Determinants of Profitability of Banks in PakistanA THESIS SUBMITTED TO THE PUNJAB COLLEGE OF COMMERECE(UNIVERSITY OF CENTRAL PUNJAB)IN FULFILLMENT OF THE REQUIREMENT FOR THE DEGREEMASTERS IN COMMERCE (ACCOUNTING & FINANCE)BYAmmar Shehzad0067Supervisor: Faisal Abbas

PUNJAB COLLEGE OF COMMERECEUniversity of Central Punjab2014

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Certified that the research work contained in this thesis Determinants of Profitability of Banks in Pakistan has been carried out and completed by Ammar Shehzad Reg # S4F12MCOM0067 under my supervision during his masters of commerce.

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Certified that quantum and quality of the research work contained in the thesis determinants of profitability of banks in Pakistan adequate for the award of degree of Masters of Commerce.

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Declaration:

I, Ammar ShehzadReg No S4F12MCOM0067, Student of masters of commerce during the session of 2012-2014, hereby declare that the matter printed in the dissertation titled Determinants of profitability of banks in Pakistan is my own work and has not been printed, published and submitted as research work in any form in any university, research institute etc in Pakistan or Abroad.

Dedication:

I would like to dedicate this report to my dear parents and respected teachers who guided me through my studying carrier and still doing their best for me. To be here in this institution at this level I am just because of my parents, especially their training, guidance, love, affection and motivation. I pray that I can serve my parents as best as I can.

ACKNOWLEDGEMENT

First of all I am very thankful to Almighty ALLAH who gave me courage and confidence to making this dissertation. I am also thankful to respected Sir Faisal &Sir Irfan Saad in the UCP campus sargodha, who gave me chance and opportunity to make such a professional project, in which I analyze the entire scenario regarding food industry. They have been a steady source of track throughout the course of this whole internship. Their innumerable ideas were precious and gave me with an insight to the path, which was off the beaten track otherwise. I have yet to see the limits of their sympathetic, stamina and altruistic concerns for me. I am especially thankful to my parents and friends for giving me the silent support in terms of courage and strength that I needed to accomplish my goals. Words might not be adequate to express my feelings towards them.

Abbreviations listOLS ordinary least squareLRM linear regression modelROA return on assetROE return on equityTLTA total liability to total assetAQR asset quality ratioCATA current asset to total assetLR liquidity ratioKSE Karachi stock exchangeSBP state bank of PakistanPROB probabilityGDP gross domestic productCOEF coefficientSTD ERR standard errorADJ adjustedOBS observationLOG logarithmCONS constant

TitlePage

FRONT COVERI

RESEARCH COMPLETION CERTIFICATEII

CERTIFICATE OF EXAMINERSIII

DECLARATOIONIV

DEDICATIONV

ACKNOWLEDGEMENTVI

TABLE OF CONTENTVIII

ABSTRACTIX

Chapter I Introduction

Introduction1.1 History of Banking sector of Pakistan1.2 Performance of banks1.3 Objectives 1.4 Problem statement 1.5 Significance of study89181819

Chapter II Literature Review

2.1 Literature Review20

Chapter III Research Methodology

3.1 Dependent variables 3.2 Independent variables 3.3 Equations303032

Chapter IV Data Analysis

4.1 Results and Discussions 4.2 First model 4.3 Second model 333335

Chapter V Conclusion Discussions

5.1 Conclusion36

References38

AbstractThe major aim of the study is to find out the determinants of the profitability of banks in Pakistan. Secondary data on financial reports is collected from 29 banks of Pakistan for the period 2007 to 2011.The study is quantitative in nature. Number of observations in this study are 145 . Ordinary least square regression has been adopted in this study.This paper is about Pakistani banks to study some factors of banks that are considered as determinants of profitability of banks.Two equation has been developed for this study .In ist equation Return on Equity ratio has been taken as dependent variable, whereas Total Liability toTotal Asset, asset quality ratio ,Current asset to Total Asset, Taxes , and liquidity ratio have been taken as independent variables While in 2nd equation Return on Asset has been taken as dependent variable while ,current ratio, total liability to total asset ,asset quality ratio ,current asset to total asset, taxes and liquidity are taken as independent variables.Key words Determinants, Profitability, Banks, Pakistan, Karachi stock exchange, asset quality ratio

1. Chapter 1Introduction1.1 History of Banking Sector of PAKISTANAs a country's banking sector no doubt plays a significant role in enhancing economic activities and economic development in general, the failure of its performance has proven to bring about a devastating impact on the economy at large. Recent economic evolutions associated with recent economic crisis sourced primarily from the global banking sector stand clear in one's mind for proof. In response to the crisis, banking sectors across the globe have come under tight scrutiny by statutory regulations that were often criticized for having a negative impact on banks' performance and profitability. This has in return provoked a number of studies focusing on analyzing banks performance that is widely seen in banking performance analysis literature to have been influenced by a range of internal variables (called also bank-specific variables) and external variables including those related to the financial market structure in which banks operate as well as the broader macroeconomic indicators. Financial sector has a precious role in the economic development of any country. As banking sector is part of financial sector so banking sector of any country should be sound and well working for economic development. Banks help many other sectors of the economy through different ways such as becoming source of finance, giving facility of payments settlement and aiding to various parts of economy to export and import their product etc. Banking sector of Pakistan includes both local, foreign banks and Islamic banks. There are some specialized and public sector banks also functioning in Pakistan. Banking sector of Pakistan has witnessed a huge change in terms of growth and development during the period of 64 years. After the independence, banking sector of Pakistan faced shortage of resources and uncertainty because of political and various other problems.

1.2Performance of BanksTo form financial sector of Pakistan the state bank of Pakistan was came into view on Ist July 1948 as central bank of the country. After this through SBP ACT 1956 regulatory and different amendments were formed for the purpose of development of banking sector. In 1974 nationalization of almost private banks was done by government and this nationalization crumbled the operation of banking sector due to bad quality of banking products and services. In the decade of 1990s banks were once more privatized under the reform policy of banking sector. Now forty banks were working all over Pakistan by the end of June 2010 according to report of state bank of Pakistan and out of these forty banks only four banks are owned by public sector and their total number of branches were one thousand six hundred and twenty one only. Total numbers of local private banks were twenty five and their total numbers of branches were six thousand eight hundred and fifty only. Moreover total numbers of foreign banks were seven and their total numbers of branches were eighty. Specialized banks were four having five hundred and thirty six branches. All statistics given above have been taken from state bank of Pakistan. Pakistani banking sector has shown significant growth in recent financial years. Since 1980 total assets of banking have been increasing fastly despite immense problems to banking sector.

Table 1

Table.1 is representing the data of total assets of all commercial banks of Pakistan from 2000 2010 at glance. In 2000 the total number of assets owned by all commercial banks were 2,637,176 in millions and now in 2010 the assets owned by commercial banks have increased upto 11,704,800 witnessing a growth almost 343 percent growth over last ten financial years.

Figure.1 is the representation of assets of all commercial banks over the last ten years. Despite world recession in 2008 the banking sector of Pakistan suffered less as compare to other sectors of economy and after a minor setback in 2008, the banking industry again witnessed growing trend in assets.

Table.2 is the tabulated representation of growth in assets of commercial banks yearly and figure depiction of yearly growth of assets of commercial banks. Highest growth in assets of commercial banks was observed in 2006 over the last ten years as cleared from table.2 andfigure.2The tendency of banking sector of Pakistan over the last few years was towards introduction and betterment of Islamic banking, privatization, competition, deregulation and mergers. Such sorts of changes in the sector have increased scope of competition and choices for consumers have also been increased. The changes mentioned posed greater challenges to banking sector of Pakistan because these rapid changes in operating environment ultimately affected the performance of banks. However, irrespective of such considerable changes in structure and substantial increase in competition, the banking sector of Pakistan had been remained under research to bring innovation, betterment in service and improved quality of product.The banking sector is well thought-out to be an important source of financing for most businesses. The common assumption, which underpins much of the financial performance research and discussion, is that increasing financial performance will lead to improved functions and actions of the Organizations. The subject of financial concert and research into its measurement is well advanced within finance and management fields. It can be argued that there are three principal factors to improve financial performance for financial institutions; the institution size, its asset management, and last one the operational efficiency.The major reforms started in banking sector of Pakistan in earlier 1990s. As the basic purpose of these reforms was to bring such change that could make them efficient and sound. Following major changes occurred due to reforms in the banking sector. Privatization of banks brought significant betterment in the quality of service through professionalism. Secondly, due to lack of innovative products and poor quality of service during nationalism era, banks were losing substantial part of profit to foreign banks. Privatization witnessed huge upward trend in profits due to more innovative product. A lot of researches has been done on the profitability of banks . Endogenous factors and exogenous factors have lot affect on the banks profitability. Endogenous factors are altered by the commercial activities and exogenous factors are affected by the variations in central banks policies, Government. The internal factors can be called as bank specific determinants of profitability and are related with the decisions and workings of the banks management. The external factors can be named as industry specific and macroeconomic determinants of profitability, and are not influenced by managements decisions and activities; but they expresses the impact of legal and economic environment that has influence on the performance and profits of a particular bank.It has been concluded from various studies that internal factors along with external factors explicate a large proportion of bank profitability . but the links among these factors cannot be same everywhere . Relationships between these factors are dissent across countries.because of the occurrence of this dissent more research is required to investigate the relationship among these factors.The following study uses panel data to study profitability of banks in Pakistan because the banking system in Pakistan has faced many technological improvements like the introduction of ATM, Credit Cards, Online Banking, and Privatization overtime. So in order to represent any rapid increased profitability that may take place overtime as technological amendments that are done in the banking industry, we will have to use time series data besides cross-section data. This will allow us to differentiate the impact of technological improvements from other factors. In effect, the panel data set grants us to study both the changes in profits of a single bank over time and the variation in profits of whole banking industry at a given point in time.The banking industry in overall has faced some intense changes in recent decades, as new additions in technology and the relentless forces driving globalization continue to create both chances for development and challenges for banking managers to remain profitable in this increasingly competitive environment. Most of the researches concerning bank profitability to date, including Short (1979), Bourke (1989), Molyneux and Thornton (1992), Demirguc-Kunt and Huizinga (2000) and Goddard, Molyneux, and Wilson (2004b), have used differentlinear models to figure out the impact of different factors that could be importantin terms of explaining profits. According to Athanasoglou and his colleagues (2005), these studies were seminal in explaining the feasibility of executing a meaningful analysis of the determinants of bank profitability, but some of the methods used by these studies doesnt get right to take into account the strong and dynamic nature of the economic environment in which they competed.Pakistans banking sector has also faced some significant changings, and has earned a rapid development. In Pakistans economy, commercial banks consider a outstanding position for being a primary source of institutional credit in the economy. They make the hub of the Pakistans financial system, as they symbolize the largest deposit institutions of the country, and act as the primary sources of short term funding in the economy.In banking terms, the determinants of profitability are well noticed and diagnosed but the definition of profitability alters in many researches . In past, researchers have strived to find out the determinants of profitability for banking sector, some researchers meditated only the banking characteristics, whereas others involved the financial structure and macroeconomic factors as well.The banks are now facing many challenges such as rapid changes in technology required for modern banking, tight prudential values , increasing competition, worrying level of NPA.s, increasing customer expectations, rising pressure on profitability, assets-liability management, liquidity and credit risk management, rising operating expenses, shortening size of spread and so on. The amendments in banking sector have also brought the profitability under pressure. RBI.s efforts to adopt international banking standards have further forced the banks to shift the focus to profitability for survival.Indeed, consolidation among banks, rising competition and continuous innovation to provide financial services, all contribute to a growing interest in a detailed critical evaluation of banks. In fact, evaluating the performance of banks is essential for managerial as well as regulatory purposes. While managers are keen to determine the outcomes of previous management decisions, bank regulators concerned about the safety and soundness of the banking system and with preserving public confidence, monitor banks performance to identify banks that are experiencing severe problems. Without persistent monitoring of performance, existing problems can remain unnoticed and could lead to financial failure in the future. Depositors may also be interested in characterizing the performance of their bank(s) since they are not entitled to fixed returns and the nominal values of their deposits are not guaranteed. Most importantly, performance evaluation is needed to provide answers to key policy questions such as: should Islamic banks be held to the same set of regulations as conventional banks? Are they relics of a bygone era, propped up by subsidies and distorting financial-sector competition? Or, are they efficient and focused financial institutions that could, if unleashed, eventually dominate the retail financial landscape?Structural, institutional, and macroeconomic aspects of financial system stability are receiving growing attention both nationally and internationally. The magnitude and mobility of international capital flows have made it increasingly important to strengthen the foundations of domestic financial system as a way to buildup flexibility to capital flow volatility. Thus the soundness of financial system, especially the banking system, is a key part of the infrastructure for strong macroeconomic and monetary policy performance at the national level.In banking terms, the determinants of profitability are well observed and explored but the definition of profitability differs in many studies. In past, researchers have tried to find out the determinants of profitability for banking sector, some researchers considered only the banking characteristics, whereas others included the financial structure and macroeconomic factors as well.Hence, profitability has become most important field to ponder for bank s management. In fact profit is an valuable criteria to measure the functioning of banks in addition to productivity, financial and operational efficiency.

Naveed et al (2011), shows that the competence of financial intermediation and shift of risk can have an effect on economic growth while at the same time institutional insolvencies can result in universal crises which have adverse penalties for the economy all together.Bell et al. (1997) compete that high performance and obligations are possible outcomes in organizations that are intended for high participation but may not take place if environmental conditions are critical.The performance of any business firm not only plays the part to boost the market value of that specific firm but also leads towards the growth of the whole sector which ultimately leads towards the overall affluence of the economy. Assessing the determinants of performance of insurers has achieved the significance in the corporate finance literature because as mediators , these companies are not only providing the method of risk transfer, but also helps to channelize the funds in an suitable way to hold up the business actions in the economy. However, it has established little concentration mainly in developing economies (Ahmed et al, 2011)One of the major determinants of a banks profitability is its capital structure. In this respect, the empirical literature devoted to the analysis of a banks profitability has mostly given importance to a monotonic linear relationship among the banks capital structure and its working (Chaudhry et al., 1995, Goddard et al., 2004, Molyneux and Thornton, 1992).Regulators and supervisory entities that set minimums for equity capital, and establish other types of regulations in order to deter excessive risk taking, can affect the banks capital structure decisions, and hence its earnings. The regulators establish the conditions of entry to the banking industry, the compliance with the capital ratios and liquidity rules, the enforcement of the larger exposure rules in the foreign exchange market, and the right of inspection (Valdez, 2007).Nienhaus (1983) tried tolink the profitability of Islamic banks with the market structure. Based on his simplisticequilibrium model, he postulated that the profit-sharing ratio (the percentage of profit paid bythe entrepreneur) of Islamic banks was positively related to the lending rate of theconventional banks.Hassan and Bashir (2003) studied the effects ofproscribed and uncontrolled variables on Islamic banks profitability. While factors such ascapital, overhead, gross domestic product and conventional interest rates were confidentlyrelated to profitability; loan ratios, reserves taxes, and size were adversely related.According to Athanasoglou and his colleagues (2005),these studies were seminal in demonstrating the feasibility of conducting a meaningful analysis of the determinants of bank profitability, but some of the methods used by these studies failed to take into account the robust and dynamic nature of the economic environment in which they competed. Berger and Deyoung (2006) emphasize that, Banks have embraced substantial advances in both physical and financial technologies during the past two decades, andthe broader industry category of which banking is a part, Depository and Non depository Financial Institutions, is the most information technology-intensive industry in the United States (p. 1483).Saira Javaid et.al (2011) 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. The globalization of operationsand development of new technologies is taking place at a rapid pace. A paradigm shift in marketing philosophy of banks is visible from the rising focus towards quality of service for customers. All this hasled to the increase in resource productivity, increasing level of deposits, credits and profitability and decrease in non-performing assets (Charan Singh-2005).Panayiotis et al.(2005), Naceur and Goaied (2001; 2003) among others, showed that both external as well as domestic factors have contributed to growth in performance of SSA banks in the last two decades. Levine during his studies determined that If a financial system is economical, it should show betterments in profitability, enhancing the volume of funds flowing from saver to borrowers, and better quality services for consumers. The financial intermediation given by the banking sector supports economic acceleration by converting deposits into productive investments (Levine et al., 2000).They terminated that Banks mainly relies on competitive marketing strategy that ascertains their success and growth. The modalities of the banking business have altered a lot in the new millennium compared to the way they were in the years bygone (Hussain and Bhatti, 2010.Dependent variable is usually used in the study analysis of bank profits is a return on assets (ROA), return on equity (ROE), return on capital employed (ROCE) and net interest margin (NIM). This study use ROA as dependent variable. ROA is the ratio of net income to total assets. ROA measures the profit generated from the asset and reflect how well the bank's management uses real investment resources to generate profits (Naceur, 2003).Furthermore, and no less prominently, the econometric analysis in most experiential literature does not take into consideration the classical problems of endogeneity or simultaneity, and unobservable heterogeneity of the data, which are so common in studies of managerial decisions (Arellano and Bover, 1990).Furthermore, regulators and supervisory entities that set minimums for equity capital. Banks have a very important function to play in the economic operations of any country as financial intermediary. The task of providing funds to the economy makes their performance an important objective of any country. Therefore, a look into the factors that affect their profitability is important and essential to the strength of the economy (Bashir. 2000).The financial system is considered foundation of expansion and enlargement in all countries. This happens as a result of their ability to utter the financial system in that economy, by performing some significant obligations such as making possible the understanding of liquidity policies and payment system (Mendes and Abreu. A 2002) .Apart from the management of a bank, information of the fundamental internal and externalfactors that have an impact on the financial performance of a bank is essential for policy makers and bank supervisors and regulators in framing future policies aimed at civilizing the profitability of the banking sector (Kosmidou, 2008; Sufian and Chong, 2008).Wanzenried (2011) for banks in Switzerland, and Funacova and Poghosyam (2011) for Russian banks have established pessimistic relationship between liquidity and bank profitability (ROA). This implies that the determinants of bank profitability are not decisive and same across countries. Thus, the particular factors that alter the profitability of the commercial banks need to be recognized on a country base.The work by Samad (1999) is considered the establishing study, which relates efficiency and performance of Islamic banks. Comparing the efficiency of conventional and Islamic banks, Samadoriginated that Islamic banks be disposed to become incompetent when operating within the dual banking environment. Applying financial ratios in their works, Samad and Hassan (1999) practical that in some aspects, Islamic banks out performed conventional banks .During their studies Goddard and his colleagues (2004a), regardless of the growing body of research into determinants of banking profitability, there remains a scarcity of studies that have examined the specific linkage between organizational size and its impact on profitability. These authors report that, Previous studies of the dynamics of growth on the one hand, and profit on the other, have in the main developed separately, and followed contrasting empirical methodologies. Nevertheless, there are several theoretical arguments to suggest that these two performance indicators are closely related. [However], few researchers have tested for empirical relationships between growth and profit directly (Goddard et al., 2004a p. 1069).Sadaqat, Akhtar and Ali (2011) acknowledged the financial market of Pakistan as among the most unpredictable markets of world, which is packed with mystery and escapade presentation. Financial sector of Pakistan possess a widespread collection of financial institutions, which includes: brokerage houses, national savings schemes, stock exchanges, investments banks, micro-finance banks, Islamic banks and commercial banks that are offering a range of products and services.

1.3 Objectives The objective of this Paper is to find out about the main drivers of commercial banks profitability in Pakistan over the period of 2007-2011. In other words the objective is to evaluate the impact of bank specific characteristics, industry specific and macro-economic factors on the profitability of banks in Pakistan. The information provided by this Paper could also offer investors some background information on investment in the Pakistan Bankingsector. The objective of this paper is to determine the factors affect the Profitability of banks in PAKISTAN. The principle of this paper is to intimatelyobserve how internal factors such as capital ratio, bank size, asset quality, liquidity and expenses management have an effect on the banks Profitability.It is critical to determine which factors essentially determine the ROA and ROE of the banks.

1.4 Problem statementIt is widely known that, over the years Sub-Saharan African countries has been relying on the aid and grants which are being provide by the western countries. There is this believe that the western countries are having the most trusted and stabilize financial institution in the world. So one could wonder that how an underdeveloped country like Pakistan (running on aid ) in his banking institutions can still experience the profitability and stability.This has necessitated the investigation to find out the main factors contributing to the profitability and the survival of the commercial banking sector in Pakistan.

1.5 Significance of the StudyIn this study, we scrutinize a series of variables by introducing internal and external factors that may considerably affect banks profitability. Our study can The Determinants of Banks Profitability in Pakistan.As one of imperative institution in our economic section, there is a need for banking performance supervisor by the banking regulator. One of the indicators to appraise the financial performance of the bank is by looking at its profitability. It is highly related with how far the bank handle its business in proficient way. competence is measured by comparing the profit earned with asset or capital that is used to construct such profit. The higher the profitability of a bank, the financial performance is at its best (Stiawan, 2009).The indicators of measuring the level of profitability are by looking at the return on equity (ROE) and the return on asset (ROA). ROE demonstrated the ability of the management in managing the capital to produce the net income, the highest the return the higher dividend to be dispersed to the shareholders. in the meantime, ROA established the ability of the bank using the assets to generate income from its assets management (Yuliani, 2007).

Chapter 22.1Literature reviewThis section provides the overview of previous studies reviewed related to the determinants ofthe profitability of banks. Some studies were country specific and few of them considered panel of countries for reviewing the determinants of profitability.The review of the literature is defined as a broad, comprehensive, in-depth, systematic, and critical review of scholarly publications, unpublished scholarly print materials, audiovisual materials, and personal communications. Gelos (2006) studies the determinants of bank interest margins in Latin America using bank and country level data. He finds that spreads are large because of comparatively high interest rates(which in the study is a proxy for high macroeconomic risk, including from inflation), less competent banks, and advanced preserve necessities. Athanasoglou, et al.(2006) study the profitability activities of the south eastern European banking industry over the period 199802. The observed results propose that the development of bank profitability in those countries requires new principles in risk management and operating competence, which, according to the verification offered in the paper, critically influence profits. A key result is that the consequence of market concentration is positive, while the picture concerning macroeconomic variables is mixed. In the study of Bourke (1989), he established an essential affirmative relation between the capital capability and profitability. He illustrated that superior the capital ratio, more the bank will be profitable. Renbao Chen et.al (2004) examined in their investigation that higher profits provide both the means (greater availability of finance from retained profits or from the capital market) and the incentive (a high rate of return) for new investment. Therefore, we can comprehend from the above explanation that insurance companies have double liability: in one way they are required to be profitable so as to have high rate of return for new investment.Hafiz malik in his study said that Profitability is one of the most important objectives of financial management because one goal of financial management is to maximize the owner` s wealth and profitability which in turn indicates better financial performance. According to Hafiz Malik (2011) insurance plays a crucial role in nurturing commercial and infrastructural businesses. From the latter point of view it promotes financial and social stability; mobilizes and channels savings; supports trade, commerce and entrepreneurial movement and improves the quality of the lives of individuals and the overall well being in a country.Demirguc- Kunt and Huizinga (1999) performed a more widespread study which examines the determinants of banking performance for 80 countries, both developed and developing, during the period 1988-1995. They terminated that foreign banks have higher profitability than domestic banks in developing countries, while the contradictory holds in developed countries. Nevertheless, their in general results show support for the optimistic relationship between the capital ratio and financial performance. In his study of the determinants of the Tunisian banking industry profitability for 10 banks in Tunisia for the period 1980-2000, Naceur (2003) investigated that high net interest margin and profitability are expected to be related with banks with high amount of capital and large overheads. Further he also noticed that other determinants such as loans has positive and bank size has pessimistic affect on profitability. Bashir and Hassan (2003) and Staikouras and Wood (2003) explained that a higher loan ratio in fact impacts profits negatively. Vong and Chan (2006 examined the affect of internal and external factors of banks on the Macao Banking industry for 15-year period. Their outcome show that with greater capitalization, there is a low risk and high profitability for the bank. Moreover, the large banking network attains higher profitability than the smaller banking association. They initiate that loan-losses provisions influence banks profitability adversely.Ataullah et al. (2004) prepared a proportional investigation of commercial banks in India and Pakistan during 1988-1998. They found that the effectiveness score in loan based model was much higher as related to the income based model. Both countries banks have desired to progress their efficiency. Burki and Niazi (2006) examined the affect of financial reforms on the competence of state, private and foreign banks of Pakistan by using data of 40 banks for the period 1991-2000. They originate affirmative impact of banks size, interest income to earning assets and loans to deposit ratio on anticipated efficiency scores. Guru, B. K., J. Staunton, et al. (2000) conducted study to find out determinants of profitability of commercial banks in Malaysia accomplished that efficiency in super visioning the expenses of banks and market interest rate plays essential role to conclude profitability of commercial banks. Further they accomplished that to increase the profit and to lessen expenses banks must increase current account deposit on which no interest is appropriate. While advancing loans to any one, commercial banks must be enormously watchful and must have vigilant eyes on the business risk indicators.

Angbazo (1997) studied that net interest margin of banks in not altered by interest rate risk where as it more affected by default risk and this higher interest margin leads towards higher profitability of banks. The banks that have small scale of operations they are affected by both default risk and interest rate risk this in due course affect their results.Naceur (2003) performed research and concluded that massive amount of overheads earnings and huge capital has positive affect on the profitability of banks. The net interest margin and loans advances by bank have momentous and positive impact on the profitability of banks. Further, from the macroeconomic indicators size and growth have a negative impact on the profitability of commercial bank. Financial markets developments also have important impact on the profitability of commercial banks .Kosmidou (2008) researched that banks which are well capitalized and have less operating cost earn higher return on assets. Bank size only matters when macroeconomic variable are integrated in the model. Mamatzakis and Remoundos (2003) accomplished that some of the significant variables that explain banks profitability are ratio of loans to assets, ratio of equity to assets and personal operating expense of banks. These variables are also straightforwardly considered as in relation of directly to strategic planning. Further, economies of scale have constructive impact on the profitability of banks and bank size is considered as economies of scale. As an external variable the size of the market is considered as having positive affect on the profitability of banks.

Naceur and Goaied (2005) banks profitability is highly related with how much cash bank holds. Banks advances to total assets have affirmative affect on the profitability of banks where as size of banks has negative major impact on the profitability of banks. Banks profitability is also altered by stock markets because if stock market will develop then demand of advances will boosts.Williams (2003) concluded that profitability of domestic banks is indirectly associated with the market share of host country competitors whereas profitability is positively allied with GDP growth. Miller and Noulas (1997) studied the factors that affected the profitability of banks in USA for the period of 1985 to 1990 in which the size of the banks was found to be a negatively linked with profitability. The negative relationship of the size expresses the diseconomies of scale.

Kosmidou(2008acknowledged the considerable relationship of size and capital adequacy ratio, while the size is directly related with performance actions.Ali, Akhtar and Ahmed (2011) demonstrated the significant role of capital adequacy ratio, operating competence, asset management and GDP that are influencing the profitability of commercial banks in Pakistan while studying the impact of bank-specific and macro-economic factors on profitability . Akhtar, Ali and Sadaqat (2011) found advanced performance in fundamentals of assets and return which recognized that conventional banks had enhanced profitability than Islamic banks in Pakistan. Ani,W.U et.al (2012) examined the determinants of profitability of commercial banks in Nigeria for the period of ten years from 2001 to 2010 together with the observation of 147 banks. Pooled ordinary least square was used to approximate the coefficient. Study finds that bank size does not raises the profit of any commercial banks in Nigeria. Greater capital-asset ratio increases the profitability of banks. The commercial banks of Pakistan for the period of 2004-2008.Pooled ordinary least square has been used to verify the affect of internal factors includes assets, loan, equity and deposits on the profitability of banks on dependant variable called return on asset (ROA).The study found that internal factors declared above consequence the banks profitability. Bank size or total assets does not escort any profitability of commercial banks but equity and deposits have important control on the profitability of commercial banks.Abdel karim Almumani (2013) studied the internal factors that impact on the profitability of the commercial banks scheduled in Amman Stock Exchange in Jordan for the duration of 2005-2011.The study constitutes that the cost-income ratio has a majorcrash with the profitability of commercial banks in Jordan.ImadZ.Ramadan et.al (2011) took separately the determinants of profitability of 10 Jordan banks for the period of 2001-2010.They have used return on equity (ROE) and return on assets (ROA) as dependant variables and internal and external factors have been used as an independent variables and the type of data of Jordan banks is penal data. Results nominated that profitability of the Jordan banks depend upon the well capitalized banks, high loaning activities, less credit risk and cost management effectiveness. conclusion also uttered that size does not increase the profitability of Jordan banks.

Fadzlan Sufian et.al (2008) investigated the profitability of the banks in Philippines for the period of 1990-2005.The conclusion paint a picture that profitability factors have drastically impact on bank profitability. The study also showed that if the expense related behavior and credit risk raises the profitability of the banks operating in Philippines decreases and the non-interest income and capitalization both have the affirmative relationship with banks profitability. During the study undertaken the inflation increases the profit of the banks in Philippines decreases. PaoloSaona Hoffmann (2011) worked out to find the determinants of profitability of the banks operating in US for the period of 1995-2007.The study undertakes the internal and external factors disturbing the profitability of banks in US economy. The study found that there is a pessimistic relationship between the capital ratio and profitability which affirms the believe that banks are operating most cautiously and dismissing potentially profitable trading chances. The cost advantages due to the bank size do not alter the profitability of the banking industry of US. Syeda Anum JavedBukhari (2012) examined the internal and external factors that affect on the profitability of 11 commercial banks operating in Pakistan for the period of 2005-2009.The study uses the regression technique to incriminate the result with the hypothesis. The conclusion from this research paper are that internal factors impact the profitability of the commercial banks whereas external factors do not affect.

Khizar Ali et.al (2011) studied the profitability factors impacting on the profit of the 22 commercial banks both public and private working in Pakistan for the period of 2006-2009.The study used the descriptive statistics, correlation and regression analysis. Return on assets (ROA) and return on equity (ROE) have been used as dependant variables and on the other hand internal and external factors have been used as independent variables. The consequences show that when the economic growth boosts the profitability increases. And on the other side when the credit risk increases the profitability becomes lesser.DegerAlper (2011) investigated the internal and external factors of banks profitability of Turkey for the period of 2002-2010.In this study the return on assets (ROA) and return on equity (ROE) both are the dependant variables and the purpose of internal and external factors. Profitability increases when the non interest income and asset size increases. And real interest rate in the external factors has positiveresult on profitability.

Dr. Srinivas Madishetti et.al (2013) analyzed the profitability determinants of Tanzania commercial banks for the period of 2006-2012.Internal determinants use the variables like liquidity risk, credit risk, operating efficiency, business assets and capital adequacy and external determinants use the variables GDP growth rate and inflation rate. All of these variables are independent. The study found that internal variables determine the banks profitability whereas external factors do not influence the profitability of commercial banks.Abuzar (2013) premeditated the determinants of profitability of Islamic banks working in Sudan. This study found that only the internal factors have the extensive impact on the profitability of the commercial banks. Cost, liquidity and the size of the banks have the positive relationship with the bank profitability. Macroeconomic or external factors have no significant affect on profitability.Flamini et al. (2009) offer facts from 41 Sub-Saharan Africa countries that during 19982006 higher capital, credit risk, bank size and improved share of services in the bank activity, inflation, and higher prices of supplies all had positive and important consequence on profitability. Oladele et al. (2012) examined Nigerian banks profitability during the period 2005-2010 and terminate that cost to income ratio and equity to total asset both have momentous control on bank profitability. Babalola (2012) studied the profitability of 14 banks in Nigeria over the period 1999-2008 and told that optimistic impact of capital capability ratio and bank size.Olweny and Shipho (2011) assessed a sample of 38 commercial banks in Kenya over the phase from 2002 to 2008 and find that stronger capital base, higher liquidity, enhanced assets quality and condensed operational costs all develop profitability. Flamini and Schumacher (2009) investigates the determinants of bank profitability, the paper projected that higher returns on assets are connected with larger bank size, activity diversification, and private ownership. Bank returns are exaggerated by macroeconomic variables, which point out that macroeconomic policies that support low inflation and stable yield growth encourage the growth of credit. The results also indicated reasonable perseverance in profitability Vong and Chan (2006) studied the affect of bank characteristics, macroeconomic variables and financial structure on the presentation of the banking industry of Macau. The results showed that the strength of the bank's capital is of central importance in influencing profitability. A well-capitalized bank is supposed to be of lower risk and such a benefit will be translated into higher profitability. On the other hand, the quality of assets, as measured by loan-loss provision affects the workings of banks negatively. In addition, banks with a large retail deposit-taking network do not attain a level of profitability higher than those with a smaller network. Finally, with consider to macroeconomic variables, only the rate of inflation showed a great affiliation with the performance of banks.Kosmidou et al. (2006) examines the impact of bank-specific characteristics, macroeconomic circumstances and financial market structure on the profits of UK owned commercial bank during the period 1995-2002. The results showed that the potency of capital of these banks has a positive affect on profitability; and other important factors being the proficient management of expenditures and size of the bank. These bank-specific determinants are vigorousto the addition of additional macroeconomic and financial market measures of bank performance, which adds slight to the descriptive power but it seems, however, that had positive affect on profitability. Gelos (2006) investigates the determinants of bank profitability in Latin America, finds that spreads are great because of comparatively high macroeconomic risk, together with inflation, less competent banks, and higher reserve necessities. In a study of United States banks, Angbazo(1997) instituted facts that bank profitability is positively correlated to capital, non-interest income, and management quality, and negatively interrelated to liquidity risk.Zimmerman (1996) originated that management decisions, especially concerning loan portfolio concentration, were an imperative contributing factor in bank performance. Researchers commonly attribute good bank performance to quality management. Management worth is assessed in terms of senior officers consciousness and managing of the banks policies and performance. Molyneux (1993) found affirmative relationship between staff expenses and total profits. As he suggests high profits earned by firms in a synchronized industry may be appropriated in the form of higher payroll expenditures. Revell (1979) examined in his study that variations in bank profitability can be robustly explained by the level of inflation. A central circuitous control on commercial banks lies in the affect of inflation on their customers and the resultant changes in the demand for different kinds of financial services. Unanticipated rises of inflation cause cash flow difficulties for borrowers which can lead to untimely execution of loan arrangements and impetuous loan losses. Furthermore, inflation is one of the main routes through which it is probable to alter the operations and margins of banks through interest rates. Samy&Mahammad (2008) investigated the affect of specific variables connected to commercial banks of Tunisia as well as macroeconomic indicators on the profitability and financial structures effect on banking sectors profitability in Tunisia from 1980 to 2000 period.Capital competency ratio has direct effect on profitability and there is negative affect of size on profitability. There is no impact of macroeconomic indicators on banks profitability in Tunisia.Fadzlan&Muzaffar (2009) premeditated the pressure of banks internal factors and macroeconomic indicators on profitability of banks in China together with all joint stock (JSCBs) commercial banks, state owned (SOCBs) and city commercial banks during 2000 to 2005. The findings exposed that liquidity has the optimistic influence and there is also a positive control of capitalization and credit risk on the profitability of State owned banks. On commercial banks of joint stock the affect of cost on the profitability is negative. But in the case commercial banks of city the influence of size is negative and the impact of costs is also negative. Diversification affect is positive. The economic growths influence is positive and there is a negative affect of money supply growth on profitability of the state owned and city commercial banks in China.Panayiotis, Sophocles and Mattaios (2006) examined the impact of banks internal factors, industry associated factors and indicators linked to macro economy on the profitability of banks in Greek during 1985-2001. By using GMM technique, the anticipated results showed that capital, credit risk, operating exp management, inflation and productivity growth, business cycle (cyclical output) have the positive as well significant impact on the banks profitability where as there is a negative affect of size on the profitability.Bikker and Hu (2002) and Goddard et al. (2004) bond bank size to capital asset ratio, and they quarrel that higher capital ratios imitate the reliability and safety of banks and with increase in capital, profitability rises because moderately large banks be likely to raise less expensive capital, thus appearing to be more profitable. The very first researcher who felt that internal variables are the part of profitability was Bourke (1989). He integrated capital ratios, staff expenses and liquidity ratios in the internal variables for profitability. The dependent variables were included the net profit before taxes against total capital ratio and net profit before taxes against total assets ratio. According to Bourke these internal variables were interrelated to the profitability absolutely.Haslem (1968) used 64 operating ratios to determine the belongings of management, size, location and time on profitability of commercial banks. He found that all the variables have important influence on the profitability. Vernon (1971) studied on the consequence of ownership on profitability. He originated that if ownership of one bank is controlled by the owner and other bank is owned by the management. In this way, the first bank which is owned by the owner will earn a smaller amount then the second bank which is handled by the management of the bank.Guru, B. K., J. Staunton, et al. (2000) made a study to find out determinants of profitability of commercial banks in Malaysia accomplished that efficiency in fantastic visioning the expenses of banks and market interest rate plays elementary role to terminate profitability of commercial banks. Further they consummated that to enhance the profit and to lessen expenses banks must broaden current account deposit on which no interest is suitable. While advancing loans to any one, commercial banks must be extremely careful and must have observant eyes on the business risk indicators. Ali, K., M. F. Akhtar, et al. (2011) illustrated that profitability of banks can be enhanced through capable asset management and through economic growth. Further they explained that high credit risk of advances result in lesser profitability of banks. As micro variable GDP has affirmative impact on the profitability of banks. As micro indicators profitability of banks is positively by size of bank, operating efficiency and profitability is indirectly altered by credit risk.Angbazo (1997) demonstrated that net interest margin of banks in notaffected by interest rate risk where as it more altered by default risk and this higher interest margin leads towards advanced profitability of banks. The banks that have small scale of operations they are embroidered by both default risk and interest rate risk this ultimately has influence on their results.Mamatzakis and Remoundos (2003) investigated that some of the significant variables that elucidate banks profitability are ratio of loans to assets, ratio of equity to assets and personal operating expense of banks. These variables are also uncomplicatedly considered as in relation of directly to strategic planning. Further, economies of scale have positive impact on the profitability of banks and bank size is considered as economies of scale. As an external variable the size of the market is considered as having direct influence on the profitability of banks. Boudriga, Taktak and Jellouli (2009) statistically demonstrated the cross-countries factors of non performing loans (NPLs) on risk exposure. The research uses data for a panel of 59 countries over the period 2002-2006 that includes financial, economic, collective banking and legal atmosphere. The realistic results showed that greater capital adequacy ratio (CAR) appears to decrease the level of problem of non-performing loans.Nissanke and Aryeetey (1998) and Aryeeteyet al. (1997) established that incessant poor performance of banking systems in Africa could be partiallyillustrated by the high degree of financial market fragmentation and inadequateright to use to basic payment services or savings accounts. On the other hand, Nissanke and Aryeetey (2006); Dermerguc-Kunt and Huizingha (2001); and Bikker and Hu (2002) exposed that African banks have not been extensively examined and was therefore complicated to notify policy on readily well-organized banks in the continent without adequate data.Al-Haschimi (2007) studied the determinants of bank net interest margin in 10 SSA countries, and applies an accounting decomposition model as well as panel regressions. Further investigated that credit risk and operational inefficiencies explain most of the distinction in net interest margins across the region, with macroeconomic factors, having less control on performance.Rovell (1979) investigated the issue of the relationship between bank profitability and inflation. distinguished that the consequence of inflation on bank profitability depends on whether bank wages and other operating expenses boost at a more rapid rate than inflation. The question is how full-grown an economy is so that future inflation is truthfully anticipated to enable banks handle their operating costs.Perry (1992) studied that the level to which inflation has impact on bank profitability depends on whether inflation prospects are fully predictable. An inflation rate fully expected by the bank management implies that banks can properly adjust interest rates in order to enlarge their revenues quicker than their costs and thus obtain more economic profits.Saunders and Schumacher (2000) applied a model of Ho and Saunders (1981) to examine the determinants of interest margin in six European Union and US banks during the period 1988 to 1995. They further recognized that macroeconomic instability and rules have an important influence on bank interest margin. The result barbed out an imperative trade off between ensuring bank solvency, as defined by high capital to asset ratio, and lowering cost of financial services to consumers, as calculated by lower interest rate margin.Afanasieffet al. (2002) also used panel data techniques to expose the main determinants of bank functioning in Brazil and originated out that macroeconomic variables such as GDP growth rate, inflation prospects are significant in determining bank profitability over time.Another study by Abreu and Mendes (2002) on commercial bank interest margins and Profitability, for banks from four different EU countries for the period of 1986-1999 examines the impact of bank-specific variables besides other variables on profitability of banks. They concluded that well-capitalized banks have lesser bankruptcy costs and higher interest margins on assets. concerning bank-specific variables, the net interest margin reacts optimistically to operating costs and the loan-to-asset ratio has a direct affect on interest margins and profitabilityChapter 3Methodology and Data3.1 Dependent variablesROEReturn on equityThe amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested.ROE is expressed as a percentage and calculated as:

Return on Equity = Net Income/Shareholder's Equity

Net income is for the full fiscal year (before dividends paid to common stock holders but after dividends to preferred stock.) Shareholder's equity does not include preferred shares.Return on asset An indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's annual earnings by its total assets, ROA is displayed as a percentage. Sometimes this is referred to as "return on investment".

The formula for return on assets is:

3.2 Independent variablesTDTATotal debt to total assets is a leverage ratio that defines the total amount of debt relative to assets. This enables comparisons of leverage to be made across different companies.

Asset quality ratioAsset quality is related to the left-hand side of thebankbalance sheet.Bank managersare concerned with the quality of theirloanssince that provides earnings for the bank. Loan quality and asset quality are two terms with basically the same meaning Government bondsandT-billsare considered as good quality loans whereasjunk bonds,corporate creditsto lowcredit score firmsetc. are bad quality loans. A bad quality loan has a higher probability of becoming anon-performing loanwith no return. Asset quality ratio affects profitability of banks negatively. Vong and Chan (2006)Current ratioA liquidity ratio that measures a company's ability to pay short-term obligations.The Current Ratio formula is:

TaxesAtax(from the Latintaxo; "rate") is a financial charge or other levy imposed upon a taxpayer (an individual orlegal entity) by astateor the functional equivalent of a state such that failure to pay, or evasion of or resistance to collection, is punishable by law. Taxes are also imposed by manyadministrative divisions. Taxes consist ofdirectorindirect taxesand may be paid in money or as its labor equivalent.Fixed asset to total assetFixed assetA long-term tangible piece of property that a firm owns and uses in the production of its income and is not expected to be consumed or converted into cash any sooner than at least one year's time.Total asset The sum of current andlong-term assetsowned by aperson,company, or otherentity.

Current Asset to total asset Current assetInaccounting, acurrent assetis anyassetreasonably expected to be sold, consumed, or exhausted through the normal operations of a business within the currentfiscal yearor operating cycle (whichever period is longer). Typical current assets includecash,cash equivalents, short-term investments,accounts receivable, stockinventoryand the portion of prepaid liabilities which will be paid within a year.Total assetThe sumof current andlong-term assetsowned by aperson,company, or otherentity.Liquidity The degree to which an asset or security can be bought or sold in the market without affecting the asset's price. Abuzar (2013)demonstrated that liquidity has positive affect on profitability.3.3 EquationsIn ist equation Return on Equity ratio has been taken as dependent variable, whereas Total Liability toTotal Asset, asset quality ratio ,Current asset to Total Asset, Taxes , and liquidity ratio have been taken as independent variablesWhile in 2nd equation Return on Assethas been taken as dependent variable while,current ratio, total liability to total asset ,asset quality ratio ,current asset to total asset, taxes and liquidity are taken as independent variables.Ordinary least square method technique is to determine the relationship between dependent and independent variables in both equations developed for this study.

1)

In Ist regression model is the profitability of banks (dependent variable) in this paper ROE (return on equity) will be used to measure profitability, is constant, and other five are independent variables and at the end is error term.

2)

In 2nd regression model denoting Return on asset (dependent variable) while other six including total liability to total asset, current ratio, asset quality ratio , current asset to total asset liquidity ratio and taxes are independent variables.Chapter 44.1Results and discussions4.2 Ist model ROECoef.Std. Err.TP>|t|[95% Conf.Interval]

TLTA.0806356.0416057 1.94.055-.0016263 .1628975

AQR-.4247575 .1859153 -2.28.024-.7923451 -.0571699

CATA-1274.094 1070.342 -1.19.236-3390.351 842.1616

LR1275.418 1070.398 1.19.235-840.9495 3391.786

Taxes5.64e-08 1.06e-08 5.30.0003.53e-08 7.74e-08

_cons-.2341426 .0886704 -2.64.009-.4094598 -.0588255

SourceSSDfMS

Model Residual6.34520075 18.379681 51391.26904015 .132227921

Total24.7248817 144.171700568

Number of obs145

F(5 , 139)9.60

Prob> F0.0000

R-squared0.2566

Adj R-squared0.2299

Root MSE.36363

In first model the dependent variable Return on equity is regressed against independent variables Total liability to total asset , asset quality ratio, current asset to total asset, liquidity ratio and taxes. There are 145 observations of this result and the results derived from this equation are that F statistics value is falling between 5 nominator degree of freedom and 139 denominator degree of freedom. The probability value F is 0.0000 showing that its a good fit model. Value of R square in this result showing that there is 25% of contribution of independent variables in the dependent variable and Adjusted R squared value shows that 22% of variations in dependent variable are explained by the variations in independent variables.. The result showing positive and negative relationship among dependent and independent variables . There is positive significant relationship between Roe and total liability to total asset , negative significant relationship among asset quality ratio and ROE , negative insignificant relationship among current asset to total asset and Return on equity, positive significant relationship between liquidity ratio and Return on equity and positive significant relationship between Return on equity and taxes . Asset quality ratio affects profitability of banks negatively Vong and Chan (2006) . Abuzar (2013)demonstrated that liquidity has positive affect on profitability.

4.3 2nd model

ROACoef.Std. Err.TP>|t|[95% Conf.Interval]

CR.1230249.04327262.840.005.0374618.2085879

TLTA.0121454.00224415.410.000.0077081.0165828

AQR-.0564548.0097287-5.800.000-.0756913-.0372182

CATA-31.7144255.31817-0.570.567-141.095277.66641

LR

31.61038

55.33184

0.57

0.569

-77.79748

141.0182

Taxes.345e-095.42e-106.360.0002.38e-094.52e-09

-cons-.0126228.0045206-2.790.006-.0215613-.0036842

SourceSSDfMS

Model

Residual.035845194

.0472893856

138.005974199

.000342677

Total.083134579144.000577323

Number of obs145

F4, 16017.43

Prob> F0.0000

R-squared0.4312

Adj R-squared0.4064

Root MSE.01851

In second model the dependent variable Return on asset is regressed against independent variables current ratio, Total liability to total asset , asset quality ratio, current asset to total asset, liquidity ratio and taxes. There are 145 observations of this result and the results derived from this equation are that F statistics value is falling between 4 nominator degree of freedom and 160 denominator degree of freedom. The probability value F is 0.0000 showing that its a good fit model. Value of R square in this result showing that there is 43% of contribution of independent variables in the dependent variable and Adjusted R squared value shows that 40% of variations in dependent variable are explained by the variations in independent variables. According to this result current ration and return on asset ratio are positively and significantly related with one another. There is affirmative and significant relationship between total liability to total asset and Roa . Negative significant relationship is existing among return on asset and asset quality ratio. There is negative insignificant linkage between roa and current asset to total asset, positive insignificant relationship among roa and liquidity ratio and there is positive significant relationship between return on asset ratio and taxes. Abuzar (2013) demonstrated that liquidity has positive affect on profitability.Asset quality ratio affects profitability of banks negatively Vong and Chan (2006)Chapter 55.1 ConclusionThe main objective of the study was to examine the factors affecting profitability of banks in Pakistan . In this study secondary data is used for the period of 2007-2011 data of 29 banks Pakistan listed at Karachi stock exchange is used. Ist model result is showing that profitability of bank is negatively affected by Asset quality ratio and Current asset to total asset ratio. While positively affected by Total liability to total asset ratio, liquidity ratio and taxes . In ist model there is significant relationship among profitability and total liability to total asset, asset quality ratio , taxes. 2nd model result is showing that profitability of bank is negatively affected by Asset quality ratio and Current asset to total asset ratio. While positively affected by total liability to total asset, Liquidity ratio, current ratio and taxes .2nd model conclusion I that in this model much variables are significantly related with profitability of banks including liquidity, Total liability to total asset, asset quality ratio and taxes.

LimitationsFuture research needs to be done in order to improve the results of this study that among other things can be done . Following are the some limitations of this study. The data collected in this study was from our country we can increase importance of our study by collecting data from another country. The data from different countries will increase the worth of results and study also. We had not much time to develop a lengthy study so time constraint was is also the limitation of study . The data of banks collected in this study are listed at Karachi stock exchange but We can collect data from more than one stock exchange like Islamabad and Lahore stock exchange. The cross sectional data can also be used to increase our research work validity. In this study we have used linear regression model but we have many techniques which can be used for running tests so it is also the limitation of this study.

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