Effect of Interest Rates and Bank Size on Profitability of Islamic Banks in an Interactive Model

43 Pages Posted: 27 Jul 2020 Last revised: 10 May 2022

See all articles by Muhammad Muzammil

Muhammad Muzammil

Karachi University Business School

Danish Ahmed Siddiqui

University of Karachi - Karachi University Business School

Date Written: July 2, 2020

Abstract

This paper is aimed at studying the role of interest rates and bank size along with other macroeconomic and firm-level factors in determining the Islamic bank's profitability. We also explored the intricate complementarities of these two factors in the relationship between Profitability and bank-level factors. Other macro variables like GDP, Inflation and Exchange rate were taken as control. We have used the interaction effect of Bank-level variables like spread, efficiency, default risk, capital adequacy, liquidity, and leverage which were taken as predictors on profitability. Profitability was measured by Return on Asset and Equity. Data from full fledge Islamic banks in Pakistan was taken during the period of 2006-2018. These Islamic banks included were Al Baraka Bank Pakistan Ltd, BankIslamiPakistan Ltd (BIPL), Dubai Islamic Bank Pakistan Ltd (DIB), and Meezan Bank Limited. The regression analysis shows there is a significant impact of macroeconomic indicators, bank-specific variables, and interaction effect of interest and size on the Islamic bank's profitability. The interest rate and exchange rate have a negative and significant impact on ROE. Whereas Asset Quality, Gearing, and Capital Adequacy seem to have a positive and significant effect on profitability. Bank specific variables such as credit risk, spread ratio, and size also seem to negatively affect profitability. With regards to interaction effect, both size and interest rate seems to complement the effect of Asset Quality, Credit Risk, Spread Ratio on Profitability. However, both size and interest rates have a negative complementary with gearing in predicting profitability. Therefore, this study will help the policymakers, regulars, and bank management to identify the key drivers of profitability so they can increase the profitability of Islamic Banks in Pakistan.

Keywords: Bank Size, Spread, Efficiency, Default Risk and Leverage, Profitability, Interest Rate, Credit Risk, Pakistan, Complementarities, Interaction

Suggested Citation

Muzammil, Muhammad and Siddiqui, Danish Ahmed, Effect of Interest Rates and Bank Size on Profitability of Islamic Banks in an Interactive Model (July 2, 2020). Available at SSRN: https://ssrn.com/abstract=3641634 or http://dx.doi.org/10.2139/ssrn.3641634

Muhammad Muzammil

Karachi University Business School ( email )

Karachi University
Karachi, Sindh
Pakistan

Danish Ahmed Siddiqui (Contact Author)

University of Karachi - Karachi University Business School ( email )

University Road
Karachi, Sindh 75270
Pakistan
3333485884 (Phone)

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