The Banking Sector in Pakistan. Internal Determinants of Commercial Banks' Profitability


Academic Paper, 2014
45 Pages, Grade: 2.92

Excerpt

2
5.1.
: Total Assets (Size) have significant affect on return on equity (ROE): ... 33
5.2.
: Banks are negatively affected by Asset Quality (loans) on their return on equity (ROE):
33
5.3.
: Banks are negatively affected by Liquidity (deposits) on their return on equity (ROE):
34
5.4.
: Banks are negatively affected by Capital Adequacy (equity) on their return on equity
(ROE): 34
5.5.
: Banks are positively affected by Earning Ability (net interest income) on their return
on equity (ROE): ... 34
5.6.
Conclusion: ... 34
5.7.
Recommendations: ... 36
5.8.
Future Implications: ... 36
References ... 37
Annexure: ... 43
List of Tables:- ... 44

3
1. Chapter: Introduction
1.1.
Background:
The banking sector and its part in the financial and economic progress have captivated
noteworthy consideration since the early 1990s. As banking area is an element of economic
and financial sector so banking area of any state should be effective and well performing for
financial and economic enhancement. Banking institutions support other sectors of the overall
economy in numerous traditions which include offering payment settlement facility, turning
out to be source of finance and assisting to different sectors of overall economy to trade in
and out the product or services and so on. A financial institution is in use as a model of
financial and economical institution (Nachane, 1999) consequently banking sector is
probably the major component of any financial and economic system. The shifting in
movement of globalization has introduced different variations in the business setting and
environment. During the last decade in all over the world, banking sector has confronted a
terrific economic downturn because of fall down in the financial investment. Banking
institutions are rated on the basis of their profitability, organization advancement & gross
margin (Singh, 1974). To build up surplus, resources and make them readily accessible for
financial investment is their most important purpose (Oldfield, 1976). By means of lending
and acquire cost in relative to their size they make revenues (Acharya, 2003) which means
superior the banks, superior would be the profitability and their expenses. The competition
surrounded by domestic and worldwide financial institutions and variations in technology
leads to the major adjustments in banks' financial and monetary surroundings (Spathis,
Kosmidoua and Doumposa 2002). Therefore in business world, make out their effect on
profitability of banks is the foremost study purpose (Baggs & Brandor, 2006).
Overall efficiency and effectiveness of financial institutions gets a substantial volume of
consideration from the finance journalism. The overall efficiency and performance of bank is
expressed in numerous conditions which include level of competition, focus, performance,
efficiency and profitability. Companies with improved efficiency are superior capable to
resist unfavorable settlement that lead to the soundness of economic and financial structure
(Athanasoglou et al, 2008). The banking profitability sector has long been in the list of
scorching challenges of financial surroundings. Since the banking sector perform a significant
function in the financial structure of the state and that supports the competitiveness of the
economic and financial establishments. Provided the connection among the benefit of the

4
financial system and the expansion of overall financial system (Levine, 1998). Understanding
of aspects that affect the profitability of financial system is important not just to the
professionals of the banking institutions, but also for various stakeholders including the
financial institutions, governments, bankers associations and various economic authorities.
Expertise in these aspects might be beneficial in supporting the regulatory authorities and
financial institution professionals formulate long run procedures aimed toward strengthening
the profitability of the banking system.
Several analysts in various nations have built exploration in this zone by taking into
consideration the significance as well as the challenge of profitability in banking sector. By
way of example, analysis carried out by Goddered, (2004) by utilizing panel data and
effective panel evaluation to analyze factors affecting profitability in European countries
banking sector; Denmark, France, Germany, Italy, Spain and the UK, the period of 1992-
1998. Ending outcome recommended that affecting determinants on profitability integrate;
size, capital asset ratio, credit risk and ownership, by assessing profitability in tenure of
return on equity (ROE), analyzed that profitability and bank particular determinant
relationship is extremely solid. Eventually they verified that there is minor indication of an
organized relationship among business particular factors (i.e ownership) form and
profitability.
In Sub-Sahara Africans (SSA) nation's financial sector context, the commercial banks
profitability is affected by various interior and exterior components. For example, study
carried out by Flamini (2009) applied a model of 389 financial institutions in 41 SSA nations
to check the factors affecting bank profitability measured through after tax profits to total
assets (ROA) ratio. Results revealed that the financial institutions particular, sector specific
and micro economic determinants influenced the bank return of profitability in solid way.
Eventually they sum up that banks' profitability is considerable and significant in Sub-
Saharan Africa in comparison with other areas.
In Ethiopia, commercial banks perform significant key function as economic and financial
intermediaries in the financial progress approach, using resources from accumulator to rustler
for investment. As economic and financial intermediaries, financial institution performs a
vital function in the overall economy procedure. In this way, industrial banks are important
suppliers of resources as well as their steadiness are of paramount significance towards the
financial structure. Therefore, knowledge of profitability determinants as well as drivers of

5
bank profitability for that case is important towards the steadiness of your financial state. On
the other hand, considerable volume of research have not carried out to analyze the position
of bank profitability and also the determinants of profitability in the Ethiopian banking
structures (Brihanu. T, 2012).
1.1.1.
Pakistan Banking Structure:
Commercial banks are dominating the financial structure of Pakistan. The banking system
framework of Pakistan underwent substantial adjustments right later 1997 when the
supervision of banks approach was associated with the global most effective techniques.
Noticeable adjustments in the possession, framework and focus within the banking sector
introduced by the public sector banks privatization. Structural and macro economic factors of
trade and industry process stability are receiving rising attention both equally domestically
and globally. The magnitude and mobility of global capital flows have built it progressively
essential to reinforce the foundations of domestic financial system as a way to build up the
flexibility to capital flow volatility. Therefore the soundness of financial system specially the
banking structure is an essential aspect of the infrastructure of the powerful macroeconomic
financial policy effectiveness in the nationwide amount.
The Banking area functions as the core feature and aspect of recent financial business
economic growth to offer serious finance supply. The profitability theory is a lot more
significant equally for the non economical and economical establishments, therefore financial
institutions tend to be the component of them. Banks mostly rely on competitive promoting
approach that establishes their achievement and development. Bank efficiency has become
one of the major considerations of management professionals. This issue intently pertains to
the numerous affect on the business profitability of organizations generally, and particularly
commercial banks on the prospective progress of the overall economy. Because of this, the
protocols have progressed an entire lot in comparison to the way in which they were within
the many years long gone in the banking enterprise (Hussain and Bhatti, 2010).
Banks soundness and effectiveness is expressed by numerous phrases, which include
competiveness, effectiveness, efficiency and profitability. Companies with improved
effectiveness are much better capable to resist unfavorable shocks and lead to steadiness in
the financial system. The profitability in the financial structure became one of several

6
scorching concerns within financial atmosphere. Because in the financial system, banking
sector perform a significant job within the nation financial system and it supports the
competitiveness of the financial establishment.
In banking conditions, the profitability determinants are effectively noticed and explored
where as the profitability classification fluctuates in several scientific studies. Earlier
scientists have attempted to locate out the profitability determinants in favor of banking
sector where as some scientists regarded only the banking attributes. While other individuals
provided the fiscal framework and macroeconomic aspects at the same time. In all these
scientific studies the contribution experienced being designed in analyzing the aspects that
consider the design for bank's profitability.
The banking system in Pakistan viewed as totally diversified banking framework that
provides a fascinating situation. A fast look at before tax profit over banks total assets
running through the entire time underneath research produce extremely minimal levels of
profitability (Ramlall, 2009). In chapter 3, Figure-1 demonstrates factors affecting the
profitability of commercial banks that explained the internal factors affecting profitability of
banks. These determinants will focus on banks specific features includes Size, Equity, Loan,
Deposits, and Interest income.
1.2.
Problem Statement:
The current financial situation in Pakistan is well known and the banking sector of Pakistan
has undergone different financial challenges. One of the major challenge is to generate
revenues. The current study focuses on that what are the internal factors & how they are
affecting the profitability of banks in Pakistan. Therefore in this research it can be checked
that which is the main profitability determinant that affects the banking sector in Pakistan.
1.3.
Research Question:
To provide a basis to conclude the problem statement stated above the report seeks answer to
the following research problem:
Which of internal determinants are affecting the commercial banks' profitability in Pakistan?

7
How the internal determinants are affecting the commercial banks Profitability of in
Pakistan?
1.4.
Study Objective:
To analyze the internal determinants affecting profitability of 14 commercial banks of
Pakistan based on availability of data over the period of 2007 to 2012 and to recognize major
determinants of profitability is the major objective of the study. Whereas the other specific
objectives of our research are as follow:
On the way to evaluate and examine the internal determinants (size, loans, deposits, equity
and net interest income) affecting the commercial banks' profitability in Pakistan
To verify the consequences of internal determinants (size, loans, deposits, equity and net
interest income) on profitability of commercial banks
To find out the significant determinants of profitability throughout commercial banking
sector.
1.5.
Significance of Study:
The main study purpose is to observe data empirically, by means of pooled data analysis,
whether profitability of commercial banks is interrelated to selected internal determinants in
compliance with the commonly accepted finance theory. This paper aims at focusing this
knowledge gap by examining how internal determinants in turns impacts on profitability.
Specifically, this research has significance to the following areas:
It allows strategy makers and administration system of your banking institutions to regulate
the system of bank administration.
For administration it might help in the direction of hedge towards adverse aspects include
unpredictability and also complementarities that strengthen overall efficiency and
performance.
Furthermore, help the traders in evaluation of overall efficiencies.
Also help the newcomers whose have an interest to perform their study in
this region.

8
It will eventually give a ground plan for professionals to evaluate the financial effectiveness
with regards to profitability and internal determinants.
Also provide guidance in favor of financial strategy makers to evaluate the banking sector
effects on overall performance in the economic system and its implications on the problems
of strategy.
1.6.
Limitations of the Study:
This study add some of the factors in the field of commercial to improve the profitability of
banks but yet there is much to be done as the data available is not 100% reliable as ever so
the results are usually doubtful in such scenarios. Following are some limitations of this
study:
This study is based on the financial statements of the banks available on their official
websites, so it is possible that the available data really don't explain all the truth of the
organization and so the research is limited to that available statement and data in it.
Some of the factors have been studied related to profitability of banks and not all of them so
that is also a limitation of the study as it does not define all the factor's effect on the banks'
profitability. But the banks' profitability is not limited to only these factors which have been
studied.
Another limitation is that very less amount of work has been done on the impact
of profitability with reference to its internal determinants of commercial banks in Pakistan.
Therefore, it was not possible to obtain a large amount of theories on a country to make
comparative analysis on the results.

9
2.
Chapter: Literature Review
A variety of determinants control banks' profitability. Acknowledging the basic concept of
the banking sector's profitability and its determinants is a main give verification to maintain
the realistic results of the hypothetical and observed views. Therefore, this part serves as a
support for this study by telling the factors that might manipulate bank's profitability
.
Literature review explains many evidences which recognize the major determinants of bank's
profitability. In this section we would be discussing about the studies which have been done
previously on the determinants of bank's profitability and would be discussing our point of
view in accordance with the old theories.
DETERMINANTS OF COMMERCIAL BANKS PROFITABILITY:
With regards to the primary target of the research, the elaboration of the different financial
gain actions and determinants theories that has been thought of in other connected research is
extremely important towards realization from the aspects to get investigated during this
research. There are actually several research papers on determinants of profitability of
economic financial institutions. Several of the investigation papers centered on one nation
and other individuals also concentrated on panel of nations. Although the underlining simple
facts of such papers would be that the financial gain measurements which also function as the
dependent variable while in the profitability designs are in the shape of ratios. Devinaga
Rasiah (2010) documented that many researchers who concentrated their research on this
location are by way of example, Demirguc-Kunt and Huizinga (1999), Bikker and
Metzemakers (2004), Davis and Zhu (2005) divide the determinants of business financial
institutions efficiency and profitability into two groups hence, the interior as well as exterior
aspects.
2.1.
Profitability Measure (ROE):
In the majority of study papers associated with this research, the profitability is calculated in
the shape of ratios which can be generally described by business financial institutions of their
yearly studies. Devinaga Rasiah (2010) statements which the use profitability ratios are
usually not affect by adjustments in value amounts. And it is claimed to be one of the most
acceptable technique for measuring profitability as just one utilize time sequence evaluation.
This is due to the actual worth of gains can't be influenced with the various inflation prices.

10
In accordance with Devinaga Rasiah (2010) for one particular to realize how effectively a
financial institution is accomplishing it is actually considerably more beneficial to think about
(ROA) and (ROE) and Molyneux and Thornton (1992).
ROE is claimed to evaluate the speed of return over the financial institution's shareholders
equity and it is actually calculated by dividing financial institutions net profits just after taxes
by whole equity cash which incorporates frequent and desired inventory, surplus, undivided
income, and cash reserves; Bourke (1989), and Molyneux and Thornton (1992).
This evaluate of profitability provides a sign of just what the financial institutions earns about
the shareholders' investment decision; Devinaga Rasiah (2010). In accordance with Anthony
Karkrah and Ameyaw (2010) several researchers have introduced ROA being an acceptable
evaluate of financial institutions profitability. Amongst them are Rivard and Thomas (1997)
who argued that financial institution profitability is most effective calculated by ROA inside
the perception that, ROA can't be distorted by significant equity multiplier? On the other
hand, Hassan and Bashir (2003) also statements that ROA are generally reduced for
economic intermediaries, most financial institutions greatly used money leverage to improve
their ROE to aggressive concentrations. (ROA) would be the ratio of net cash flow just after
taxes divided by overall assets. The ROA signifies managerial performance to put it
differently it depicts how powerful and successful the administration of financial institutions
has become since they search for to rework property into earnings. As well as the greater
ratio suggests the upper efficiency from the financial institutions. It is actually a great tool for
evaluating profitability of one financial institution with other or the entire industrial banking
technique.
2.2.
Size:
Ayanda, Cgristopher & Mudashiru (2013) conducted their research on determinants of bank's
profitability in a developing economy of Nigeria and the results revealed that bank size and
cost efficiency are not significantly determine the profitability of banks in Nigeria. On the
other hand, credit risk and capital adequacy showed the important affect on profitability of
banks both in the long go and short goes respectively. At the same time as deposits affects the
bank's profitability in short run. Ameur & Mhiri (2013) recognized the factors explaining
Tunisian bank performance by keeping the main 10 commercial Tunisian banks during the
period of 1998 to 2011. The experimental results revealed a heavy quantity of perseverance
Excerpt out of 45 pages

Details

Title
The Banking Sector in Pakistan. Internal Determinants of Commercial Banks' Profitability
Grade
2.92
Author
Year
2014
Pages
45
Catalog Number
V375955
ISBN (eBook)
9783668535909
ISBN (Book)
9783668535916
File size
1218 KB
Language
English
Notes
The author of this paper is not a native English speaker. We kindly ask for your understanding concerning any errors and inconsistencies in grammar or expression.
Tags
banking, sector, pakistan, internal, determinants, commercial, banks, profitability
Quote paper
Saira Anis (Author), 2014, The Banking Sector in Pakistan. Internal Determinants of Commercial Banks' Profitability, Munich, GRIN Verlag, https://www.grin.com/document/375955

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