Interest Spread and the Banking Sector Profitability- An Empirical Investigation for Pakistan

Abstract

The paper is an empirical exploration around the commercial banks’ interest spread and the profitability performance for Pakistani banking industry. Earlier studies have evidently proven the sensitivity of commercial banks financial performance towards the gap between their deposit rate and the lending rate. The present study therefore aims at validating (invalidating) the subject relationship using advance time-series econometric procedures. The study attempts to yield a robust statistical analysis since three different measures of banks’ profitability are employed for the purpose of econometric testing i.e. return on assets, return on equity and earnings per share. The study sample comprises seven major participants from commercial banking sector of Pakistan and the sample study period rangers from year 2002 to 2018. From the series of robust regression models, Newey-West Hetroskedasticity and Autocorrelation Consistent (HAC) estimator is used to test the hypothesized relationship. Valid statistical support is yielded in case of all three measures of profitability; however, return on assets as indicator of profitability receives highest amount of statistical support. The results hold strong policy implications for commercial banking sector of the country, calling for wise management decisions whilst deciding the deposit and the lending and rates since they are key to determining the interest spread observed by a bank which in return determines its profitability margins.