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