EFFECT OF INTEREST RATES ON PROFITABILITY OF COMMERCIAL BANKS
IN KAMPALA, UGANDA: A CASE STUDY OF BANK OF BARODA LTD.
BY
NAYEBARE JUDITH
1153-05014-00040
A RESEARCH REPORT SUBMITTED TO THE COLLEGE OF ECONOMICS AND
MANAGEMENT IN PARTI~L FULFILMENT OF THE REQUIREMENT
FOR THE AWARD OF BACHELOR'S DEGREE IN BUSINESS
ADMINISTRATION-FINANCE AND ACCOUNTING
OF KAMPALA INTERNATIONAL
UNIVERSITY
JUNE, 2018
I
DECLARATION
I Nayebare Judith, declare that this report is my original work and it has never
been submitted to any university, or similar institution of higher learning, for the
awarding of a degree, or any other academic award.
SIGNATURE ... ...... . ~ .. .' ............ ~ ... . DATE ..... \.~. J_ . 9.T..l .. ~ . f K. .. : ...... .
NAYEBARE JUDITH
1153-05014-00040
I I • I
I •
APPROVAL
I confirm that the work reported ·in this report was carried out by the candidate
under my supervision.
SIGNATUR~ ----- ------------- DATE _____ __ )_f if,)'.'f.:r~--t-~------MS. IRAU FLORENCE
(SUPERVISOR)
I I
I
ii
DEDICATION
I dedicate this research report to my parents who supported me through my
education career.
iii
ACKNOWLEDGEMENT
I would like to acknowledge and express my heartfelt gratitude to all those who
helped me complete my report and supported me throughout my studies. First of all,
I would like to thank the Almighty God for making it possible for me to complete this
report. Secondly, I thank my supervisor Ms. Irau Florence for her timeless guidance
and correction in the conduct of this research report. I am extremely grateful for all
her valuable comments and guidance throughout the process of writing my report.
Further thanks to the management of Bank of Baroda for its support in providing me
with the data and to the authors whom I have used their references in coming up
with this report. In addition, many thanks to my family and friends for their moral
support and encouragements in helping me accomplish my academic education. At
)ast, I would also like to thank Kampala International University for their excellent
and outstanding level of academic education.
'
iv
TABLE OF CONTENTS
DECLARATION .......................... : ........................................................................ i
APPROVAL ........................................................................................................ ii
DEDICATION ................................................................................................... iii
ACKNOWLEDGEMENT ....................................................................................... iv
TABLE OF CONTENTS ........................................................................................ v
LIST OF TABLES ............................................................................................. viii
LIST OF FIGURES ............................................................................................. ix
LIST OF ACRONYMS .......................................................................................... x
ABSTRACT ....................................................................................................... xi
CHAPTER ONE ............................................................................................ 1
INTRODUCTION ......................................................................................... 1
1.0 Introduction ................................................................................................ 1
1.1 Background to the study .............................................................................. 1
1.1.1 Historical perspective ................................................................................ 1
1.1.2 Theoretical perspective ............................................................................. 3
1.1.3 Conceptual perspective ............................................................................. 5
1.1.4 Contextual perspective .............................................................................. 6
1.2 Statement to the problem ............................................................................ 6
1.3 Purpose of the study ............ : ....................................................................... 7
1.4 Research objectives ..................................................................................... ?
1.5 Research questions ...................................................................................... ?
1.6 Hypothesis .................................................................................................. 8
1.7 Scope of study ............................................................................................ 8
1.7.1 Geographical scope ................................................................................... 8 '
1.7.2 Content scope .......................................................................................... 8
1.7.3 Time scope ............................................................................................... 8
1.8 Significance of the study .............................................................................. 8
1.9 Operational definition of key terms ............................................................... 9
V
CHAPTER TWO ......................................................................................... 11
LITERATURE REVIEW ............................................................................... 11
2.1 Introduction .............................................................................................. 11
2.2 Theoretical review ..................................................................................... 11
2.2.1 Liquidity preference theory ...................................................................... 11
2.2.2 Loanable funds theory ............................................................................ 12
2.2.3 Rational expectations theory ................................................................... 14
2.3 Concept of interest rates ............................................................................ 15
2.4 Conceptual framework ............................................................................... 15
2.4 .1 Interest rates ......................................................................................... 15
2.5 Profitability ................................................................................................ 16
2.5.1 Return On Assets .................................................................................... 16
2.5.2 Return On Equity .................................................................................... 16
2.6 Empirical literature review .......................................................................... 17
2.6.1 Effect of interest rates on profitability ...................................................... 17
: CHAPTER THREE ................... : .................................................................. 22
. METHODOLOGY ........................................................................................ 22
3.1 Introduction .............................................................................................. 22
3.2 Research design ........................................................................................ 22
3.3Research data ............................................................................................ 22
3.4 Data sources ............................................................................................. 22
3.5 Measurement of variables .......................................................................... 23
3.6 Data analysis ............................................................................................. 23
CHAPTER FOUR ........................................................................................ 25
PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA ................ 25
';1.1 Introduction .............................................................................................. 25
4.2 Descriptive statistics on reseqrch variables .................................................. 25
4.3 Effect of lending interest rates on profitability of Bank of Baroda Ltd, Uganda
······················································································································26
4.4 Effect of saving interest rates on profitability of Bank of Baroda Ltd, Uganda 27
vi
4.5 Effect of market interest rates on profitability of Bank of Baroda Ltd, Uganda29
4.6 Hypothesis testing ..................................................................................... 31
CHAPTER FIVE .......................................................................................... 32
DISCUSSION OF FINDINGS, CONCLUSIONS AND RECOMMENDATIONS32
5'. l Introduction .............................................................................................. 32
5.2 Discussion of findings .......... : ..................................................................... 32
5.2.1 Effect of lending interest rates on profitability of Bank of Baroda Ltd, Uganda
······················································································································32
5.2.2 Effect of saving interest rates on profitability of Bank of Baroda Ltd, Uganda
······················································································································32
5.2.3 Effect of market interest rates on profitability of Bank of Baroda Ltd, Uganda
······················································································································33
5.3 Conclusions of the study ............................................................................ 33
5.4 Recommendations ..................................................................................... 34
5.5 Contribution to knowledge ......................................................................... 34
5.6 Areas for future research ........................................................................... 36
i REFERENCES ............................................................................................ 37
APPENDICES ............................................................................................. 41
APPENDIX A .................................................................................................... 41
TIME FRAME ................................................................................................... 41
APPENDIX B .................................................................................................... 42
ACTUAL STUDY BUDGET ................................................................................. 42
APPENDIX C .................................................................................................... 43
RAW PANEL DATA ........................................................................................... 43
vii
LIST OF TABLES
Table 3.1 Measurement of variables ................................................................. 23
Table 4.1: Descriptive statistics on research variables ........................................ 25
Table 4.2 A: Model summary ........................................................................... 26
Table 4.2 B: Analysis Of Variance (ANOVN) ...................................................... 26
Table 4.2 C: Coefficients• ................................................................................. 27
Table 4.3 A: Model summary ........................................................................... 28
!Table 4.3 B: Analysis Of Variance (ANOVN) ...................................................... 28
Table 4.3 C: Coefficients• ........... : ..................................................................... 29
Table 4.4 A: Model summary ........................................................................... 29
Table 4.4 B: Analysis Of Variance (ANOVN) ...................................................... 30
Table 4.4 C: Coefficients• ................................................................................. 30
viii
LIST OF FIGURES
Figure 2.1: Conceptual framework of interest rates and profitability ................... 15
ix
LIST OF ACRONYMS
BOBU Bank of Baroda (Uganda)
BoU Bank of Uganda
CBR Central Bank Rate
GDP Gross Domestic Product
NIM Net Interest Margin
POLS Pooled Ordinary Least Square
ROA Return On Assets
ROCE Return on Capital Employed
ROE Return On Equity
SPSS Statistical Package for Social Sciences
X
ABSTRACT
The purpose of this study was , to investigate the effect of interest rates on
profitability of Bank of Baroda Ltd, Uganda. The study was based on the following 3
objectives; (i) to determine the effect of lending interest rates on profitability of
Bank of Baroda Ltd, Uganda; (ii) to find out the effect of saving interest rates on
profitability of Bank of Baroda Ltd, Uganda and (iii) to assess the effect of market
interest rates on profitability of Bank of Baroda Ltd, Uganda. The study employed
ex-posto facto research design and employed panel data for Bank of Baroda Ltd,
Uganda for over the period of 2007-2016. The findings revealed that lending interest
rates negatively (~=-0.001) and does not significantly (p-value=0.950) affect
profitability of Baroda Ltd, Uganda; saving interest rates negatively (~=-0.002) and
does not significantly (p-value=0.508) affect profitability of Baroda Ltd, Uganda; and
market interest rates positively W=0.000) and does not significantly (p-value=0.979) : affect profitability of Baroda Ltd, u9anda. The study concluded that; lending interest
rates have no significant effect on profitability of bank of Baroda; saving interest
rates have no significant effect on profitability of bank of Baroda; and market
interest rates have no significant effect on profitability of bank of Baroda. The study
recommended that; in regard to lending interest rates, government should review
and strengthen bank lending rate policies through effective and efficient regulation
and supervisory framework; In regard to saving interest rates, bank's management
should create the conditions for an efficient banking system devoid of information
asymmetry to adapt to changing macroeconomic variables of deposit saving interest
rates. Banks' management must efficiently manage their deposits in order to earn
savings from amounts due from other banks and all deposits. In regard to market
.interest rates, Bank's management should obtain bank borrowings from other
banking institutions at less interest rates to increase its profitability. In regard to
contribution of knowledge, apart rrom lending interest rates, saving interest rates
and market interest rates, other variables that include market size, macro-economic
conditions and monetary policy contribute towards the profitability of the bank. The
study developed great ideas that the management of the bank should have priorities
set to meet its objectives by using some specific interest rates and not all.
xi
CHAPTER ONE
INTRODUCTION
1.0 Introduction
This chapter presents the background, problem statement, purpose, specific
objectives; research questions, hypotheses, scope and significance of the study and
definition of key terms.
1.1 Background to the study
This background was segmented into four perspectives, namely historical, theoretical
conceptual, and contextual.
1.1.1 Historical perspective
Banking is an economic activity, which deals with the intermediation of funds
petween the surplus units and the ,deficit units of an economy and the channeling of
.such resources to profitable investments. Banks also facilitate the provision of an
efficient payment system. A sound, profitable, efficient and well managed banking
system contributes to the stability of the financial system and protects a country
from any undesirable crisis (Athanasoglu et al., 2006; Aburime, 2008; and Ramlall,
2009). Alper and Anbar (2011) posit that an efficient banking sector can promote
economic growth, while credit insolvencies could result in systematic crisis. In Africa,
banks are regarded as dominant financial institution thus, their health condition is
crucial to the general health of the economy (Suffian, 2009). Therefore, having the
knowledge of factors influencing commercial banks' profitability is not only important
but also essential in stabilizing the economy. The importance of banks' profitability
cannot be over emphasized. Profitability is considered as a crucial objective to
,conduct a business without which money deposit banks will not be in business. With ' ~ood profit figures, banks are able to enhance the confidence of their stakeholders,
:maximize shareholders wealth as well as being able to stay competitive in the
financial market. However, to achieve their desired level of profits, banks are
1
confronted with several factors both internal and external. One of such external
factors is the interest rate.
Over the years, interest rates have remained a subject for critical assessment with
diverse implications for savings mobilization and investment promotion. Historically,
~he interest rate regime in Uganda has been very stochastic. According to Daily
Monitor (2016), prominent business people in Uganda, warned that Uganda's
interest rates were high and many companies are going to go out of business as a
result. Several companies have been struggling to meet debt obligations and have
been lobbying for the government to reign in on high-interest rates. This has not
only come from the business community, but also President Museveni who has
argued that having more commercial banks in the country has not brought in lower
interest rates. President Museveni revealed that interest rates were one of the
challenges the country faced if there was going to be an economic recovery. The
Bou monetary policy committee believed that further depreciation of the Uganda
Shilling would lead to an increase in inflation that would hurt the economy. In April
2015, the committee recommended the raising of the Central Bank Rate (CBR) to 12
per cent from 11 per cent. By August 2015, the CBR had been raised to 16 per cent
(Mutebile, 2015). As at the end, of June 2016, commercial bank lending rates
averaged 23.54 per cent. These rates are still considered to be high and prohibitive
of the private sector.
Commercial banking in Uganda started before Uganda's independence in 1962,
where government-owned institutions dominated most banking in Uganda. In 1966,
the Bank of Uganda (BoU), which controlled the issue of currency and managed
foreign exchange reserves, became the central bank and national banking regulator.
Uganda Commercial Bank, which had fifty branches throughout the country,
dominated commercial banking and In 1960s, other commercial banks included local
operations of the Bank of Baroda, Barclays Bank, the Bank of India, Grindlays Bank,
Standard Chartered Bank, and the Uganda Cooperative Bank(Uganda Banking,
2014). In the late 1990s and early 2000s, several indigenous commercial banks were I ,
,declared insolvent, taken over by tne central bank, and eventually sold or liquidated.
2
These included the Uganda Cooperative Bank, Greenland Bank, the International
Credit Bank, Teefe Bank, Nile bank and Gold Trust Bank (Juuko, 2007).
1.1.2 Theoretical perspective
The study was based on theory of liquidity preference theory by Keyness (1936),
loanable funds theory by Froyen (1996) and rational expectations theory by Moore
(1988). ! '
Liquidity preference theory was first advanced by Keyness (1936). He stated that the
interests are determined by the demand and supply of money balances. The theory
assumes that people's demand for money is not for transactions purpose but as a
precaution and for speculative purposes, whereby, the transaction demand and
precautionary demand for money increase with income, while the speculative
demand is inversely related to interest rates because of the forgone interest. He
further stated that investors will always prefer short term securities to long term
securities. To encourage them hold long term bonds, long term securities should
yield higher interests than short term bonds thus increases the profitability.
Loanable funds theory was first developed by Froyen (1996) and stated that the rate
pf 'interest is determined at that level which equates the supply of securities with the
demand for them and the factors that determines interests are real investment
demand and real saving, what the new classical economist called the forces of
'productivity and thrift'. The determination of the interest rate in case of the loanable
funds theory of the rate of interest depends essentially on the availability of loan
amounts. The availability of such loan amounts is based on certain factors like the
net increase in currency deposits, the amount of savings made willingness to
enhance cash balances and opportunities for the formation of fresh capitals.
The relevance of the theory to the study is that, in the loanable funds theory of
interest the nominal rate is determined by the interaction between the demand and
supply of loanable funds. Keeping the same level of supply, an increase in the
demand for loanable funds would lead to an increase in the interest and the vice I
~hsa. Also, an increase in the supply of loanable funds would result in fall in the
3
rate but if both demand and supply of the loanable funds change, the resultant rate
would depend much on the magnitude and direction of movement of the demand
and supply of the loanable funds.
Rational expectations theory developed by Moore (1988) is based on the idea that
people formulate expectations based on all the information that is available in the
market. It holds that the best estimation for future interests is the current spot rate
.and that changes in the interests are primarily due to unexpected information or
changes in the economic factors. The rational expectation theory can be
,incorporated with loanable funds theory in order to better consider the available
information with the economy.
The limiting factor of rational expectation theory is mostly related to the difficulty in
gathering information and understanding how the public uses its information to form
its expectations. Russell (1992) stated that the theory is built on the premise of
expectations that people will have in regard to future conditions. If investors expect
future interests to be high, they will prefer to hold long term securities and if the
vice versa is true, they will prefer short term securities such that their profitability
will be maximised.
According to Campbell(1998) the expectations theory of the term structure implies '
tl;lat a longer term interest and a shorter term interest forecasts two subsequent
interest changes; the change in the yield of the longer-term bond over the life of the I
shorter-term bond, and weighted average of the changes in shorter-term rates over
the life of the longer-term bond. Therefore, the longer-term rates contain a
prediction of future short-term rates. It further postulates that you would earn the
same amount interest by investing in a one-year bond today and rolling that
investment into one-year bond later compared to buying a two year bond today.
Hence, investors expecting higher short-term rates are more likely to buy bonds
maturing in the short term but if they were to invest money into a long-term bond
they might not be able to make as much interest since this affects their profitability.
4
The relevance of the theory to this study is that outcomes do not differ
systematically from the expectations due to the forecasting rules which implies that
higher profits accrue to investors who acts on the basis of better forecast so as to
eliminate avoidable errors. Investors also consider yields because longer-term bonds
tend to pay more than shorter-term bonds that add up to the same maturity but
they prefer short term bonds but are only interested in longer term bonds if they pay
a risk premium.
1.1.3 Conceptual perspective
qenerally, interest rates are the rental payments for the use of credit by borrowers
i3hd return for parting with liquidity by lenders (Ogunbiyi, 2014). Jimenez, Lopez &
Saurina (2013) defines interest as- the amount a borrower pays in addition to the
principal of loan to compensate the lender for the use of the money while Interest
rates are the expressions of interest as a percentage of the principal. Whereas
interest rate is a rate which is charged or paid for the use of money, an interest rate
is often expressed as an annual percentage of the principal. It is calculated by
dividing the amount of interest by the amount of principal. In general, interest rates
rise in times of inflation, greater demand for credit, tight money supply, or due to
higher reserve requirements for banks. A rise in interest rates for any reason tends
to dampen business activity (because credit becomes more expensive) and the stock
market (because investors can get better returns from bank deposits or newly issued
bpnds than from buying shares).
I '
According to Saunders (1999) an interest rate is a price, and like any other price, it
relates to a transaction or the transfer of a good or service between a buyer and a
seller. This special type of transaction is a loan or credit transaction, involving a
supplier of surplus funds, i.e., a lender or saver, and a demander of surplus funds,
i.e., a borrower.Operationally, interest rates included lending interest rates, saving
interest rates and market interest rates.
Profitability is the ability for an organization to make profit from its activities. Agha
(2014) defines profitability as the ability of a company to earn profit. To measure the
5
profitability, there are a variety of ratios used of which Return on Asset, Return on
Equity and Net profit Margin are the major ones (Ongore & Kusa 2013).
Conceptually, determinants of profitability comprises of return on assets (ROA) and
return on equity (ROE).
1.1.4 Contextual perspective
Previous studies such as Mwangi (2014); Ndegwa et al., (2016) and Musa (2011)
were conducted on interest rates and financial performance. However, financial
performance considers many factors and thus the studies never concentrated well
on profitability. Furthermore, these studies some were conducted in Microfinance
institutions and not in commercial banks (Mwangi, 2014 and Ndegwa et al., 2016).
Furthermore, Mmasi (2013) conducted research on an investigation of the
relationship between interest rat~ and inflation. His study was not focused on
profitability.
While the above studies provide valuable insights on interest rates and financial
performance, they only provide partial insight on the influence of specific interest
rates determinants and performance of commercial banks. This study will therefore
study on the relationship between interest rates constructs and profitability of
commercial banks in Uganda.
1.2 Statement to the problem
Commercial banks are the dominant players in the financial services sector in
Uganda. Interest rates in the Ugandan banking sector keeps on varying and are
)rifluenced by various factors and can thus greatly affect the profitability of banking
institutions. According to Robinson (2010), banks profitability are affected by
unanticipated changes in interest rates. In Uganda, the potential impact of interest
rates on commercial banks profitability has long been a concern for policy makers
and bankers and this led some banks to close down their banking operations
(Mugume, 2011).
6
Due to unanticipated changes in interest rates, failure has been witnessed different
banks that include Uganda Cooperative Bank, Greenland Bank, the International
~:redit Bank, Teefe Bank, Nile bank and Gold Trust Bank to close down businesses in ' Uganda (Juuko, 2007). In addition, failure in the financial services system as seen
during the events unfolding after the sub-prime crisis in the United States also
motivated this study on performance of banks in Uganda and the effects that
regulation such as control of interest rate can have on the same. Therefore, these
factors have influenced the researcher to conduct a study on interest rates and
profitability of commercial banks.
1.3 Purpose of the study
The purpose of the study was to investigate the effect of interest rates on
profitability of Bank of Baroda Ltd, Uganda.
1L4 Research objectives
(i) To determine the effect of 'lending interest rates on profitability of Bank of
Baroda Ltd, Uganda.
(ii) To find out the effect of saving interest rates on profitability of Bank of
Baroda Ltd, Uganda.
(iii) To assess the effect of market interest rates on profitability of Bank of Baroda
Ltd, Uganda.
1.5 Research questions
(i) What is the effect of lending interest rates on profitability of Bank of Baroda
Ltd, Uganda?
(ii) What is the effect of saving interest rates on profitability of Bank of Baroda
Ltd, Uganda?
(iii) What is the effect of market interest rates on profitability of Bank of Baroda
Ltd, Uganda?
7
1.6 Hypothesis
Ho1: There is no significant effect of lending interest rates on profitability of Bank of
Baroda Ltd, Uganda?
Ho2: There is no significant effect of saving interest rates on profitability of Bank of
/3aroda Ltd, Uganda? '
Ho3: There is no significant effect of market interest rates on profitability of Bank of
Baroda Ltd, Uganda?
1.7 Scope of study
1.7.1 Geographical scope
The study was carried out in Bank of Baroda Ltd, Kampala, Uganda.
1.7.2 Content scope
In terms of content, lending interest rates, saving interest rates and market interest
rates are the independent variables. Dependent variable is profitability and will ' comprise of return on assets (ROA), return on equity (ROE).
1.7.3 Time scope
This study was conducted from March 2018 to June, 2018, whereby proposal writing
took place from March 2018 to April 2018, data collection and analysis were done in
May 2018, and then the final report was written and submitted in June 2018.
1.8 Significance of the study
The study will aim at providing banks with a better understanding of the effects of
interest rates on profitability. From the outcome of this study, banks will be expected
to influence matters of regulation with policy makers, institute policy changes and
,strategies to adopt in order to cope with the likely effects of interest rates on their
profitability.
8
Researchers
The research will provide a better understanding of interest rates and how they
affect the profitability of banks. Out of this study, researchers are expected to be in
a position to evaluate the need to investigate correlation if any between interest
rates and related macroeconomic factors of inflation and foreign exchange rates,
increase in informal lending, financial inclusion and to formulate policies that can be
adopted by governments to cope with negative effects if any of rate capping laws.
Business People
This study will enable business people to get a clear insight and establish if indeed
interest rate laws that has led to the desired increase in access to credit and
therefore profitability of their businesses.
Government
This study will be very important to the Ugandan government in evaluating the
effects of the interest rates. The Government will be expected to be in a position to
evaluate whether interest rates are having the desired effect on the profitability and
growth of economy from the projected benefit of assumed increase in credit access.
Put of this study, the government- should be in a position to take stock of positive ' ahd negative effects on the economy and specifically whether it is aiding in stifling or
spurring economic growth.
1.9 Operational definition of key terms
Interest rate: The proportion of a loan that is charged as interest to the borrower,
typically expressed as an annual percentage of the loan outstanding (Andersen &
Piterbarg, 2010).
Profitability; this is a company's ability to earn a reasonable profit on the owner's
investment (Buffet, 2005).
9
Lending interest rate is the bank rate that usually meets the short- and medium
term financing needs of the private sector.
Saving interest rate is the bank rate retained from deposit account holders.
Market interest rate is the bank rate that the bank pays when acquiring loans
from other financial institutions.
I I ' ' '
: I ' '
10
CHAPTER TWO
LITERATURE REVIEW
2.1 Introduction
This chapter presented different subjects that included concept of interest rates,
theoretical review, conceptual framework, profitability, and empirical literature
review and research gaps.
2.2 Theoretical review
m,e study was based on theory of liquidity preference theory by Keyness (1936),
loanable funds theory by Froyen (1996) and rational expectations theory by Moore
(1988).
2.2.1 Liquidity preference theory
Liquidity preference theory was first advanced by Keyness (1936). He stated that the
interests are determined by the demand and supply of money balances. The theory
assumes that people's demand for money is not for transactions purpose but as a
precaution and for speculative purposes, whereby, the transaction demand and
precautionary demand for money increase with income, while the speculative
demand is inversely related to interest rates because of the forgone interest. He
further stated that investors will always prefer short term securities to long term
~ei:urities. To encourage them hold long term bonds, long term securities should I
yield higher interests than short term bonds thus increases the profitability.
Therefore, the yield curve will always be upward sloping. It is based on the
observation that, all else being equal, people prefer to hold on to cash and that they
will demand a premium for investing in non-liquid assets such as bonds, stocks, and
real estate. The theory also suggests that the premium demanded for parting with
cash increases as the term for getting the cash back increases. According to
Auerbach (1988), stated that the rate in the increase of the premium slows down
with the increase in the period for getting the cash back. In financial terms, this
11
' I
theory is expressed as "forward rates should exceed the future spot rates". The ' expectation, therefore, is that forward exchange rates should offer a premium over
expected future spot exchange rates since those who are risk-averse demand a
premium for securities with longer-term maturities. A premium is offered by way of
greater forward rates in order to attract investors to longer-term securities.
In the general theory of employment, people's ability to save depends very much
upon their level of income. Therefore, Reilly and Norton (2006) stated that the
theory of liquidity preference holds that long term securities should provide higher
returns than short term obligations because investors are willing to sacrifice some
yields to invest in short maturity obligations to avoid the higher price volatility of
long maturity bonds.
Were and Wambua (2014) argued that the liquidity preference theory of interest
suffers from a fallacy of mutual 'determination. Keynes alleges that the rate of
interest is determined by liquidity preference. In practice, however, Keynes treats
the rate of interest as determining liquidity preference. Therefore, Keynesians treat
the rate of interest, not as they believe they do as determined by liquidity preference
but rather as some sort of mysterious and unexplained force imposing itself on the
other elements of the economic system.
In relevance to the study, interests are purely driven by demand and supply of
money in the economy whereby, interests tend to go up and down according to the
level of liquidity in the economy and preference for the liquidity by users of the
funds. Hence, the variation in the premium depends totally on the scope of payment
,in the liquidity level of the economy. The mathematical implication of the preference
theory of interest finds expression ,in the discount function which simply means that
yvith increase in the preference, the discount rates escalate on the receivable returns
in future.
2.2.2 Loanable funds theory
Loanable funds theory was first developed by Froyen (1996) he stated that the rate
of interest is determined at that level which equates the supply of securities with the
12
demand for them and the factors that determines interests are real investment
demand and real saving, what the new classical economist called the forces of
'productivity and thrift'. The determination of the interest rate in case of the loanable
funds theory of the rate of intere'st depends essentially on the availability of loan
amounts. The availability of such loan amounts is based on certain factors like the
net increase in currency deposits, the amount of savings made willingness to
enhance cash balances and opportunities for the formation of fresh capitals.
According to Fixler and Zieschang (1998) he stated that this theory is a dynamic and
optimizing theory of the bank operation that integrates insights of production theory,
financial intermediation and portfolio theories. The unified model clarifies the
relationship between the risk of asset portfolios and a bank's output of services.
Portfolio risk determines the rate of return on loans and banks' borrowed funds and
,in turn the discount used to derive the present value of future profits part of which
~re generated by bank services. The quantity of the service output is affected by risk
only to the extent that portfolios of different risk require different amounts of
information processing. In addition, the models show the loanable funds are merely
an intermediate input that passes through banks, whereas true bank value added is
only the services facilitating the provision of funds. The model further establishes
separability between the use of funds and production functions of value added in a
bank's overall optimization problem.
The relevance of the theory to the study is that, in the loanable funds theory of
interest the nominal rate is determined by the interaction between the demand and
supply of loanable funds. Keeping the same level of supply, an increase in the
demand for loanable funds would lead to an increase in the interest and the vice
yersa. Also, an increase in the supply of loanable funds would result in fall in the
rate but if both demand and supply of the loanable funds change, the resultant rate
would depend much on the magnjtude and direction of movement of the demand
and supply of the loanable funds.
13
2.2.3 Rational expectations theory
This theory was first developed by Moore (1988). He stated that the theory is based
pn the idea that people formulate expectations based on all the information that is
available in the market. It holds that the best estimation for future interests is the
r:urrent spot rate and that change~ in the interests are primarily due to unexpected
information or changes in the economic factors. The rational expectation theory can
be incorporated with loanable funds theory in order to better consider the available
information with the economy.
The limiting factor of rational expectation theory is mostly related to the difficulty in
gathering information and understanding how the public uses its information to form
its expectations. Russell (1992) stated that the theory is built on the premise of
expectations that people will have in regard to future conditions. If investors expect
future interests to be high, they will prefer to hold long term securities and if the
vice versa is true, they will prefer short term securities to maximise their profitability.
According to Campbell(1998) the expectations theory of the term structure implies '. I
that a longer term interest and a, shorter term interest forecasts two subsequent
interest changes; the change in the yield of the longer-term bond over the life of the
shorter-term bond, and weighted average of the changes in shorter-term rates over
the life of the longer-term bond. Therefore, the longer-term rates contain a
prediction of future short-term rates. It further postulates that you would earn the
same amount interest by investing in a one-year bond today and rolling that
investment into one-year bond later compared to buying a two year bond today.
Hence, investors expecting higher short-term rates are more likely to buy bonds
maturing in the short term but if they were to invest money into a long-term bond
they might not be able to make as much interest.
The relevance of the theory to this study is that outcomes do not differ
~ystematically from the expectations due to the forecasting rules which implies that
higher profits accrue to investors who acts on the basis of better forecast so as to
eliminate avoidable errors. Investors also consider yields because longer-term bonds
14
tend to pay more than shorter-term bonds that add up to the same maturity but
they prefer short term bonds but are only interested in longer term bonds if they pay
a risk premium.
2.3 Concept of interest rates
2.4 Conceptual framework
Figure 2.1: Conceptual framework of interest rates and profitability
Independent Variable Dependent Variable
Interest rates Profitability
Lending interest rates Return on assets
Saving interest rates Return on equity
Market interest rates
Source: Ndegwa, Waweru & Huka (2014).
2.4.1 Interest rates
~ljlterest is the "rent" paid to borrow money. The lender receives a compensation for
foregoing other uses of their funds, including (for example) deferring their own
consumption. The original amount lent is called the "principal," and the percentage
of the principal which is paid or is payable over a period of time is the "interest
rate." (Thygerson, 1995)
According to Saunders, (1999) an interest rate is a price, and like any other price, it
relates to a transaction or the transfer of a good or service between a buyer and a
seller. This special type of transaction is a loan or credit transaction, involving a
supplier of surplus funds, i.e., a lender or saver, and a demander of surplus funds,
i.e., a borrower.
15
Interest was used in the study to relate to additional money received as payment for
a loan that is calculated as a fraction of the amount borrowed and is used to make a
profit from the transaction.
2.5 Profitability
Profit is the ultimate goal of commercial banks .All the strategies designed and
activities performed are geared towards realizing these grand objective. Therefore,
profitability is the process of evaluating relationships between component parts of
financial statements to obtain a better understanding of the firm's financial position.
[fhe analysis involves selection from the total information available to those relevant
t0 the decision under consideration, arranging the information in a manner that
would bring out the relationship and a study of the relationships and interpretation
of the results thereof. The techniques widely used for analysis are; ratio analysis,
trend analysis and cross sectional analysis (Pandey, 1997).
2.5.1 Return On Assets
Return on Assets (ROA), is the ratio of income to total assets (Khrawish, 2011). It
measures the ability of the bank management to generate income by utilizing bank
assets at their disposal. In other words, it shows how efficiently the resources of the
1=ompany are used to generate the income. It further indicates the efficiency of the
:management of a company in generating net income from all the resources of the
)~stitution. Wong (2004) states that a higher ROA shows that, the company is more
,bfficient in using its resources. Return on Assets is calculated as follows: ROA=Net
income after tax/Total Assets.
2.5.2 Return On Equity
According to Higgins (2012), return on equity (ROE) is a measure of profitability that
calculates how many dollars of profit a company generates with each dollar of
shareholders' equity. ROE is a measure of how well a company uses shareholders'
funds to generate a profit (Kijewska, 2016). The formula for ROE is: ROE=Net
Income/Shareholders' Equity. ROE is sometimes called "return on net worth." Phillips
16
I
& Phillips (2016), Return on equity measures a corporation's profitability by revealing
how much profit a company generates with the money shareholders have invested.
Phillips & Phillips (2016) stated that ROE is expressed as a percentage and
calculated as: Return on Equity=Net Income/Shareholder's Equity. Phillips & Phillips
(2016) noted that net income is for the full fiscal year (before dividends paid to
common stock holders but after dividends to preferred stock).
2.6 Empirical literature review
2.6.1 Effect of interest rates on profitability
On the related topic, the numerous studies have been carried out in the past and the
focus of those studies was the de~eloping nations. Major purpose of those studies
~as to discover the factors that influence banks' profitability.
In early literature, for discovering the financial position of the banks, interest rate
was used mostly. The net interest margin rate of the banks is extremely delicate to
change. The profit of banks increases as the interest rate of the banks increases,
according to Shiller and Mcculloch (1987) and Samuelson (1945) the general market
situation. Samuelson (1945) expressed "The banking system as a whole is
immensely assisted rather than hindered by an increase in the interest rate and
commercial banks would profit more than savings banks".
The investigation of Maisal and Jacobson (1978) demonstrated that in an efficient
market there is no need to consider the institutional forces of market. Financial
l~stitution can easily get the outcome from accessible data to foresee the future '
pc:tivities and responses. Financial institutions always discover better approaches to
balance their cost and return. They believed that through an efficient financial
market they anticipate their asset management results very efficiently and rapidly
like cost and return, assets, liabilities. Authors directed this study on the base of
cross sections banks cost and revenue from the period 1962-1975. Their estimate
was based on cost of book value of assets and the net rate of income. The outcomes
additionally demonstrated the major shifting happened in the period of 1970-1975.
17
trhe investigation of English (2002) and Hanweck and Ryu (2005) bank's income is ' '
largely affected by the changes ln the interest rate. As per the investigation of
English (2002) the net interest margin of commercial banks and market interest
rates revealed steady in the perspective of relationship among the market interest
rate and net interest margin of the banks.
The paper of Davies and Vaught (2010) narrated "the impact of interest rate on the
profitability of banks in south specific". Findings show that the profit margin of this
region banks is in conformity with the line or criteria mentioned by the central banks
of all the countries in that specific region. The information was accumulated through
the region's central banks prudential. Economic and country risk is comparatively
high in this area, the expense of compliance with prudential regulations additionally
lrpact the interest rates, the banks profit remain was high in light of the fact that
~li]e ROA is 4.8% since 2001, which comes mostly through the foreign exchange
,~~alings of goods and services.
Research paper of Tamoorespouri and Ardekani (2012) examined the impact of
interest rate on the bank return and size of the bank. The data was taken from 14
different markets from the period 2001 to 2010. Researchers considered different
financial ratios and bank return as variables for the purpose of study. The analysis
shows the different positive and negative results because of fluctuations of interest
rate. This is because of difference in market size, macro-economic conditions,
monetary policy and difference among countries. Most countries' banks indicated
positive associations with return and interest rate difference however couple of
countries like India, Japan, Denmark, and Switzerland were not in accordance with
it\ ! !
Molyneux and Thornton (1992) examined the profitability of banking zone 18
European nations' data amid the 1986-1989 periods, utilizing pooled data. They
identified considerable direct relationship with the return on equity and the level of
interest rates, bank concentration and government ownership during their study.
Their findings recommends that keeping in mind the competition or the quality of
18
bank performance the anti-trust or regulatory policy must be formulated according
to the changing market structure. i' i
dgunbiyi and Ihejirika (2014) inve~tigated the effect of interest rates on profitability
of deposits money banks in Nigeria. The study covered all the data of thirteen years
at the country level and used multivariate regression analysis. The dependent
variables for measuring the Banks performance were return on assets (ROA), return
on equity (ROE) and net interest margin (NIM). The independent variables were Real
interest rate, T-bill rate, Minimum discount rate, interbank rate, Savings deposit rate
and Inflation. According to the estimated results, profitability of Nigerian deposits
money banks were influenced significantly and negatively by Real interest rate and
Savings deposit rate as measured by return on assets and return on equity. In
contrast, it was found that there seems to be no prominent relationship between
interest rate variables and Net interest margin. According to the results of this study,
t~e profitability of the banking depends on the changing interest rates. I i'
The study of Demirguc-kunt and Huizinga (1999) studied the determinants of the
bank profitability and interest rate are: macroeconomic conditions, regulations,
organization financial structure, implicit and explicit bank taxation, deposit insurance
regulations, bank characteristics and several legal underlying institutional indicators.
Study also clarified that foreign banks had higher profit margin in developing
countries as compared to domestics banks and a reverse situation is entailing in
industrial countries. The regression technique was used to find out the results of
determinants on profit and interest rates which were collected from banking
institutions of 80 countries from 1988-1995.
Gui et al., (2011) studied the relationship between bank-specific and macro
~c:onomic characteristics over bank profitability for the period of 2005-2009. Pooled i : '
brdinary Least Square (POLS) method was used to examine the effects.
Determinants of banks' profitability were categorized into two types of factors;
internal and external factors. The study defined external factors; GDP, Inflation and
Market capitalization and internal factors; Size, Capital, Loan, and Deposits as
independent variables and return on asset (ROA), return on equity (ROE), return on
19
capital employed (ROCE) and net interest margin (NIM) as the dependent variables.
The results showed that the value for R-square in model is 0.54 that shows 54% of
variation in the dependent variable is explained by the independent variable. Overall
results found that these bank-specific and macro-economic factors affect the
p~ofitability of banks in Pakistan.
Khan and Sattar (2014) examined the impact of interest rate changes on the
profitability of commercial banks operating in Pakistan during 2008-2012. According
to study, for the couple of previous years interest rate spread is growing, by which
savings and investment are discouraged and on the other hand it ensures the
efficient bank lending. For the purpose of discovering the relationship between
interest rate and profitability, they used Pearson Correlation method. In their study
they took profitability as dependent variable and interest rate as independent
variable. They individually analyzed the impact of interest increase and interest
decrease on the bank's profitability. The results showed that interest rate and
commercial bank's profitability are strongly and negatively correlated. The result
.differs from the literature review because there is huge banking spread in Pakistan
which absorbs the changes in interest rates. In addition, investment also contributes '
to the banks' earning, so their income does not only depend upon interest margins.
Azam and Siddiqui (2012) through their study examined the market interest rate
effects on profits of banks. They divided the sample into two categories; the public
sector banks and the private sectors banks of Pakistan. Banking lending rate was
taken as a proxy for interest rate while return on asset and return on equity were
taken as a proxy for profitability. Method of analyses was Regression technique. The
results showed that there are significant effects on the profitability of both public
sector and private sector, the interest rate affect the private sector the most.
.Gull and Zaman (2013t evaluated the impact of interest rate fluctuations and
fi~.ancial outcomes of banking sector of Pakistan. A sample of 20 banks listed at ) i
Karachi Stock Exchange KSE was taken into consideration on the basis of high return
.and market share for the period of 2007-2012. The determinants for measuring the
financial performance were return on assets, return on equity, earnings per share as
20
dependent variables and independent variables include Interest rate, loans or
advances, investment and deposits with other banks. Descriptive, correlation and
regression analysis were used as statistical techniques. The results showed the value
for R-square model for ROA is 0.43 that shows that 43% variations in ROA is
explained by independent variables. The value of R-square for ROE is 0.30 that
snows that 30% variations in ROE are explained by independent variables. The value
bf R-square for EPS is 0.717 that shows that 71 % variations in EPS is explained by
independent variables. From the Outcomes of analysis it is concluded that interest
rate and other variables show significant influence on financial performance of
commercial banks operating in Pakistan.
The bank's sensitivity with net interest margin, profitability and term structure set
across product specializations. Hanweck and Ryu (2005) examined that the changes
of interest rate are most sensitive with bank's portfolios which are related to the net
interest margin. According to finding of Basel Committee on Banking Supervision
(2004), the changes in net interest margin are negatively related to the interest rate
volatility but it will show positive result because of the increase in yield curve. The
pcale of the effect depends upon the assets and liabilities composition.
Moreover given the slope of yield curve, whenever there happens an increase in
~hart and long term interest rate is always subjected to reduce the income for the
time being, signifies that the maximum adjustment of the asset and liability yields.
According to the study of English (2002) the margin of net interest of commercial
banks and rates of market interest found supportive in the view of relationship
among the slope of the curve and market interest rate on net interest margin of the
banks.
21
CHAPTER THREE
METHODOLOGY
3.1 Introduction
This chapter described the procedures that were followed in conducting the study.
These included research design, research data, sample size, sampling procedure,
data sources, and research instruments, measurement of variables, data analysis
~nd ethical considerations.
3.2 Research design
The study used ex-post-facto research design. This enabled the researcher to collect
quantitative data about the variables under study by using quantitative tool. The
researcher selected a sample of panel data at the outset of the study and then at
each subsequent panel data collection point, the researcher surveyed the same
sample. This was done over time, and helped the researcher to note the changes in
specific data and explored reasons for data change. The panel data also has the
advantage of giving more informative data as it consists of both the cross-sectional
information, which captures individual variability, and the time-series information,
that captures dynamic natures of the data (Bryman & Bell, 2015). ' ' I I
3.3Research data
The study employed panel data of Bank of Baroda (Uganda) (BOBU) over the period
of 2007-2016(BOBU, 2017). The ten-year period that was from 2007-
2016waschosen because it was current and thus helped in obtaining valid
conclusions for the study.
3.4 Data sources
The researcher used only secondary data for data collection. Secondary data was
gathered from secondary sources of BOBU's extracted financial statements and
annual financial reports that were issued by the banks at end of each year.
22
3.5 Measurement of variables
The study variables were measured as shown below;
Table 3. 1: Measurement of variables
Type of Variable Measurement Author(s)
Variable
Independent Lending • Local currency loans and advances Ogunbiyi (2014)
Interest rates to customers; and foreign currency
loans and advances
Independent Saving • Amounts due from group Ogunbiyi (2014)
interest rates -companies/other banks, interest ' bearing current and savings
deposits, and time deposits
Independent Market • Foreign bank borrowings and local Ogunbiyi (2014)
interest rates bank borrowings
Dependent Return on • Ratio of Net Income / Average Total Demirg0c;-Kunt &
Assets (ROA) Assets Huizinga (2015)
Dependent Return on • Net Income / Average Total Equity Demirg0c;-Kunt &
Equity (ROE) Huizinga (2015)
3.6 Data analysis
Data collected from annual reports of the bank were analyzed using a Statistical
Package for Social Sciences (SPSS}, which helped to show data in percentages. The
mean was applied for the extent of interest rates and profitability of commercial
bank. Panel data regression was used to determine the significant effect between
the variables by using the following regression model;
Where
LIRt = Lending interest rates for bank in year t
23
pIRt = Saving interest rates for ban_k in year t
MIRt = Market interest rates for bank in year t
~o = the constant whose influence on the model is insignificant
~1 = the slope which represents the degree with which profitability change as the
interest rates change by one unit
Et= the error term
24
CHAPTER FOUR
PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA
4.1 Introduction
Under this chapter the researcher presented, interpreted and analyzed the findings
according to the research. Tables were used to present and analyze the findings.
The study investigated interest rates panel data of Bank of Baroda for a ten-year
period of 2007-2016.
The chapter was divided into four major sections of descriptive statistics, regression
analysis, correlation analysis and hypotheses testing. Section 4.2 described the
descriptive statistics of the variables of the study. Whereas section 4.3, 4.4 and 4.5
illustrated the regression analysis while section 4.6 described the hypothesis testing
py comparing the P-Value obtained using SPSS with 0.05 which is the alpha level of I . significance.
4.2 Descriptive statistics on research variables
This section discussed the descriptive statistics on research variables from
commercial banks' panel data analysed for ten-year duration. The descriptive
statistics for dependent variable that is profitability and the independent variable
that is interest rates show the results indicated in the table 4.1 below;
Table 4. 1: Descriptive statistics on research variables
N Minimum Maximum Mean Std. Deviation
Lending Interest rates 10 4.416 5.451 4.99870 .258277
Saving interest rates 10 .497 4.717 2.64390 1.348864
Market interest rates 10 ' 1.386 3.608 2.00310 .679094
Return on Assets 10 .855 .872 .86320 .006197
Return on Equity 10 .935 .951 .94240 .004926
Valid N (listwise) 10
25
Table 4.1 presents a summary of descriptive statistics of the dependent and
independent variables used in the study. The mean of profitability (return on assets
and return on equity) are approximately 0.86320 and 0.94240 respectively.
pescriptive statistics show the mean of lending interest rates, saving interest rates
ahd market interest rates was 4.99870, 2.64390 and 2.00310 respectively. This I '
lmplies that the bank relies on different interest rates to achieve its profitability.
4.3 Effect of lending interest rates on profitability of Bank of Baroda Ltd,
Uganda
The regression results shown in table 4.2A, 4.2B and 4.2C, below indicate the effect
of lending interest rates on profitability of Bank of Baroda Ltd, Uganda.
Table 4.2 A: Model summary
Model R R Square Adjusted R Square Std. Error of the Estimate
I 1, .023a .001 -.124 .01159
ia:. ,Predictors: (Constant), Lending Interest rates
From table 4.2A, results indicate that R2 = 0.023, therefore, the predictor variable
that is lending interest rates account for 2.3% of the variance in profitability of bank
of Baroda. This implies that lending interest rates contributes towards profitability of
commercial bank by 2.3%.
Table 4.2 B: Analysis Of Variance (ANOVAa)
Model Sum of df Mean F Sig.
Squares Square
Regression .000 1 .000 .004 .950b
,1 Residual .001 8 .000 I
I Total .001 9
a. Dependent Variable: Profitability'
b. Predictors: (Constant), Lending Interest rates
26
From table 4.2B, results indicated that the overall computed probability value (p
value) of predictor variable that is lending interest rates is 0.950. This value is
greater than the level of statistical significance (sig.), alpha ( a = 0.05). This implies
that the regression analysis is statistically insignificant and thus lending interest rates
insignificantly affects profitability of Bank of Baroda.
I : [Ji~ble 4.2 C: Coefficients3
Model Un standardized Standardize t Sig.
Coefficients d
Coefficients
B Std. Error Beta
(Constant) 1.810 .075 24.193 .000
1 Lending Interest -.001 .015 -.023 -.065 .950
rates
a. Dependent Variable: Profitability
The results in table 4.2C, indicated that lending interest rates are negatively (~ = -' ' mool) and insignificantly (p-value = 0.950) related to profitability. The individual
tests of computed probability vah:ie of lending interest rates is 0.950 and this is
much greater than the level of statistical significance value (a = 0.05). This implies
that the amount of unique variance the lending interest rates account for in
predicting bank of Baroda's profitability is statistically insignificant. This indicates
that an increase in lending interest rates decreases the profitability of the bank and
a decrease in lending interest rates increases its profitability.
4.4 Effect of saving interest rates on profitability of Bank of Baroda Ltd,
Uganda
The regression results shown in table 4.3A, 4.3B and 4.3C, below indicate the effect
bf saving interest rates on profitability of Bank of Baroda Ltd, Uganda.
i I
27
Table 4.3 A: Model summary
Model R R Square Adjusted R Std. Error of the Estimate
Square
1 .238a .057 -.061 .01126
a. Predictors: (Constant), Saving interest rates
from table 4.3A, results indicate that R2 = 0.238, therefore, the predictor variable '
that is saving interest rates account for 23.8% of the variance in profitability of bank
of Baroda. This implies that saving' interest rates contributes towards profitability of
commercial bank by 23.8%.
Table 4.3 B: Analysis Of Variance (ANOVA")
Model Sum of df Mean F Sig.
Squares Square
Regression .000 1 .000 .481 .508b
1 Residual .001 8 .000
Total .001 9
a. Dependent Variable: Profitability
!a. Predictors: (Constant), Saving interest rates
From table 4.3B, results indicated' that the overall computed probability value (p
value) of predictor variable that is saving interest rates is 0.508. This value is greater
than the level of statistical significance (sig.), alpha (a = 0.05). This implies that the
regression analysis is statistically insignificant and thus saving interest rates
insignificantly affects profitability of Bank of Baroda.
28
Table 4.3 C: Coefficientsa
Model Unstandardized Standardiz t Sig.
Coefficients ed
Coefficient
s
B Std. Error Beta
(Constant) 1.811 .008 221.628 .000
11:IJ Saving interest -.002 .003 -.238 -.693 .508
rates .
,a. Dependent Variable: Profitability,
The results in table 4.3C, indicated that saving interest rates are negatively (~=-
0.002) and insignificantly (p-value = 0.508) related to profitability. The individual
tests of computed probability value of saving interest rates is 0.984 and this is much
greater than the level of statistical significance value (a = 0.05). This implies that
the amount of unique variance the saving interest rates account for in predicting
bank of Baroda's profitability is statistically insignificant. This indicates that an
increase in saving interest rates decreases the profitability of the bank and a
decrease in saving interest rates increases its profitability.
<f.5 Effect of market interest rates on profitability of Bank of Baroda Ltd,
,Uganda
The regression results shown in table 4.4A, 4.4B and 4.4C, below indicate the effect
of market interest rates on profitability of Bank of Baroda Ltd, Uganda.
Table 4.4 A: Model summary
Model R R Square Adjusted R Square Std. Error of the Estimate
1 .0103 .000 -.125 .01159
a. Predictors: (Constant), Market interest rates
29
.From table 4.4A, results indicate t-hat R2 = 0.010, therefore, the predictor variable
that is market interest rates account for 1 % of the variance in profitability of bank of
Baroda. This implies that market interest rates contribute towards profitability of
commercial bank by 1 %.
Table 4.4 B: Analysis Of Variance (AN OVA")
Model Sum of df Mean F Sig.
Squares Square
Regression .000 1 .000 .001 .979b
1 Residual .001 8 .000
Total .001 9
:a. Dependent Variable: Profitability
b. Predictors: (Constant), Market interest rates
From table 4.4B, results indicated that the overall computed probability value (p
value) of predictor variable that is market interest rates is 0.979. This value is
greater than the level of statistical significance (sig.), alpha (a = 0.05). This implies
that the regression analysis is statistically insignificant and thus market interest rates
insignificantly affect profitability of Bank of Baroda.
Table 4.4 C: Coefficients•
Model Unstandardized Standardize t Sig.
Coefficients d ' Coefficients
B' Std. Error Beta
(Constant) 1.805 .012 150.835 .000
1 Market interest .000 .006 .010 .027 .979
rates
a. Dependent Variable: Profitability
30
The results in table 4.4C, indicated that market interest rates are positively W =
Q;000) and insignificantly (p-value = 0.979) related to profitability. The individual
tests of computed probability value.of market interest rates is 0.979 and this is much
greater than the level of statistical significance value (a = 0.05). This implies that
the amount of unique variance the market interest rates account far in predicting
bank of Baroda's profitability is statistically insignificant. This indicates that an
increase in market interest rates increases the profitability of the bank and a
decrease in market interest rates decreases its profitability.
4.6 Hypothesis testing
In hypothesis testing, the decision rule was to reject the null hypothesis if the P
Value obtained using SPSS is less than 0.05 that is the alpha level of significance
specified in SPSS for this analysis. However, if otherwise, then do not reject the null
hypothesis.
' Ho1: There is no significant effect of lending interest rates on profitability of Bank of
Baroda Ltd, Uganda. The researcher accepted the null hypothesis because the p
value (p-value = 0.950) of lending interest rates and profitability of Bank of Baroda
Ltd is greater than 5% (a = 0.05) level of significance.
Ho2: There is no significant effect of saving interest rates on profitability of Bank of
Baroda Ltd, Uganda. The researcher accepted the null hypothesis because the p
value (p-value = 0.508) of saving interest rates and profitability of Bank of Baroda
Ltd is greater than 5% ( a = 0.05) level of significance.
H03 : There is no significant effect of market interest rates on profitability of Bank of
Baroda Ltd, Uganda. The researcher accepted the null hypothesis because the p
value (p-value = 0.979) of market interest rates and profitability of Bank of Baroda ' ' ~td is greater than 5% (a= 0.05) level of significance.
31
CHAPTER FIVE
DISCUSSION OF FINDINGS, CONCLUSIONS AND RECOMMENDATIONS
5.1 Introduction
,Under this chapter, the researcher discussed and gave conclusion to the major
findings of the study. The researcher also presented recommendations for the study
and areas for future research.
5.2 Discussion of findings
5.2.1 Effect of lending interest rates on profitability of Bank of Baroda Ltd,
Uganda
The study found out that lending interest rates have no significant effect on
profitability of bank of Baroda. The study was in agreement with Khan and Sattar
(2014) who examined the impact of interest rate changes on the profitability of
1cpmmercial banks operating in Pakistan during 2008-2012. According to study, for
~t;ie couple of previous years interest rate spread is growing, by which savings and
investment are discouraged and on the other hand it ensures the efficient bank
lending. For the purpose of discovering the relationship between interest rate and
profitability, they used Pearson Correlation method. In their study they took
profitability as dependent variable and interest rate as independent variable. They
individually analyzed the impact of interest increase and interest decrease on the
bank's profitability. The results showed that interest rate and commercial bank's
profitability are strongly and negatively correlated.
5.2.2 Effect of saving interest rates on profitability of Bank of Baroda Ltd,
Uganda
iT)1e study found out that saving interest rates have no significant effect on I
profitability of bank of Baroda. The-study was in agreement with Ogunbiyi & Ihejirika
'(2014) who investigated the effect of interest rates on profitability of deposits
money banks in Nigeria. According to the estimated results, profitability of Nigerian
32
deposits money banks were influenced significantly and negatively by real interest
rate and savings deposit rate as measured by return on assets and return on equity.
In contrast, it was found that there seems to be no prominent relationship between
interest rate variables and net interest margin.
512.3 Effect of market interest rates on profitability of Bank of Baroda Ltd,
liganda ' I '
The study found out that market interest rates have no significant effect on
profitability of bank of Baroda. This was in disagreement with Azam and Siddiqui
(2012) who examined the market interest rate effects on profits of banks using
method Regression analysis technique. The results showed that there are significant
effects on the profitability of both public sector and private sector, the interest rate
affect the private sector the most.
The result differs from the literature review because there is huge banking spread in
Uganda that absorbs the changes in interest rates. In addition, investment also
contributes to the banks' earning, so their income does not only depend upon
interest margins. I ! ' I i5.3 Conclusions of the study
The main purpose of the research was to investigate the effect of interest rates on
profitability of Bank of Baroda Ltd, Uganda and the conclusions were based on
research objectives of the study.
According to the findings, lending interest rates have no significant effect on
profitability of bank of Baroda. Thus, an increase in lending interest rates decreases
the profitability of the bank and a decrease in lending interest rates increases its
profitability.
According to the findings, saving interest rates have no significant effect on
pfiofitability of bank of Baroda. Thus, an increase in saving interest rates decreases
33
the profitability of the bank and a decrease in saving interest rates increases its
profitability.
According to the findings, market interest rates have no significant effect on
profitability of bank of Baroda. Thus, an increase in market interest rates decreases
the profitability of the bank and a decrease in market interest rates increases its
profitability.
5;.4 Recommendations
Based on the research objectives of the study, the following recommendations were
suggested by the researcher;
In regard to lending interest rates, government should adopt monetary policies that
will help Ugandan commercial banks to improve on their profitability and there is
need to review and strengthen bank lending rate policies through effective and
efficient regulation and supervisory framework. Bank of Baroda can improve its
profitability through charging moderate lending rates as against maximum rates as
its circumstances may allow.
In regard to saving interest rates, management of the bank are expected to create
F~e conditions for an efficient banking system devoid of information asymmetry to
b6apt to changing macroeconomic variables of deposit saving interest rates. Banks'
management must efficiently manc1ge their deposits in order to earn savings from
amounts due from other banks and all deposits.
In regard to market interest rates, Bank of Baroda's management should obtain
bank borrowings from other banking institutions at less interest rates to increase its
profitability.
5.5 Contribution to knowledge
The study revealed that apart from lending interest rates, saving interest rates and
market interest rates, other variables that include market size, macro-economic
34
I I
conditions and monetary policy contribute towards the profitability of the bank. The
study developed great ideas that the management of the bank sho
35
i I
uld have priorities set to meet its objectives by using some specific interest rates and '
not all. Society had been highlighted with knowledge by interpreting figures of the
bank that has made clear analysis for them to clearly know how the bank performs.
5.6 Areas for future research
Although it was found out that lending interest rates, saving interest rates and
market interest rates has no significant effect on the profitability of bank of Baroda,
further research should be conducted on the effect of treasury bonds rates, treasury
bills rates local placement rates and foreign placement rates.
36
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40
! i
Item{fime
Proposal writing
Data collection and
analysis
Data Presentation
)=)nal report submission I
APPENDICES
APPENDIX A
TIME FRAME
June 2018
41
'APPENDIX B
ACTUAL STUDY BUDGET
Item Quality /Quantity Unit Total Cost
Cost
Pens 1 box 3,000 3,000
Box file 2 files 5,000 10,000
Clip board 2 clip boards 5,000 7,000
Ruled paper 2 reams 10,000 20,000
Note book 2 books 5,000 10,000
pl;lotocopying 58 pages 100 5,800
IT'.yping 40 pages 500 20,000
Printing 40*3 pages 100 12,000
Spiral binding 3 copies 1,500 4,500
Sub Total 92,300
Transport 5 days 20,000 100,000
Lunch 5 days 20,000 100,000
Sub Total 200,000
Coding 5 days 5,000 25,000
Data entry 8 days 5,000 40,000
Sub Total 65,000
Typing 64 pages 500 32,000 ' printing i i:
3*64 pages 100 19,200
Photocopying 35 pages 100 3,500
Binding 3 books 9,000 27,000
Sub Total 81,700
Grand Total 439,000
42
APPENDIXC
RJ\W PANEL DATA
' 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
rrency loans and 22% 18.27% 18.38% 18.41% 20.89% 24.56% 17.67% 18.84% 19.79% 19.08%
is to customers
currency loans and 8% 8% 8% 7.66% 3.96% 9.49% 7.44% 8.07% 8.19% 8.05% ,5
r bonds 15.80% 14.99% 14.59% 14.15% 11.10% 11.24% 11.84% 13.54% 15.56% 17.07%
r bills 11.75% 13.50% 13.50% 7.61% 8.76% 12.52% 11.07% 12.74% 19.28% 16.43%
,cements 7.75% 8.63% 6.35% 3.53% 15.94% 18.23% 11.68% 11.00% 13.42% 13.95%
placements 5.53% 4.27% 2.51% 2.90% 4.55% 2.78% 2.55% 2.61% 0.60% 1.73%
; due from group 5.30% 5.30% 1.53% 1.52% 0.43% 1.25% 1.13% 0.78% 0.28% 1.73%
es
bearing current and 2% 2% 2% 1.28% 1.25% 0.72% 0.79% 0.67% 0.73% 0.70%
jepqsits
JOSits, 10.23% 10.55% 11.17% 8.48% ' '
7.99% 12.06% 11.23% 11.21% 8.04% 8.15%
Jank borrowings 5.40% 5.40% 5.40% 1.05% 0.50% 0.33% 0.41% 0.45% 0.45% 1.12%
nk borrowings 0.00% 0.00% 6.83% 3.81% 22.91% 17.74% 17.74% 9.84% 9.99% 10.72%
43