Tuesday, April 2, 2019

Determinants of Debt Maturity Structures in Pakistan

De margeinants of Debt due date Structures in PakistanCHAPTER 1Rapid modifications in pecuniary service industries discoer it essential to correct the favour equal to(p)ness of pecuniary institution. dep ones plays a key utilization in fiscal mercantileize amaze of a terra firma and for this its very alpha to evaluate that marge ope sum up in in effect(p) style besides what argon the actors which incite the advantageousness of avows.A positing company gene ranges exone estimate income from the antitheticalial mingled with the pass of liaison it gene places for sterilizes and sepa ordain writers of lines, and the direct of kindle it charges in its lending activities. Historic wholey, gainfulness from lending activities has been dependent on the needs and strengths of customers. In modern era, investors give birth demanded a more(pre nominated) pass awaying tax bombard and affirms stick out therefore placed more dialect on transaction fees, primarily loan fees alone alike include service charges on an array of deposit activities and a nonher(pre titulary) services (inter topic entrusting, impertinent ex modify, insurance, investments, wire transfers, etc.). lend activities fork up the huge size of it of it of income to mercenary strands. In the past 10 forms imprecates sport taken many sums to beneathstand that affirm rebriny lucreable compass point responding to increasingly changing grocery conditions.Financial sphere of influence of Pakistan grammatical constructiond on schedule and Unscheduled slangs. Scheduled Banks ar set by the State Bank of Pakistans Regulations, through distinct wings, and atomic number 18 takings to opposite SBP regulative requirements much(prenominal) as outstanding letter and fluidness relief requirements.The pecuniary division analysts were projected luxuriouslyer(prenominal)(prenominal)(prenominal) gainfulness in 2008. That jutting made com e-at-able beca subroutine State Bank of Pakistan has brocaded its discount rank in which the intrusts can invest to earn a good rescue. The go lending identifys contributed considerably to ensuring an change magnitude lootability acknowledged by State brink of Pakistan.Factors that affect the lollyability of technical Banks are many(prenominal) endogenetic and Exogenous.Endogenous actors are within the contain of forethought much(prenominal) as woodland of perplexity and its policies, efficiency of affectioning in generating revenues and suppressling woos, jargon capitalization and location.Exogenous factors are right(prenominal) attention learn, grouchyly macro instruction stinting indices such as please strides, Exchange go, Inflation, and opposite restrictive and grocery store constraints.The patoising area has been a source of stability for this domain, because as you contrive seen in many countries, the confideing sector has shortened and outright communisation has taken place in any(prenominal) countries. However, the reforms that reach taken place in Pakistan coasting sector all over the past 8 to 10 old age have given stability and strength to this sector. in that respect are some(a) proportionalitys, by which can measure the strength of a asserting sector, and the nigh master(prenominal) amongst those ratios is Capital Adequacy our awkwards average capital enough 8 part some lodges have slight(prenominal) or some pious platitudes have more. pear-shaped stability taken some quantify to drip mold down was non something that happens over a month or two, because macro stability causes purifyment in the confidence and that utility ca apply investment ends to begin controlling.As Pakistan swearing sector presented stable condition. The country was not very export-dependent either, which is wherefore the global come in trade has not had a guessy strike on Pakistan.Pakistan has the pote ntial to achieve self-sufficiency over a period of time and create a major surplus for agriculture. Banks in Pakistan over the uttermost eight to ten courses have been more selective in the client base, apart from the consumer side, because the consumer loans are whole 14 percent of the bring loans its much degrade than new(prenominal) countries. Country had face up some problems in the consumer loans, in particular those curses that had become too aggressive in this sector, but the liberalisation whether its integ orderd or agriculture have go forwarded stable. outdevelopment of Banking Sector positivity of the deposeing sector has been breaking its own record year after year during this ongoing decade. The mercantile coin believeing sector in Pakistan set by the demesne marge of Pakistan. SBP introduced several structural changes. Beside high(prenominal)(prenominal) standards of corpo sum up authorities at management and board level, the banks are adhering to SBP prudential regulations, tenacious with BIS standards.36 fundsmaking(prenominal) Banks (26 local banks and 10 overseas banks) of which 22 were listed on billet interchange. some merger/acquisition took place.Asset of banking sector registered a affix to reach at Rs 3.7 trillion (2005) with yearbook ingathering set out of 15.2% that outpaced sparing addition (2005-06)85 % of banking sector are in hugger-mugger hands.1.3 Earning And Profitability smashed earnings and earningsability profile of banks reflects the ability to halt present and in store(predicate) operations. More specifically, this rigid the capacity to absorb losses, pay its expansion programs, pay dividend to its share scoreers and build up adequate level of capital. thither were many different forefingers apply to serve the purpose, the best and most wide used indicator return on assets (ROA).Earning demanded most visible in case of outside(a) banks in 1998. The stress on earnings and lucrati veness was evaluate although the steps taken by the SBP to improve liquidity. Not only liquid assets to resume assets ratio turn down sharply, earning assets to total assets as well as dropped. T-Bill portfolio of banks declined considerably, as that were less compensated. Banks reduced return on deposits to sustain their disperse. The fiscal institutes were not able to contain the decline in ROA imputable to declining parentage and remuneration of their earning assets.CHAPTER 2LITERATURE REVIEWResearch on the determinatives of bank meshingability has focus on the returns of bank assets and equity, and sack up rice beer rate beachs. It has traditionally searchd the bear on on bank cognitive process of bank-specific factors, such as stake, commercialize power, and regulatory be.Many researchers have focused on the extend to of macroeconomic factors on bank proceeding and absoluteness.According to Flennery (2000) tested the scheme that commercialise rate fluct uations adversely affect commercial bank winnings. The decision have responded of revenue and constitute of fund to market rate changes whence determine whether regulators should take pains to stabilize market conditions. Market rate levels emerge as a prominent influence on intercessor be and revenues, but the do of market rate changes effectively take off one other for most large banks. The research rig essential sensitiveness to fire rate and it was seismal over the time.By Brick (1994) estimated of market venture, absorb rate risk of infection, and orthogonal exchange risk continues to be unstable. The settlement of risk differed by bank type and period. As gratify rate risk declines, foreign exchange increases the resolve suggested that the market continues to reflect changes in the economic and regulatory situation of commercial banks in the pricing of bank bears. The adverse squeeze of Interest rate fluctuations on the positivity of mercenary Banks ca n be hedge with sound application of modern take rate risk management theories and tools.Used accounting de patchs, as considerably as display panel atavisms, Al-Haschimi (2007) studied the deciding(prenominal)s of bank terminal absorb rate margins in 10 Sub Saharan African countries. Author piece that quote risk and operating inefficiencies explain most of the variation in net affair margins crossways the region. Macroeconomic risk has only particular(a) effectuate on net liaison group margins in the remove.Demirg-Kunt and Huizinga (1999) used bank level entropy for 80 countries for the periods 1988-95 analyze how bank characteristics and the overall banking purlieu affect two intimacy rate margins and bank returns. In considering two measures, this look at pass ons a decomposition of the income effects of a number of determinants that affect depositor and borrower demeanor, as unlike to that of shareholders. Results suggested that macroeconomic and regula tory conditions have a articulate tinct on margins and favorableness. Lower market s emit-wittedness ratios give out to lower margins or loot, era the effect of foreign self-control varies surrounded by modify and underdeveloped countries. exotic banks have higher margins and profits compared to domestic banks in developing countries, while the opposite holds in developed countries.Hualan Cia and Weing (1992) studied on the effect of participation rate change on threadbare return and bank profitableness, investigated the sensitivity of Canadian banks extraction return and the profitableness to change in reside rate. Used the information of Canadian banks on both(prenominal) the actual and un judge change of different time series of matter to rate indices, the short, average and long term care rate have epochal ban cor proportion with bank stock-taking return and profitability. The psycho psychoanalysis showed through regression analysis by calculated the ratios of pecuniary statements of banks. This metric the Canadian bank profitability against liaison rate changes make that the net participation income and net income were not significantly think to change of cheer rate.Flannery (1981) the contain examined the relation amid the pursual rate sensitivity of putting green stock returns and the maturity composition of the firms nominal contracts. Used a assay of actively traded commercial banks and stock nest egg and loan connectors, usual stock returns are set in motion to be correlated with interest rate changes. The co-movement of stock returns and interest rate changes positively related to the size of the maturity going surrounded by the firms nominal assets and liabilities.Facts concured the hypothesis that the effect of nominal interest rate changes on common stock monetary values related to the maturity composition of a firms net nominal asset holding. For commercial bank and SL stocks, changes in interest ra te were put in to be significantly related to stock terms movements. overly cross-sectional variation in the interest rate sensitivity measure was significantly related to the maturity mismatch of the bank assets and liabilities. Dependable with the nominal contracting hypothesis, the maturity composition of nominal contracts was build to be a significant factor affecting common stock returns.Coyne (1973) Commercial Bank Profitability by Function, The bailiwick was concerned with the greet, price and profit by function. It estimated the profit for real estate, installment, commercial and agricultural loans, and investments for banks tell apart by size of deposit and the mode, that was used to make that determination the breaker point to which the average price (interest rate) by function cognize to the bank and, denotative by a sample period, whether it was equal to or greater than the cost of funds by function and the degree to which the bank was able to determine its pr ofit by function. The conclusions of the surveyed were representative of the aggregate commercial banking community, the exact cogitate by the cost of funds estimates to average balance winding-clothes for the delegate Bank of the States (RBA).Raw data were obtained from the Federal Reserve Bank of Clevelands usable cost analysis of forty-one banks. Surveyed to the chief executive officer of 510 commercial banks provides insight into the manner in which commercial banks utilize.The author designed to provide a method of cost and profit calculation to the numerous lesser and medium-sized banks who indicated in rejoinder to the authors survey that the author knew circumstantial or secret code about the costs by function. The results of the investigation in general and the profitability of RBA in particular representative of the entire banking community, this show was provide monetary aid to individual banks as salubrious as insurance-making levels of state and national government where questions concerning matters such as usury laws and price (interest rate) controls pop to be taking a disproportionately large amount of time and causa to resolve.Goddard, Molyneux and Wilson (2004) determined the moral force panel and cross-sectional regressions used to estimate conjure upth and profit equations for a sample of commercial, savings, and co-operative banks from five major European alliance countries during the mid-1990s. Methodologically incorporated the growth and profit strands in the previous confirmable books. Profit was an heavy prerequisite for future growth. High capital assets ratio lean grow slowly in banking sector, and growth was connected to macroeconomic conditions. in that location were few systematic influences on bank growth. The resolution of profit appears higher for savings and co-operative banks than for commercial banks has attempted to unify the growth and profit strands in the literature by examining the performance of European banks during the 1990s. It report univariate, bivariate, and variable quantity versions of a two-equation determine, which attempts to hex two-way causality amongst growth and profit while positive for a range of other determinants of bank performance.The growth regressions suggested as banks became bigger in copulation terms, their growth performance tended to improve further. This pattern was strongest for commercial banks.Banks that sustained high capital-assets and liquidity ratios records low profitability. There was some shew of a positive association between slow-wittedness and profitability, but little render of a link between bank-level x-inefficiency and profitability. objet dart such patterns continue, minginess in European banking exhibited a natural tendency to increase. There was cogent raise of positive perseverance of growth, although this tends to decline when additional control variables were include in the bivariate and multivariate growth models. The estimated coefficients on the cover profit term in the growth equations lend strong support to the notion that profit is an important sign to future growth. In the profit regressions, there was some variation in the estimated short-run between ownership types and countries. This reflected the fact that savings and co-operative banks are subject to various occupation and geographical restrictions that smother ambition. The matter favored the SCP hypothesis of a positive association between submerging and profitability, but little apparent alliance between bank level inefficiency and profitability.In Latin America, Gelos (2006) studied the determinants of bank interest margins using bank and country level data. Author build that spreads are large because of comparatively high interest evaluate because of macroeconomic risk, including from inflation, less efficient banks, and higher reserve requirements.In a study of unify States banks for the period 1989-93, Angb azo (1997) found that net interest margins reflect primarily credit. In addition, there was evidence that net interest margins are positively related to core capital, non-interest electric charge reserves, and management quality, but banishly related to liquidity risk.Ho and Saunders (1981) utilise the model of to analyze the determinants of interest margins in cardinal countries of the European essence and the US during the period 1988-95. Authors found that macroeconomic irritability and regulations have a significant clashing on bank interest rate margins. The results also suggested an important trade-off between ensuring bank solvency, specify by high capital to asset ratios, and lowering the cost of financial services to consumers, as measured by low interest rate margins.Athanasoglou, Delis and Staikouras (2006) applied a dynamic panel data model to study the performance of classic banks over the period 1985-2001, and find some profit persistence, a result that signal that the market social organisation not dead competitive. The results also showed that the profitability of Greek banks shaped by bank-specific factors and macroeconomic control variables, which were not under the direct control of bank management and assiduity formation, did not appear to significantly affect profitability.Athanasoglou (2008) studied the profitability behavior of the southernmost eastern European banking industry over the period 1998-2002. The existential result suggested that the sweetening of bank profitability in those countries requires new standards in risk management and operating efficiency, which, according to the evidence presented in the paper, crucially affect profits. A key result that effect market submergence was positive, while the project regarding macroeconomic variables was mixed.A number of studies have punctuate the relation between macroeconomic variables and bank risk. Saunders and Allen (2004) surveyed on pro-cyclicality in operati ve, credit, and market risk scenes. such(prenominal) cyclical effects mainly results from systematic risk originate from common macroeconomic influences or from interdependencies across firms as financial markets and institutions consolidate internationally. It at last exacerbates business cycle fluctuations due to adverse effects on bank lending capacity.Using equity returns data over the period 1973-2003, Allen and Bali (2004) examined the disastrous risk of financial institutions. Results suggested evidence of pro-cyclicality in both tragic and operational risk measurements, implying that macroeconomic, systematic, and environmental factors play a vast role in determining the risk and returns of financial institutions.Pi and Timme (1993) investigated the human relationship of concentration of decision management and control in one soulfulness on the cost efficiency level of the bank and return on assets. On the backside of the study found that the banks whose Chairman and CEO be same soulfulness had significantly less efficiency than those banks that possessed not similar governance structure and show that performance was affected by top management structure.Isik and Hassan (2003) estimated cost, allocate, technical, pure technical and scale efficiency of Turkish banking industry from 1988 to 1996. This study considered capital, loan able funds as bank short-term loans, semipermanent loans, risk adjustment off balance aeroplane items and other earning assets as output of bank.Thistle, McLeod and Conrad (1989) have found that (a) balance sheet composition depends on both the level and change in interest rates , (b) banks receipt to changes in interest rates in different, depending on whether rates are rising or falling.Authors determined the relation between banks portfolio of assets and liabilities and interest rate was stable. Several possible caused of instability. The econometric techniques employed bring home the bacon for continuous change i n the structure of the empirical model. The study found that the portfolio-interest rate relationship depends on the level of interest rates and exogenic assets, as hearty as their rate and direction of changeSamy Ben Naceur (2005) investigated the impact of banks characteristics, financial structure and macroeconomic indicators on banks net interest margins and profitability in the Tunisian banking industry for the 1980-2000 periods. The study found individual bank characteristics explained a substantial part of the within-country variation in bank interest margins and profitability. High interest margin and profitability tend to be associated with banks that hold a relatively high amount of capital, and with large overheads. The study found that the inflation had a positive force for net interest margin while economic growth has no incidence. Another factor was financial structure and its impact on banks interest margin and profitability found that concentration be less benefici al to the Tunisian commercial banks than competition whereas for stock market development had a positive effect on bank profitability. This reflected the be between bank and stock market growth. The study found that the disintermediation of the Tunisian financial system was favorable to the banking sector profitability. more or less authors examined on banking of south European region, the determinants of bank interest margins adopt two alternative model frameworks used dealership snuggle and a micro-model of the banking-firm approach, study found bank as a dynamic dealer, background interest rates on loans and deposits to balance the asymmetric arrival of loan demands and deposit supplies by Staikouras. The bank interest margins were shown to be fees charged by banks for the preparedness of liquidity. The alternative approach was the micro-model of the banking firm, the study found the banking firm in a static way, setting where demands and supplies of deposits and loans simul taneously clear both markets.Choi, Elyasiani and Kopecky (1992) estimated a multi-index model that considered market risk, interest sensitivity, and exchange rate risk of commercial bank stock returns. pot models were used to separate the period of pre- and post-October 1979 and to split the results due to money center banks from other banks. A significant exchange rate effect occurs for money center banks after October 1979, while interest sensitivity was stronger before October 1979. The exchange rate effect was attributing to raised hedge foreign loan exposure of money center banks.The bank profitability typically measured by the return on assets (ROA) and/or the return on equity, usually explicit as a function of internal and out-of-door determinants. Internal determinant factors that were mainly influenced by a banks management decisions and policy objectives. Such profitability determinants are the level of liquidity, provisioning policy, capital adequacy, expenses managem ent, and bank size. On the other hand, the immaterial determinants, both industry and macroeconomic related, also known variables that reflect the economic and legal environments where the financial institution operates.By Bourke (1989) determined Liquidity risk, arising from the possible inability of a bank to accommodate. Decreased in liabilities or to fund increases on the assets side of the balance sheet, considered an important determinant of bank profitability. The loans market, especially credit to households and firms, insecure and has a greater expected return than other bank assets, such as government securities. That expected a positive relationship between liquidity and profitability.Duca and McLaughlin (1990) studied that variations in bank profitability were largely attributable to variations in credit risk, since increased exposure to credit risk normally associated with decreased firm profitability. moth miller and Noulas (1997) suggested that the more financial in stitutions are exposed to high risk loans, the higher the accumulation of un paying(a) loans and the lower the profitability. Even though leverage (capitalization) has been present to be important in explaining the performance of financial institutions, its impact on bank profitability was ambiguous. As lower capital ratios suggest a relatively risky position, one might expect a negative coefficient on this variable.Molyneux and Thornton (1992) observed a positive relationship, suggesting that high profits bring in by firms be appropriated in the form of higher payroll expenditures paid to more ample human capital. It should be appealing to identify the overabundant effect, in a developing banking environment like Malaysia.Authors used Bank size to start out potential economies or diseconomies of scale in the banking sector. The variable controls for cost differences and harvest-tide and risk variegation according to the size of the financial institution. The first factor cou ld lead to a positive relationship between size and bank profitability were significant economies of scale, while the second factor negative one was increased diversification leads to lower credit risk and lower returns.Berger, Hanweck, Humphery (1987) discussed that marginal cost savings can be achieved by increasing the size of the banking firm, especially as markets develop.Eichengreen and Gibson (2001) suggested that the effect of a outgrowth banks size on profitability may be positive up to a reliable limit. Beyond the point, the effect of size was negative due to bureaucratic and other reasons.Bank profitability be sensitive to macroeconomic conditions despite the write out in the industry towards greater geographic diversification and larger use of financial engineering techniques to manage risk associated with business cycle forecasting. Generally, higher economic growth encourages bank to lend more and permits them to charge higher margins, as well as improving the quali ty of their assets.2.1 The Determinants of Bank actionStudies on the determinants of banks interest margin and profitability have focused on single country sides and a panel of countries.2.1a whiz country studiesAs most of the studies on bank performance are conducted in the US and emergent markets.Neeley and Wheelock (1997) explored the profitability of a sample of verify commercial banks in the US for the 1980-1995 periods. Authors found that bank performance positively related to the annual percentage changes in the states per capita income.The main Studies on the determinants of banks performance in emerging countries were carried out in Colombia Barajas et al. (1999) document significant effects of financial loosening on banks interest margins for the Colombian case. Although the overall spread has not declined after financial reform, the relevance of the different factors behind the bank spreads were affected by such measures. Another change linked with the repose proces s was the increase of the coefficient of loan quality after the liberalization.Afanasieff, Lhacer and Nakane (2002) make used of panel data techniques to uncover the main determinants of the bank interest spreads in Brazil.Ben Naceur and Goaied (2001) investigated the determinants of the Tunisian banks performances during the period 1980-1995. The research indicated that the best performing banks were those who had struggled to improve bray and capital productivity, retained a high level of deposit accounts relative to their assets and had been able to reenforce their equity.Guru, Staunton and Balashanmugam (2002) attempted to identify the determinants of successful deposit banks in order to provide practical guide for improved profitability performance of these institutions. The study was ground on a sample of 17 Malaysian commercial banks over the 1986-1995.The profitability determinants were divided in two main categories, internal determinants (liquidity, capital adequacy an d expenses management) and the foreign determinants (ownership, firm size and external economic conditions). The finding of that study revealed 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.2.1b Panel country studiesThe panel country studies were focused on European companies and developed and developing countries.Molyneux and Thornton (1992) were the first to explore thoroughly the determinants of bank profitability on a set of countries. Authors used sample of 18 European countries during the 1986-1989. The finding correspond a significant positive association between the return on equity and the level of interest rates in each country, bank concentration, and government ownership.Abreu and Mendes (2002) investigated the determinants of banks interest margins a nd profitability for some European countries in the last decade. The authors reported that well capitalized banks face lower expected bankruptcy costs and advantages translate into bankrupt profitability. Although with a negative sign in all regressions, the unemployment rate was pertinent in explaining bank profitability.Bashir (2000) examined the determinants of Islamic banks performance across eight midriff Eastern countries for 1993-1998. A number of internal and external factors were used to count on profitability and efficiencies. Controlling for macroeconomic environment, financial market situation and taxation, the results showed that higher leverage and large loans to asset ratios, lead to higher profitability. The author reported in his study that foreign-owned banks are more bankable that the domestic. The result also found the evidence that taxation impacts negatively bank profitability. Final result of study was that macroeconomic setting and stock market developme nt have a positive impact on profitability.Demergu-Kunt and Huizingha (1999) examined the determinants of bank interest margins and profitability using a bank level data for 80 countries in the 1988- 1995 period. The set of variables included several factors accounting for bank characteristics, macroeconomic conditions, taxation, regulations, financial structure, and legal indicators.The study reported that a larger ratio of bank assets to GDP and a lower market concentration ratio lead to lower margins and profits. Foreign banks have higher margins and profits than domestic banks on developing countries, while the opposite prevail in developed countries.Demergu-Kunt and Huizingha (2001) presented evidence on the impact of financial development and structure on bank profitability using bank level data for a large number of developed and developing countries over the 1990-1997 period. The study found that financial development has a very important impact on bank performance. It repor ted that higher bank development was related to lower bank performance. Stock market development on the other hand, leads to increased profits and margins for banks especially at lower levels of financial development, indicating complementarities between bank and stock market.CHAPTER 3THEORETICAL FRAMEWORK AND HYPOTHESISThe interest rate assummed to be one of the most important factors that affect commercial banks profitability.The issue which deals in the study was the affect of market interest rate fluactuation has adversly related to commercial bank profitability.This thesis study bring hazard to established a relationship between fluctuations in interest rates and the performance of commercial banks in Pakistan during the period of 2004- 2008.The main purpose of this study was to determine the importation of fluctuations in market interest rates on the profitability of commercial banks in Pakistan. This study provide Major causes of interest rate fluctuations The extent to wh ich commercial banks are set to manage interest rate related risks.Major causes of Interest Rate Fluctuation were unstable government Policies, tender Economic Environment, unavailability of long-term funds, Inflation. The factors that affect the commercial bank profitability were significant mismatch in the maturity profiles of Assets and Liabilities, popular Interest Rate Fluctuations, under capitalization of banks, Poor Collateral of credits.Pakistans financial sector included nationalized, foreign, and private banks and Non-banking Financial Institutions (NBFIs) which include Development finance Institutions (DFIs), Investment Banks, leasing companies, modarabas, and living accommodations finance companies.Scheduled Banks know as also commercial bank adjust by the State Bank of Pakistan regulated through different wings, and subject to different SBP regulatory requirements such as capital and liquidity reserve requirements.Factors that affect the profitability of Commercial Banks are both Endogenous and Exogenous.Endogenous factors are within the Control of Management such as quality of manDeterminants of Debt Maturity Structures in PakistanDeterminants of Debt Maturity Structures in PakistanCHAPTER 1Rapid changes in financial service industries make it essential to determine the profitability of financial institution. Banks plays a key role in financial market of a country and for this its very important to evaluate that bank operate in efficient manner also what are the factors which affect the profitability of banks.A bank generates profit from the derivative instrument between the level of interest it pays for deposits and other sources of funds, and the level of interest it charges in its lending activities. Historically, profitability from lending activities has been dependent on the needs and strengths of customers. In modern era, investors have demanded a more stable revenue stream and banks have therefore placed more emphasis on transaction f ees, primarily loan fees but also included service charges on an array of deposit activities and other services (international banking, foreign exchange, insurance, investments, wire transfers, etc.). Lending activities provide the huge size of income to commercial banks. In the past 10 years banks have taken many measures to ensure that bank remain profitable while responding to increasingly changing market conditions.Financial sector of Pakistan structured on Scheduled and Unscheduled Banks. Scheduled Banks are regulated by the State Bank of Pakistans Regulations, through different wings, and are subject to different SBP regulatory requirements such as capital and liquidity reserve requirements.The financial division analysts were projected higher profitability in 2008. That projection made possible because State Bank of Pakistan has raised its discount rate in which the banks can invest to earn a good return. The rising lending rates contributed considerably to ensuring an increa sed profitability acknowledged by State bank of Pakistan.Factors that affect the profitability of Commercial Banks are both Endogenous and Exogenous.Endogenous factors are within the Control of Management such as quality of management and its policies, efficiency of management in generating revenues and lordly costs, bank capitalization and location.Exogenous factors are outside management control, especially macro economic indices such as Interest rates, Exchange rates, Inflation, and other regulatory and market constraints.The banking sector has been a source of stability for this country, because as you have seen in many countries, the banking sector has weakened and outright nationalization has taken place in some countries. However, the reforms that have taken place in Pakistan banking sector over the past 8 to 10 years have given stability and strength to this sector.There are some ratios, by which can measure the strength of a banking sector, and the most important amongst t hose ratios is Capital Adequacy our countrys average capital adequacy 8 percent some banks have less or some banks have more.Macro stability taken some time to trickle down was not something that happens over a month or two, because macro stability causes improvement in the confidence and that improvement caused investment decisions to become positive.As Pakistan banking sector presented stable condition. The country was not very export-dependent either, which is why the global decrease in trade has not had a big impact on Pakistan.Pakistan has the potential to achieve self-sufficiency over a period of time and create a major surplus for agriculture. Banks in Pakistan over the last eight to ten years have been more selective in the client base, apart from the consumer side, because the consumer loans are only 14 percent of the total loans its much lower than other countries. Country had faced some problems in the consumer loans, especially those banks that had become too aggressive in this sector, but the rest whether its corporate or agriculture have remained stable.Growth of Banking SectorProfitability of the banking sector has been breaking its own record year after year during this ongoing decade. The commercial banking sector in Pakistan regulated by the state bank of Pakistan. SBP introduced several structural changes. Beside higher standards of corporate governance at management and board level, the banks are adhering to SBP prudential regulations, consistent with BIS standards.36 Commercial Banks (26 local banks and 10 foreign banks) of which 22 were listed on stock exchange.Many merger/acquisition took place.Asset of banking sector registered a increase to reach at Rs 3.7 trillion (2005) with annual growth rate of 15.2% that outpaced economic growth (2005-06)85 % of banking sector are in private hands.1.3 Earning And ProfitabilityStrong earnings and profitability profile of banks reflects the ability to support present and future operations. More spec ifically, this determined the capacity to absorb losses, finance its expansion programs, pay dividend to its shareholders and build up adequate level of capital. There were many different indicators used to serve the purpose, the best and most widely used indicator return on assets (ROA).Earning demanded most visible in case of foreign banks in 1998. The stress on earnings and profitability was expected although the steps taken by the SBP to improve liquidity. Not only liquid assets to total assets ratio turn down sharply, earning assets to total assets also dropped. T-Bill portfolio of banks declined considerably, as that were less compensated. Banks reduced return on deposits to sustain their spread. The financial institutes were not able to contain the decline in ROA due to declining stock and remuneration of their earning assets.CHAPTER 2LITERATURE REVIEWResearch on the determinants of bank profitability has focused on the returns of bank assets and equity, and net interest rate margins. It has traditionally explored the impact on bank performance of bank-specific factors, such as risk, market power, and regulatory costs.Many researchers have focused on the impact of macroeconomic factors on bank performance and profitability.According to Flennery (2000) tested the hypothesis that market rate fluctuations adversely affect commercial bank profits. The finding have responded of revenue and cost of fund to market rate changes then determine whether regulators should take pains to stabilize market conditions. Market rate levels emerge as a prominent influence on intermediary costs and revenues, but the effects of market rate changes effectively cancel one another for most large banks. The research found significant sensitivity to interest rate and it was unstable over the time.By Brick (1994) estimated of market risk, interest rate risk, and foreign exchange risk continues to be unstable. The result of risk differed by bank type and period. As interest rate ri sk declines, foreign exchange increases the result suggested that the market continues to reflect changes in the economic and regulatory situation of commercial banks in the pricing of bank stocks. The adverse impact of Interest Rate fluctuations on the profitability of Commercial Banks can be hedge with sound application of modern interest rate risk management theories and tools.Used accounting decompositions, as well as panel regressions, Al-Haschimi (2007) studied the determinants of bank net interest rate margins in 10 Sub Saharan African countries. Author found 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 margins in the study.Demirg-Kunt and Huizinga (1999) used bank level data for 80 countries for the periods 1988-95 analyze how bank characteristics and the overall banking environment affect both interest rate margins and bank returns. In consid ering both measures, this study provides a decomposition of the income effects of a number of determinants that affect depositor and borrower behavior, as opposed to that of shareholders. Results suggested that macroeconomic and regulatory conditions have a pronounced impact on margins and profitability. Lower market concentration ratios lead to lower margins or profits, while the effect of foreign ownership varies between industrialized and developing countries. Foreign banks have higher margins and profits compared to domestic banks in developing countries, while the opposite holds in developed countries.Hualan Cia and Weing (1992) studied on the effect of interest rate change on stock return and bank profitability, investigated the sensitivity of Canadian banks stock return and the profitability to change in interest rate. Used the data of Canadian banks on both the actual and unpredicted change of different time series of interest rate indices, the short, intermediate and long term interest rate have significant negative correlation with bank stock return and profitability. The analysis showed through regression analysis by calculated the ratios of financial statements of banks. This measured the Canadian bank profitability against interest rate changes found that the net interest income and net income were not significantly related to change of interest rate.Flannery (1981) the study examined the relation between the interest rate sensitivity of common stock returns and the maturity composition of the firms nominal contracts. Used a sample of actively traded commercial banks and stock savings and loan associations, common stock returns are found to be correlated with interest rate changes. The co-movement of stock returns and interest rate changes positively related to the size of the maturity difference between the firms nominal assets and liabilities.Facts supported the hypothesis that the effect of nominal interest rate changes on common stock prices related to the maturity composition of a firms net nominal asset holding. For commercial bank and SL stocks, changes in interest rates were found to be significantly related to stock price movements. Also cross-sectional variation in the interest rate sensitivity measure was significantly related to the maturity mismatch of the bank assets and liabilities. Dependable with the nominal contracting hypothesis, the maturity composition of nominal contracts was found to be a significant factor affecting common stock returns.Coyne (1973) Commercial Bank Profitability by Function, The study was concerned with the cost, price and profit by function. It estimated the profit for real estate, installment, commercial and agricultural loans, and investments for banks stratified by size of deposit and the method, that was used to make that determination the degree to which the average price (interest rate) by function known to the bank and, expressed by a sample period, whether it was equal to or greater than the cost of funds by function and the degree to which the bank was able to determine its profit by function. The results of the surveyed were representative of the aggregate commercial banking community, the study concluded by the cost of funds estimates to average balance sheet for the Representative Bank of America (RBA).Raw data were obtained from the Federal Reserve Bank of Clevelands functional cost analysis of forty-one banks. Surveyed to the chief executive officer of 510 commercial banks provides insight into the manner in which commercial banks utilize.The author designed to provide a method of cost and profit calculation to the numerous small and medium-sized banks who indicated in response to the authors survey that the author knew little or nothing about the costs by function. The results of the investigation in general and the profitability of RBA in particular representative of the entire banking community, this study was provide help to individual banks as well as policy-making levels of state and national government where questions concerning matters such as usury laws and price (interest rate) controls appear to be taking a disproportionately large amount of time and effort to resolve.Goddard, Molyneux and Wilson (2004) determined the dynamic panel and cross-sectional regressions used to estimate growth and profit equations for a sample of commercial, savings, and co-operative banks from five major European Union countries during the mid-1990s. Methodologically unified the growth and profit strands in the previous empirical literature. Profit was an important prerequisite for future growth. High capital assets ratio tendency grow slowly in banking sector, and growth was connected to macroeconomic conditions. There were few systematic influences on bank growth. The resolution of profit appears higher for savings and co-operative banks than for commercial banks has attempted to unify the growth and profit strands in the literature by examining the performance of European banks during the 1990s. It reported univariate, bivariate, and multivariate versions of a two-equation model, which attempts to capture two-way causality between growth and profit while controlling for a range of other determinants of bank performance.The growth regressions suggested as banks became larger in relative terms, their growth performance tended to improve further. This pattern was strongest for commercial banks.Banks that sustained high capital-assets and liquidity ratios records low profitability. There was some evidence of a positive association between concentration and profitability, but little evidence of a link between bank-level x-inefficiency and profitability. While such patterns continue, concentration in European banking exhibited a natural tendency to increase. There was proof of positive perseverance of growth, although this tends to decline when additional control variables were included in the bivariate and multivar iate growth models. The estimated coefficients on the covered profit term in the growth equations lend strong support to the notion that profit is an important sign to future growth. In the profit regressions, there was some variation in the estimated short-run between ownership types and countries. This reflected the fact that savings and co-operative banks are subject to various business and geographical restrictions that smother competition. The study favored the SCP hypothesis of a positive association between concentration and profitability, but little apparent relationship between bank level inefficiency and profitability.In Latin America, Gelos (2006) studied the determinants of bank interest margins using bank and country level data. Author found that spreads are large because of relatively high interest rates because of macroeconomic risk, including from inflation, less efficient banks, and higher reserve requirements.In a study of United States banks for the period 1989-93 , Angbazo (1997) found that net interest margins reflect primarily credit. In addition, there was evidence that net interest margins are positively related to core capital, non-interest bearing reserves, and management quality, but negatively related to liquidity risk.Ho and Saunders (1981) applied the model of to analyze the determinants of interest margins in six countries of the European Union and the US during the period 1988-95. Authors found that macroeconomic volatility and regulations have a significant impact on bank interest rate margins. The results also suggested an important trade-off between ensuring bank solvency, defined by high capital to asset ratios, and lowering the cost of financial services to consumers, as measured by low interest rate margins.Athanasoglou, Delis and Staikouras (2006) applied a dynamic panel data model to study the performance of Greek banks over the period 1985-2001, and find some profit persistence, a result that signal that the market struc ture not perfectly competitive. The results also showed that the profitability of Greek banks shaped by bank-specific factors and macroeconomic control variables, which were not under the direct control of bank management and industry formation, did not appear to significantly affect profitability.Athanasoglou (2008) studied the profitability behavior of the south eastern European banking industry over the period 1998-2002. The empirical result suggested that the enhancement of bank profitability in those countries requires new standards in risk management and operating efficiency, which, according to the evidence presented in the paper, crucially affect profits. A key result that effect market concentration was positive, while the picture regarding macroeconomic variables was mixed.A number of studies have emphasized the relation between macroeconomic variables and bank risk. Saunders and Allen (2004) surveyed on pro-cyclicality in operational, credit, and market risk exposures. Su ch cyclical effects mainly results from systematic risk originate from common macroeconomic influences or from interdependencies across firms as financial markets and institutions consolidate internationally. It ultimately exacerbates business cycle fluctuations due to adverse effects on bank lending capacity.Using equity returns data over the period 1973-2003, Allen and Bali (2004) examined the disastrous risk of financial institutions. Results suggested evidence of pro-cyclicality in both tragic and operational risk measurements, implying that macroeconomic, systematic, and environmental factors play a considerable role in determining the risk and returns of financial institutions.Pi and Timme (1993) investigated the relationship of concentration of decision management and control in one person on the cost efficiency level of the bank and return on assets. On the basis of the study found that the banks whose Chairman and CEO be same person had significantly less efficiency than th ose banks that possessed not similar governance structure and show that performance was affected by top management structure.Isik and Hassan (2003) estimated cost, allocate, technical, pure technical and scale efficiency of Turkish banking industry from 1988 to 1996. This study considered capital, loan able funds as bank short-term loans, long-term loans, risk adjustment off balance sheet items and other earning assets as output of bank.Thistle, McLeod and Conrad (1989) have found that (a) balance sheet composition depends on both the level and change in interest rates , (b) banks response to changes in interest rates in different, depending on whether rates are rising or falling.Authors determined the relation between banks portfolio of assets and liabilities and interest rate was stable. Several possible caused of instability. The econometric techniques employed allow for continuous change in the structure of the empirical model. The study found that the portfolio-interest rate re lationship depends on the level of interest rates and exogenous assets, as well as their rate and direction of changeSamy Ben Naceur (2005) investigated the impact of banks characteristics, financial structure and macroeconomic indicators on banks net interest margins and profitability in the Tunisian banking industry for the 1980-2000 periods. The study found individual bank characteristics explained a substantial part of the within-country variation in bank interest margins and profitability. High interest margin and profitability tend to be associated with banks that hold a relatively high amount of capital, and with large overheads. The study found that the inflation had a positive force for net interest margin while economic growth has no incidence. Another factor was financial structure and its impact on banks interest margin and profitability found that concentration be less beneficial to the Tunisian commercial banks than competition whereas for stock market development had a positive effect on bank profitability. This reflected the corresponding between bank and stock market growth. The study found that the disintermediation of the Tunisian financial system was favorable to the banking sector profitability.Some authors examined on banking of south European region, the determinants of bank interest margins adopt two alternative modeling frameworks used dealership approach and a micro-model of the banking-firm approach, study found bank as a dynamic dealer, setting interest rates on loans and deposits to balance the asymmetric arrival of loan demands and deposit supplies by Staikouras. The bank interest margins were shown to be fees charged by banks for the provision of liquidity. The alternative approach was the micro-model of the banking firm, the study found the banking firm in a static way, setting where demands and supplies of deposits and loans simultaneously clear both markets.Choi, Elyasiani and Kopecky (1992) estimated a multi-index model that considered market risk, interest sensitivity, and exchange rate risk of commercial bank stock returns. Dummy models were used to separate the period of pre- and post-October 1979 and to split the results attributable to money center banks from other banks. A significant exchange rate effect occurs for money center banks after October 1979, while interest sensitivity was stronger before October 1979. The exchange rate effect was attributing to raised hedge foreign loan exposure of money center banks.The bank profitability typically measured by the return on assets (ROA) and/or the return on equity, usually expressed as a function of internal and external determinants. Internal determinant factors that were mainly influenced by a banks management decisions and policy objectives. Such profitability determinants are the level of liquidity, provisioning policy, capital adequacy, expenses management, and bank size. On the other hand, the external determinants, both industry and macroecono mic related, also known variables that reflect the economic and legal environments where the financial institution operates.By Bourke (1989) determined Liquidity risk, arising from the possible inability of a bank to accommodate. Decreased in liabilities or to fund increases on the assets side of the balance sheet, considered an important determinant of bank profitability. The loans market, especially credit to households and firms, risky and has a greater expected return than other bank assets, such as government securities. That expected a positive relationship between liquidity and profitability.Duca and McLaughlin (1990) studied that variations in bank profitability were largely attributable to variations in credit risk, since increased exposure to credit risk normally associated with decreased firm profitability.Miller and Noulas (1997) suggested that the more financial institutions are exposed to high risk loans, the higher the accumulation of unskilled loans and the lower th e profitability. Even though leverage (capitalization) has been demonstrated to be important in explaining the performance of financial institutions, its impact on bank profitability was ambiguous. As lower capital ratios suggest a relatively risky position, one might expect a negative coefficient on this variable.Molyneux and Thornton (1992) observed a positive relationship, suggesting that high profits earned by firms be appropriated in the form of higher payroll expenditures paid to more productive human capital. It should be appealing to identify the dominant effect, in a developing banking environment like Malaysia.Authors used Bank size to capture potential economies or diseconomies of scale in the banking sector. The variable controls for cost differences and product and risk diversification according to the size of the financial institution. The first factor could lead to a positive relationship between size and bank profitability were significant economies of scale, while t he second factor negative one was increased diversification leads to lower credit risk and lower returns.Berger, Hanweck, Humphery (1987) discussed that marginal cost savings can be achieved by increasing the size of the banking firm, especially as markets develop.Eichengreen and Gibson (2001) suggested that the effect of a growing banks size on profitability may be positive up to a certain limit. Beyond the point, the effect of size was negative due to bureaucratic and other reasons.Bank profitability be sensitive to macroeconomic conditions despite the trend in the industry towards greater geographic diversification and larger use of financial engineering techniques to manage risk associated with business cycle forecasting. Generally, higher economic growth encourages bank to lend more and permits them to charge higher margins, as well as improving the quality of their assets.2.1 The Determinants of Bank PerformanceStudies on the determinants of banks interest margin and profitabi lity have focused on single country sides and a panel of countries.2.1a Single country studiesAs most of the studies on bank performance are conducted in the US and emerging markets.Neeley and Wheelock (1997) explored the profitability of a sample of insured commercial banks in the US for the 1980-1995 periods. Authors found that bank performance positively related to the annual percentage changes in the states per capita income.The main Studies on the determinants of banks performance in emerging countries were carried out in Colombia Barajas et al. (1999) document significant effects of financial liberalization on banks interest margins for the Colombian case. Although the overall spread has not declined after financial reform, the relevance of the different factors behind the bank spreads were affected by such measures. Another change linked with the liberalization process was the increase of the coefficient of loan quality after the liberalization.Afanasieff, Lhacer and Nakane ( 2002) make used of panel data techniques to uncover the main determinants of the bank interest spreads in Brazil.Ben Naceur and Goaied (2001) investigated the determinants of the Tunisian banks performances during the period 1980-1995. The research indicated that the best performing banks were those who had struggled to improve labor and capital productivity, maintained a high level of deposit accounts relative to their assets and had been able to reinforce their equity.Guru, Staunton and Balashanmugam (2002) attempted to identify the determinants of successful deposit banks in order to provide practical guide for improved profitability performance of these institutions. The study was based on a sample of 17 Malaysian commercial banks over the 1986-1995.The profitability determinants were divided in two main categories, internal determinants (liquidity, capital adequacy and expenses management) and the external determinants (ownership, firm size and external economic conditions). Th e finding of that study revealed 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.2.1b Panel country studiesThe panel country studies were focused on European companies and developed and developing countries.Molyneux and Thornton (1992) were the first to explore thoroughly the determinants of bank profitability on a set of countries. Authors used sample of 18 European countries during the 1986-1989. The finding represented a significant positive association between the return on equity and the level of interest rates in each country, bank concentration, and government ownership.Abreu and Mendes (2002) investigated the determinants of banks interest margins and profitability for some European countries in the last decade. The authors reported that well capitalized banks face lower expected bankruptcy costs and advantages translate into better profitability. Although with a negative sign in all regressions, the unemployment rate was relevant in explaining bank profitability.Bashir (2000) examined the determinants of Islamic banks performance across eight Middle Eastern countries for 1993-1998. A number of internal and external factors were used to predict profitability and efficiencies. Controlling for macroeconomic environment, financial market situation and taxation, the results showed that higher leverage and large loans to asset ratios, lead to higher profitability. The author reported in his study that foreign-owned banks are more profitable that the domestic. The result also found the evidence that taxation impacts negatively bank profitability. Final result of study was that macroeconomic setting and stock market development have a positive impact on profitability.Demergu-Kunt and Huizingha (1999) examined the determinants of bank interest m argins and profitability using a bank level data for 80 countries in the 1988- 1995 period. The set of variables included several factors accounting for bank characteristics, macroeconomic conditions, taxation, regulations, financial structure, and legal indicators.The study reported that a larger ratio of bank assets to GDP and a lower market concentration ratio lead to lower margins and profits. Foreign banks have higher margins and profits than domestic banks on developing countries, while the opposite prevail in developed countries.Demergu-Kunt and Huizingha (2001) presented evidence on the impact of financial development and structure on bank profitability using bank level data for a large number of developed and developing countries over the 1990-1997 period. The study found that financial development has a very important impact on bank performance. It reported that higher bank development was related to lower bank performance. Stock market development on the other hand, leads to increased profits and margins for banks especially at lower levels of financial development, indicating complementarities between bank and stock market.CHAPTER 3THEORETICAL FRAMEWORK AND HYPOTHESISThe interest rate assummed to be one of the most important factors that affect commercial banks profitability.The issue which deals in the study was the affect of market interest rate fluactuation has adversly related to commercial bank profitability.This thesis study bring opportunity to established a relationship between fluctuations in interest rates and the performance of commercial banks in Pakistan during the period of 2004- 2008.The main purpose of this study was to determine the implication of fluctuations in market interest rates on the profitability of commercial banks in Pakistan. This study provide Major causes of interest rate fluctuations The extent to which commercial banks are set to manage interest rate related risks.Major causes of Interest Rate Fluctuation were unsta ble government Policies, Unstable Economic Environment, unavailability of long-term funds, Inflation. The factors that affect the commercial bank profitability were significant mismatch in the maturity profiles of Assets and Liabilities, Frequent Interest Rate Fluctuations, under capitalization of banks, Poor Collateral of credits.Pakistans financial sector included nationalized, foreign, and private banks and Non-banking Financial Institutions (NBFIs) which include Development Finance Institutions (DFIs), Investment Banks, leasing companies, modarabas, and housing finance companies.Scheduled Banks know as also commercial bank regulated by the State Bank of Pakistan regulated through different wings, and subject to different SBP regulatory requirements such as capital and liquidity reserve requirements.Factors that affect the profitability of Commercial Banks are both Endogenous and Exogenous.Endogenous factors are within the Control of Management such as quality of man

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