coefficients
Model Unstandardized Coefficients Standardized T Sig.
Coefficients

B Std. Error Beta

(Constant) -56.637 57.893 -.978 .400

1
Interest coverage 38.950 18.911 .765 2.060 .132

a. Dependent Variable: EPS

41
Residuals Statistics

The minimum predicted value is the 16.946 and maximum value is negative which 85.034
are and the minimum standard deviation is negative which is -1.511. The minimum
residual is relatively negative and the maximum standard deviation predicted value is
.886. The minimum standard deviation residual value is negative also.

Table-4.15 Residuals Statistics

Minimum Maximum Mean Std. Deviation N

Predicted Value 16.9462 85.0349 59.8660 28.40927 5

Residual -22.96486 37.85136 .00000 23.88994 5
Std. Predicted Value -1.511 .886 .000 1.000 5
Std. Residual -.832 1.372 .000 .866 5
a. Dependent Variable: EPS

42
Chapter No. 5

Findings and Discussions:

5.1- Introduction:
In this chapter the researcher describe results and discussions.

5.2- Findings:
After the deeply findings, now we are seeing the hypothesis whether it is accepting or
rejecting.

 The return on total assets has a positive relationship with the interest rate. In this
scenario H1 is accepted and Ho is rejected.
 The return on equity has no any relation with the interest rate which we have
finned.
 The earning per share has strongly correlated and positive relation with the interest
rate. In this scenario H2 is accepted and Ho is rejected.

There is the positive impact on the return on total assets and the interest rate both factors
are high correlate with each other. On the other hand the return on equity has no any
relation with the interest rate. Lastly, the earning per share which is the positive
relationship and highly correlated with the interest rate. Moreover, the return equity is
fluctuating even have no any relationship with the interest rate. After the find of its
regression, he shows his relation with interest which is zero.

5.3- Discussions:
As we know that after all the findings we see that the positive impact of interest rate on
the return on total assets and earning per share as well and there is no any relation with
return on equity because his regression value is 0 and correlation is only .010. In this
research project the Samuelson (1945),

He stated that when interest rate increases it obviously effects to borrowers but it don’t
affect the banks performance. The borrowers tolerate the impact of high interest rate while
the performance of bank would not be affected by high interest rates.

43
Because when interest rates go upward then the bank charges more to borrower than the
return it pays to depositors. However, both the borrower and depositor tolerate the cost.
This is related with my findings there is a positive relationship between interest rate and
bank profitability.

One more review which we discuss in my project, which is related with my findings.
Barajas (1999), the interest rate cause the some significant effects on commercial banks
profitability but the change in interest rate does create some negative factors as well.
Moreover, the spread of interest rate do not decline the overall profitability of banks and
the total performance is not based only on interest rate.

As we know that we have find that there is not any relation of return on equity with the
interest rate. The author Nolle did find same results regarding the relationship between
return on equity and interest rate fluctuations. Furthermore findings of Nolle (1997), He
stated that the bank powers, banks profitability, banking concentrations and the changes
in interest rate do not significantly affect the return on equity of banks. He can also
describe that the return on equity may be fall or rise by some other factors along with the
change in interest rate. Besides that, the decline in equity of banks may be conduct in
any other factor or reason- it may be mismanagement and improper structure of banks.

The Levin (1997) findings which is not related with my findings,

He stated that the spreads of interest rate have fully influence the efficiency and
profitability of banks and the financial intermediation affects the net return to saving s and
the gross return to investment. The spread between these two returns bank interest
margins, Moreover the interest spread is the big challenge because it do not effect only
to the profitability but is can effect also to the investments, customers behaviors and
equity of banks.

44
Chapter no 6

Conclusion
6.1- Introduction
In this chapter the researcher describe Conclusion, Limitations, Further study and Impact
of Study.

6.2- Conclusion
The study which is done after all discussions and findings regarding the impact of interest
rate on the profitability of five commercial banks and find the positive relationship between
the dependent and independent variables. Moreover, these findings are showing the high
correlation between them. The spread of interest rate do not decline the overall
profitability of banks and the total performance is not based only on interest rate. The
return on equity may be fall or rise by some other factors along with the change in interest
rate. Besides that, the decline in equity of banks may be conduct in any other factor or
reason- it may be mismanagement and improper structure of banks. If the interest rate
increases then the profitability also increased. The bank powers, banks profitability,
banking concentrations and the changes in interest rate do not significantly affect the
return on equity of banks. The banks better performance and profit is not only conduct
from the low interest rates it’s also depend to improve the performance and those who
have successfully improved labor and capital productivity, those who have maintained a
high level of deposit accounts relative to their assets and finally, those who have been
able to reinforce their equity.

45
6.3- Further study
 Due to the shortage of time, we have found the impact of interest rate only on
return on total assets, return on equity, and earning per share. For the further study
in this project we do check return on capital employed also or increase the
variables.
 I have used five commercial banks only, if any student wants to do further in that
study then we will also conduct this study with the selection of more than five
commercial banks.
 I have used only one dependent variable which is the profitability; we do use
investments also as a dependent variable.
 I have target only one sector, if any student wants to conduct the further study on
it then target more than one sector.

6.4- Research Limitations

 Less time period.
 Fewer variables.
 Select only five commercial banks.
 Using a specific technique for analyze.
 Use only banking sector, no work on any firm.

6.5- Impact of the study

 Impact on banks.
 Impact on customers.
 Impact on shareholders
 Impact on lenders.
 Impact on investors.

46
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