Print Email Download

Paid Writing Services

More Free Content

Get Your Own Essay

Order Now

Instant Price

Search for an Essay


The Impact Of Risk Management On Financial Performance Finance Essay

Every business organization has risk impact over it either directly or indirectly. The possibility that the ability of the business will impair to provide desired returns on investment, is always involved in any form of the business. In the age of fierce competition, organizations’ managers find out every way to optimize organizations’ cost and maximize the profitability; so as the banking sector. Due to which risk management is becoming an integral part for the success of almost every organization. The probability of risk also affects the banking sector. It has been founded that there are several types of risks faced by the commercial banks and have impact over their financial performance. The main purpose of this study is to identify the Effect of Risk Management Practices on Banking Financial Performance. For this research, Public sector commercial banks of Pakistan are taken as a selected sector which includes National Bank, Bank of Punjab, Bank of Khyber, Sindh Bank Ltd and First Women Bank ltd. Quantitative research approach has been used and the source of numeric data was secondary i.e. World Development Indicator (WDI), State Bank of Pakistan (SBP) and KSE for the period of 2004-12. The results provide evidence that risk management practice critically affect the financial performance of commercial banks of Pakistan.

Introduction:

The present global financial crisis resulted in a near collapse of the world banking system. Banking system suffering losses the one of the largest reason of this losses are inefficient risk management practices which affect the overall banking financial performance. The absence or mismanagement of such practices can have devastating effects on exposed organizations and the wider economy .Today's organizations and corporate leaders must learn the lessons of such failures by developing practices to deal effectively with risk.

Commercial banks are in the risk business because of providing financial services. The banking industry recognizes that an institution need not engage in business in a manner that unnecessarily imposes risk upon it; nor should it absorb risk that can be efficiently transferred to other participants. Rather, it should only manage risks at the firm level that are more efficiently managed there than by the market itself or by their owners in their own portfolios.

As it is the major goal of a firm to maximize benefits from cash flows and market status, managers usually achieve their objective through series of activities ranging from product sales, deposit acceptance, provision of funds to clients, etc. For as long as profit is a goal, risk is inevitable for financial institutions. Industrial concerns and product companies are well characterized as risk averters. Thus, financial institutions are prompted to seek out risk to make money.

Risk management becomes a very important practice in every financial institution especially in bank. In dynamic environment there is nothing constant but risk. So, because of the vital importance of risk management “An efficient risk management system is the need of time”. Managing risk is one of the basic tasks to be done. Risk and return are directly related to each other which means if you will take the high risk you will get the high return similarly if you will take the low risk you will get the low return.

The prime reason to adopt risk management practices is to avoid the probable failure in future. But, in realistic terms, risk management is clearly not free of cost. In fact, it is expensive in both resources and in institutional disruption. But the cost of delaying or avoiding proper risk management can lead to some adverse results, like failure of a bank and possibly failure of a banking system (Meyer, 2000).

Risk Management is a discipline at the core of every institution and encompasses all the activities that affect its risk profile. Risk management as commonly perceived does not mean minimizing risk; rather the goal of risk management is to optimize risk-reward trade-off. This can be achieved through putting in place an effective risk management framework which can adequately capture and manage all risks an institution is exposed to. Risk Management.

In order to manage risk, risk identification is a first process. Once risks have been identified, they should be measured in order to determine their impact on the institution’s profitability and capital. This can be done using various techniques ranging from simple to sophisticated models. Accurate and timely measurement of risk is essential to effective risk management systems. An institution that does not have a risk measurement system has limited ability to control or monitor risk levels. An institution should periodically test to make sure that the measurement tools it uses are accurate. Good risk measurement systems assess the risks of both individual transactions and portfolios.

The benefit of managing risk management includes identifying positive opportunity as well as avoiding negative threats. A systematic process for evaluating and measuring risk identifies problems early on, those problems which are fixed in less time it definitely means more time for production and growth. Effective managing risk management allows management to quantitatively measure the risk and capital allocation and liquidity need to match the on and of balance sheet risks faced by the institution.

The purpose of this study is investigate the how the risk management practice effect the bank financial performance. This study focuses on the role of risk management practice within commercial banking in Pakistan. Banks are exposed to a variety of risk but in this research we took the interest rate risk, credit risk, foreign exchange risk, investment portfolio risk and liquidity risk. The goal of such an activity is that to check the relationship between these risk and bank financial performance

Literature review:

The past decade banking industry have suffering losses. The one of the major cause of these losses is inefficient risk management. Financial risk in a banking industry have the possibility of that out comes against the actions which bring out the adverse impact. These results may occur in the form of direct loss of earning or may result in imposition of constraints on bank’s ability to meet its business objectives.

Global financial crises describes that the world banking system has collapsed due to the inefficient risk management practices in their institutions. Risk management is a prominent issue linked to financial system. The concept of risk as performance variance is widely used in finance, economics and strategic management. Any institution wants to maximize its profitability.

The banking sector is considered to be an important source of financing for most businesses. The common assumption, which underpins much of the financial performance research and discussion, is that increasing financial performance will lead to improved functions and activity of the organizations (Akram Alkhatib, 2012).

It is very commonly said that higher risk will always be rewarded with higher return. According to Levy and Srenatcs (1972) the fact that risk is an objective measure which is quantitative in nature, which can be calculated using historical as well as statistical data.

This study brings out the need and importance of the risk management practices in financial institution. This study shows the relationship between the credit risk, interest rate risk, liquidity risk, foreign exchange risk, equity market risk and financial performance in banking sector.

There is a large body of literature available regarding banking risk, but very few researches have been found regarding bank risk and financial performance. This literature review provides an overview of previous research on bank risk introduces the concept of financial performance.

Risks in financial services are larger in scope and scale than ever before. Along with revenue maximization and operational cost minimization, risk management has moved to center stage in defining superior performance. Differences in risk management philosophy and technique can produce prosperity, mediocrity, or failure. No senior management of today's financial institutions can perform its function without a vastly expanded understanding of the dimensions of risk and the various tools to manage it (Shahbaz Haneef, 2012).

Aremu et al, (2010) pointed out that the major problem of bank management is the miss-prioritization of short term goals over its long term objectives. While the profitability centers on the quality of short term reprise able assets and liabilities, net worth expansion which is the equity capital, is a function of total asset and liability. In Nigeria, it has been observed that most bank managers have focused more on profitability (which usually is a short term objective), with little attention on risk managing the quality of assets which has better impact on the long term sustainability of a financial institution.

Commercial banks are in the risk business because of providing financial services. The banking industry recognizes that an institution need not engage in business in a manner that unnecessarily imposes risk upon it; nor should it absorb risk that can be efficiently transferred to other participants. Rather, it should only manage risks at the firm level that are more efficiently managed there than by the market itself or by their owners in their own portfolios.

Risk can be defined as “A state in which the number of possible future events exceeds the number of actually occurring events and some measure of probability is unknown can be attached to them”. (Lane and Quack 1999).

Risk is usually defined by the adverse impact on profitability of several distinct sources of uncertainty (Risk Management Guide Lines for Commercial Banks and DFI`s).

Looking at the various definition of risk it can be conclude that the meaning of risk can be summarized as the potential recognition of an undesirable consequence that is happen to anybody. Risk is significant if the probability of occurrence or the severity of the potential impact is high (Dr. Dirk Steinwand, 2005).

Managing risk is a complex task for every financial institution, and it becomes very important where economic and financial system is linked together. In banking sector regulators have emphasized the managing risk management as an essential element for the success of bank for the long term duration. Today management and regulators not more focusing on previous financial performance, it focuses on an ability to identify and manage the future risk as the best predictor of long term benefits.

The definition of risk provided by (Haslem, 2003) whereby risk was defined from a financial perspective point of view leads us to the notion of return. Return is the change of value of a portfolio over an evaluation period. Return may be in the form of profit and loss. Whenever you invest your money somewhere likes stocks, real estate or any company from where you get some profit it is also called the return. There are so many meanings and definition regarding of return.

Risk and return very important aspects in finance, it calls for concern to study the relationship that exit between them. It has been brought to our notice that there has been a debate on whether the relationship existing between risk and management is positive, negative or curvilinear. (Fiegenbaum et al, 1996). Statistics have proven that most investors are risk averse. This idea serves as a back bone for looking into the positive relation existing between risk and return. According to Bowman (1980 and 1982), after carrying out exclusive research and sampling from different industries it was resulted in suggesting the existence of considerable variance with the classical finance theory in relation to risk and return in what become known as the Bowman paradox or known as risk and return paradox. It has been evident from his finding that most of the time, when there happen to be a negative relation between risk and return, that implies investors must have swapped from being risk averse to risk seekers and this can be experienced in any institution whether the institution are performing well or not..

A comprehensive approach to risk management, reduces the risk of loss, builds creditability in market place and creates new opportunity for growth (Dr. Dirk Steinwand, 2005).

Risk management practice in banking organization has become an important indicator for maximizing their profitability. Because there is a common objective of commercial bank is to maximize their profit.

The Company is exposed to credit risk and fluctuations in the market values of its investment portfolio although the Company has not recognized any material losses on its cash, cash equivalents and marketable securities, any significant future declines in their market values could materially adversely affect the Company’s financial condition and operating results. Given the global nature of its business, the Company has investments. (United States, Securities and Exchange Commission, 2009).

Foreign Exchange Risk is also called currency risk this risk under the financial risk category the simply meaning of foreign exchange risk is difference between the currency rates of the countries which are traded. In our business world investors and multinational company’s import and export of the goods and services and using currency for this global economy face this foreign exchange risk.

Measurement of credit risk has the vital importance in risk management. Qualitative and quantitative techniques are use to measure the risk. To measure the all type of credit activities bank should establish the credit risk-rating framework. Banks need to make a system in which the bank check and monitor the credit risk portfolio day by day and check the balance sheet as well. For the controlling the credit risk there should be restriction by the state bank.

Market risk is the risk in which market prices adversely affect the value of on and off balance sheet positions. It is due to the change in market condition. The risk is associated with financial instruments and the banking operations activities. In which including loan, deposits, securities, short term borrowing, long term debt, and trading account asset and liability.

Trading positions are subject to various risk factors, which include exposures to interest rates and foreign exchange rates, as well as mortgage, equity market, (Bank of America, 2004).

Interest rate risk takes place when there is a mismatch between the position and adjustment of interest rate. The lending of bank, funding and investment lead to the high interest rate. The recent impact of variation the interest rate is on bank`s net income.

In earning perspective the main focus is on the reported earnings. It is the rational approach to assessment the credit risk which is obtained by the measuring the net interest income.

In particular, it is defined as the possible direct loss (as a result of an no hedged exposure) or indirect loss in the firm’s cash flows, assets and liabilities, net profit and, in turn, its stock market value from an exchange rate move. To manage the exchange rate risk inherent in multinational firms’ operations, a firm needs to determine the specific type of current risk exposure, the hedging strategy and the available instruments to deal with these currency risks.

(Michael Papaioannou, Nov, 2006)

It refers to the impact of adverse change in currency rate on the value of open foreign currency position. Banks are exposed that risk which arise from the maturity mismatching of the position of foreign currency.

Equity market valuation usually involves estimates of this risk premium in addition to base risk free return. Hence estimated stock market returns and fair value measures are depending upon view about the size of the current and future risk premium (Fama and French (2002), Arnott and Bernstein (2002). The concern of management of market risk must start from the higher management. Board of directors and senior management make the policy of market risk to attain the higher return. The simplest form is to measure the market premium is to use the historical average market access return.

If the premium is time varying, as asset pricing theory suggests, then a historical average will be sensitive to the time period used. For example, if the level of market risk were higher in some sub periods than others, then the average excess return will be sensitive to the subsample chosen (Maheu & McCurdy, 2007)

A form of risk that summarizes the risks a company or firm undertakes when it attempts to operate within a given field or industry. Operational risk is the risk that is not inherent in financial, systematic or market-wide risk. It is the risk remaining after determining financing and systematic risk, and includes risks resulting from breakdowns in internal procedures, people and systems (Operational Risk Management, 2012).

Regulator have strict request to the bank in credit risk and operational risk in the past, but do not focus on liquidity risk. However, we can found that liquidity risk will cause severe consequence to banks following the subprime mortgage crisis. Besides, the credit crunch of 2007 reminded many banks of the importance of liquidity risk (Matz, 2008). Thus, it is important for banks to strengthen liquidity risk management, and liquidity risk will be an important issue in the future.

Liquidity risk is considered as an important internal determinant of bank profitability because it can be a source of bank failures. It arises from the possible inability of a bank to accommodate decreases in liabilities or to fund increases on the assets’ side of the balance sheet (Athanasoglou et al. 2006). To avoid insolvency, banks often hold liquid assets that can be easily converted into cash. However, liquid assets are usually associated with lower rate of return; therefore, the higher liquidity would be associated with lower profitability. This is supported by Molyneux and Thorton (1992) who prove that there is a weak negative relationship between the level of liquidity and bank profitability. However, Bourke (1989) found that there is a strong and positive relationship between them.

Hypotheses

Developing and testing the hypothesis to check whether it has an effect or not

Ho: There is no relation between ROE and market index.

H1: There is relation between ROE and market index.

Ho: There is no relation between ROE and FOREX.

H2: There is relation between ROE and FOREX.

Ho: There is no relation between ROE and interest rate.

H3: There is relation between ROE and interest rate.

Ho: There is no relation between ROE and liquidity risk.

H4: There is relation between ROE and liquidity risk.

Ho: There is no relation between ROE and credit risk.

H5: There is relation between ROE and credit risk.

3.1 Research Question

3.1.1 Main Question...

Does Risk management affect financial position of the banks?

3.1.2 Sub Question…

Does equity market risk affect ROE?

Does ROE can be affected by FOREX risk?

Does that ROE can be affected by interest rate risk?

Does ROE can be affected by liquidity risk?

Does ROE can be affected by credit risk?

Theoretical Framework:-

Financial Performance

Equity Market Risk

Foreign Exchange Risk

Interest Rate Risk

Liquidity Risk

Credit Risk

The conceptual framework presented in the following Figure: 1 is used to examine the Effect of Risk Management Practices on Banking Financial Performance. The framework has risk factors which are taken as an independent variable and Bank Financial Performance as a dependent variable.

On the basis of the literature review earlier mentioned and the research gap, theoretical framework is designed for this study in order to determine Effect of Risk Management Practices on Banking Financial Performance in the country like Pakistan. The theoretical framework has risk factors have taken as an independent variable and bank financial performance as a dependent variable. Whereas, the risk factors are grouped as Credit Risk (CR), Interest Rate Risk (IR), Liquidity Risk (LR), Foreign Exchange Risk (XR), and Equity Market Risk (ER) and on the other side Bank Financial Performance is only dependent factor which is measured in terms of Return on Equity (ROE).

Data and Methodology

5.1 Data

This study is based on the positivism paradigm; cross sectional research design has been used in order to get secondary data in numerical form, from world development indicator WDI, state bank of Pakistan and KSE for the period of 2004-2012 and quantitative research approach has been used. The benefit of a cross-sectional study design is that it allows researchers to compare many different variables at the same time (iwh.on.ca.com). Using numerical data will enhance the specification and accuracy of results. WDI is the primary World Bank collection of development indicators, compiled from officially-recognized international sources (world bank.org). State bank of Pakistan is the central bank of Pakistan and the most expert institute in R&D and the most reliable data base in Pakistan. Karachi stock exchange is the largest stock exchange of Pakistan. On annual bases, one year has been taken as a case so a sample yielding 09 cases, have been used in this study

Public sector commercial banks are taken as a selected sector which includes National Bank. Bank of Punjab, Bank of Khyber, Sindh Bank Ltd and First Women Bank ltd. Independent variables are foreign exchange risk, interest rate risk, equity market risk, credit risk and liquidity risk which explains the measure of RISK management.

5.2 Methodology

The data has been subjected to descriptive analysis, inferential analysis and SPSS software has been used to perform statistical analysis to determine the degree and direction of the relationship between Financial Position (in terms of ROE) and explanatory variables. As data is time series in nature and comprised of such a long period it is subjected to an equal no. of cases to take unbiased set of data to provide results.

Liquidity risk is measured in terms of the ratio of liquid asset to total deposit

Market index data is taken from KSE and change in market index shows the equity market risk.

Risk premium on lending id used to measure credit risk

Exchange rate is used as the measure of foreign exchange risk.

Interest rate on lending is used as the measure of interest rate risk

Data on financial position is measured in terms of ROE.

Dependent variable is financial position which is measured in terms of ROE. This ratio expresses the return on shareholders‟ equity. ROE is a direct measure of returns to the shareholders. It is calculated as a percentage of the net profit after tax to total Shareholders‟ equity. It is also useful for whole financial sector. i.e. ROE=100* net profit after tax\ total share holder’s equity

Results

6.1 Descriptive analysis Results

In descriptive analysis we took six variables one dependent i.e. ROE and other independent variables.

Table 1

N

Minimum

Maximum

Mean

return on equity

9

4.40

21.70

14.1111

market index

9

5348.00

15171.66

1.0214E4

FOREX

9

58.28

94.38

73.0075

interest rate

9

5.97

14.60

11.8789

liquidity risk

9

38.90

52.60

44.7444

credit risk

9

1.30

4.77

2.1511

Valid N (list wise)

9

In above table we have taken data of last 9 years, and dependent variable is market index and independent variable is return on equity and return on equity maximum value is 21.70 and its minimum value is 4.40, its mean value is 14.1111 and its standard deviation is 6.00238. Another independent variable is FOREX, its maximum value is 94.38 and its minimum value is 58.28, its mean value is 73.0075, and its standard deviation is 14.08152. In interest rate, its maximum value is 14.60 and its minimum value is 5.97, its mean value is 11.8789, and its standard deviation is 3.06539. In liquidity risk its maximum value is 52.60, and its minimum value is 38.90, its mean value is 44.7444, and its standard deviation is 4.76081. In market index the dependent variable, its maximum value is 15171.66 and its minimum value is 5348.00, its mean value is 1.024E4 and its standard deviation is 3067.51362.

6.2 Scatter plots:

Along x-axis and y axis we take independent and dependent variables, which show that function is linear. Matrix scatter plot graph is plotted to check the linearity assumptions for the inferential statistics that are correlation and regression analysis between dependent variable ROE and independent variables i.e. market index, forex, interest rate, liquidity risk and credit risk. The scatter plot is showing the dispersion and fluctuations in the variables due to unstable economy. ROE has positive and linear relationship with liquidity and credit risk while a linear and negative relationship with interest rate and foreign exchange, while there is an insignificant relationship between ROE and Market index.

Graph 1

6.3 Correlation Analysis:

The correlation coefficient measure the strength of linear relationship between two or more numerical variables, so we use Pearson correlation. When we have take two variables that are scale and normal. In correlation table, we take significance value it at 0.01 and 0.05 level it is (2 tailed) test. The table shows that there is weak and insignificant relationship between market index and ROE. The relationship between Interest rate and ROE is strong and significant. The relationship between FOREX, Liquidity risk and Credit risk Moderate and insignificant. The FOREX and Interest rate is negatively related to ROE and Rest of the independent Variables are positively related to ROE.

Table 2

return on equity

market index

FOREX

interest rate

liquidity risk

return on equity

Pearson Correlation

1

Sig. (2-tailed)

N

9

market index

Pearson Correlation

.153

1

Sig. (2-tailed)

.694

N

9

9

FOREX

Pearson Correlation

-.661

.553

1

.

Sig. (2-tailed)

.053

.123

N

9

9

9

interest rate

Pearson Correlation

-.710*

.454

.840**

1

Sig. (2-tailed)

.032

.219

.005

N

9

9

9

9

liquidity risk

Pearson Correlation

.427

.033

-.151

-.540

1

Sig. (2-tailed)

.251

.932

.699

.133

N

9

9

9

9

9

credit risk

Pearson Correlation

.425

-.568

-.614

-.837**

.584

Sig. (2-tailed)

.255

.110

.078

.005

.098

N

9

9

9

9

9

**. Correlation is significant at the 0.01 level (2-tailed).

*. Correlation is significant at the 0.05 level (2-tailed).

Relationship between ROE and market index

In this table we investigate if there was a statistically significance association between ROE and market index a correlation was computed. Both the variables were approximately normal and there is linear relationship between them hence fulfilling the assumptions for Pearson’s. (R) Is calculated R= .153, P= .694 relating that highly insignificance relationship between the variable, the positive sign shows the there is positive relationship between ROE and market index.

Variables: - ROE, market index rate

R= .153, P < .694

Relationship between ROE and FOREX

To check if there was a statistically significance association between ROE and FOREX, a correlation was computed. Both the variables were approximately normal and there is linear relationship between them hence fulfilling the assumptions for Pearson’s correlation. (R) Is calculated that is R= -.661, P= .053 the calculated R values greater than significance level and the value shows that there is negative relationship between and is shows there is relationship between these variables.

Variables: - ROE, FOREX

R= -.661, P < .053

Relationship between ROE and Interest rate

To check if there was a statistically significance association between ROE and interest rate, a correlation was computed. Both the variables were approximately normal and there is linear relationship between them hence fulfilling the assumptions for Pearson’s correlation. (R) Is calculated that is R= -.710, P= .032 the calculated R values lower than significance level and the value shows that there is negative relationship between and is shows there is no relationship between these variables.

Variables: - ROE, Interest rate

R= -.710, P < .032

Relationship between ROE and liquidity risk

To check if there was a statistically significance association between ROE and liquidity risk, a correlation was computed. Both the variables were approximately normal and there is linear relationship between them hence fulfilling the assumptions for Pearson’s correlation. (R) Is calculated that is R= .427, P= .251 the calculated R values greater than significance level and the value shows that there is positive relationship between ad is shows there is no relationship between these variables.

Variables: - ROE, Liquidity risk

R= .427, P > .251

Relationship between ROE and credit risk

We investigate if there was a statistically significance association between ROE and credit risk correlation was computed. Both the variables were approximately normal and there is linear relationship between them hence fulfilling the assumptions for Pearson’s. (R) Is calculated R=.425, P= .255 relating that highly significance relationship between the variables, the positive sign shows the there is positive relationship between these variables.

Variables: - ROE, credit risk

R=.425, P > .255

Relationship between market index and FOREX

We investigate if there was a statistically significance association between market index and FOREX a correlation was computed. Both the variables were approximately normal and there is linear relationship between them hence fulfilling the assumptions for Pearson’s. (R) Is calculated R= .553, P= .123 relating that highly insignificance relationship between the variables, the positive sign shows the there is positive relationship between market index and FOREX.

Variables: market index, FOREX

R= .553, P > .123

Relationship between market index and interest rate

We investigate if there was a statistically significance association between market index and interest rate a correlation was computed. Both the variables were approximately normal and there is linear relationship between them hence fulfilling the assumptions for Pearson’s. (R) Is calculated R= .454, P= .219relating that highly insignificance relationship between the variables, the positive sign shows the there is positive relationship between consumer goods and exchange rate.

Variables: - market index, interest rate

R = .454, P > .219

Relationship between market index and liquidity risk

We investigate if there was a statistically significance association between market index and liquidity risk a correlation was computed. Both the variables were approximately normal and there is linear relationship between them hence fulfilling the assumptions for Pearson’s. (R) Is calculated R .033, P = .932 relating that highly significance relationship between the variables, the positive sign shows the there is positive relationship between market index and liquidity risk.

Variables: - market index, liquidity risk

R = .033, P < .932

Relationship between market index and credit risk

To check if there was a statistically significance association between market index and credit risk a correlation was computed. Both the variables were approximately normal and there is linear relationship between them hence fulfilling the assumptions for Pearson’s correlation. (R) Is calculated that is R = -.568, P= .110 the calculated R values less than insignificance level and the value shows that there is negative relationship between ad is shows there is no relationship between these variables.

Variables: - market index and credit risk

R = -.568, P >.110

Relationship between FOREX and interest rate

We investigate if there was a statistically significance association between FOREX and interest rate a correlation was computed. Both the variables were approximately normal and there is linear relationship between them hence fulfilling the assumptions for Pearson’s. (R) Is calculated R = .840, P = .005 relating that highly significance relationship between the variables, the positive sign shows the there is positive relationship between FOREX and interest rate.

Variables: - FOREX, interest rate

R = .840, P > .005

Relationship between FOREX and liquidity risk

We investigate if there was a statistically significance association between FOREX and liquidity risk a correlation was computed. Both the variables were approximately normal and there is linear relationship between them hence fulfilling the assumptions for Pearson’s. (R) Is calculated R = -.151, P = .699 relating that highly significance relationship between the variables, the negative sign shows the there is negative relationship between FOREX and liquidity risk.

Variables: - FOREX, liquidity risk

R = -.151, P < .699

Relationship between FOREX and credit risk

We investigate if there was a statistically significance association between FOREX and credit risk a correlation was computed. Both the variables were approximately normal and there is linear relationship between them hence fulfilling the assumptions for Pearson’s. (R) Is calculated R = -.614, P= .078 relating that highly significance relationship between the variables, the negative sign shows the there is negative relationship between FOREX and credit risk.

Variables: - FOREX, credit risk

R = -.614, P < .078

Relationship between interest rate and liquidity risk

We investigate if there was a statistically significance association between interest rate and liquidity risk a correlation was computed. Both the variables were approximately normal and there is linear relationship between them hence fulfilling the assumptions for Pearson’s. (R) Is calculated R =-.540, P = .133 relating that highly significance relationship between the variables, the negative sign shows the there is negative relationship between interest rate and liquidity risk.

Variables: - interest rate, liquidity risk

R = -.540, P < .133

Relationship between interest rate and credit risk

We investigate if there was a statistically significance association between interest rate and credit risk a correlation was computed. Both the variables were approximately normal and there is linear relationship between them hence fulfilling the assumptions for Pearson’s. (R) Is calculated R = -.837, P = .005 relating that highly significance relationship between the variables, the negative sign shows the there is negative relationship between purchasing power and lending.

Variables: - interest rate, credit risk

R = -.837, P < .005

Relationship between liquidity and credit risk

We investigate if there was a statistically significance association between liquidity risk and credit risk a correlation was computed. Both the variables were approximately normal and there is linear relationship between them hence fulfilling the assumptions for Pearson’s. (R) Is calculated R = .584, P = .098 relating that highly significance relationship between the variables, the positive sign shows the there is positive relationship between purchasing power and lending.

Variables: - liquidity risk, credit risk R = .584, P > .098

Simple regression

This test was applied to measure the individual relationship of the independent variables representing risk management and dependent variable Financial Position represented by ROE

Table 3

Model

(Constant)

Adj. R²

F

Sig

B

t – value

Sig

Market index

11.045

-.116

.169

.694

.000

.411

.694

FOREX

34.667

..356

5.418

.053

-.282

-2.328

.053

Interest rate

30.623

.433

7.111

.032

-1.390

-2.667

.032

Liquidity risk

-10.004

.066

1.565

.251

.539

1.251

.251

Credit risk

9.019

.063

1.539

.255

2.367

1.241

.255

dependent variable: RETURN ON EQUITY

6.4.1 Relationship between ROE and market index:

In simple regression the results were statistically insignificant of the ROE and market index n (1, 9) F = .169, p < .694. The adjusted R square value was -.116. Equation shows that a unit increase in market index will not affect ROE of public banks at all as b=000.

Y=a +b x

Y= 11.045+.000x

6.4.2. Relationship between ROE and FOREX:

In simple regression the results were statistically significant the ROE and FOREX N (1, 9) F = 5.418, p > .053. The adjusted R square value was .356. and with a unit increase in exchange rate of Pakistani rupee will decrease the ROE by 0.282 units. 35.6 % variation in ROE can be explained by the variation in the exchange rate

Y=a +b x

Y= 34.667-.282x

6.4.3. Relationship between ROE and interest rate:

In simple regression the results were statistically significant the ROE and interest rate N (1, 9) F = 7.111, p > .032. The adjusted R square value was .433. equation shows that with unit increase in interest rate the ROE of public sector bank will decrease by 1.39 units as b= -1.39. 43.3% of variation in ROE can be explained by the variation of Interest rate.

Y=a +b x

Y= 30.623-1.390x

6.4.4. Relationship between ROE and liquidity risk:

In simple regression the results were statistically significant the ROE and liquidity risk N (1, 23) F = 1.565, p > .251. The adjusted R square value was .066. With unit increase in Liquidity the ROE will increase by 0.539 units. Almost 7% variation in ROE is explained by liquidity.

Y=a +b x

Y= -10.004+.539x

6.4.5. Relationship between ROE and credit risk:

In simple regression the results were statistically significant the ROE and credit risk N (1, 9) F = 1.539, p >.255. The adjusted R square value was .063. With unit increase in Credit risk the ROE will increase by 2.367 units. Almost 7% variation in ROE is explained by credit risk.

Y=a +b x

Y= 9.019+2.367x

Multiple regressions:-

Table 4

General Model

Variables

B

t-value

(Constant)

23.985

1.259

Market index

.002

2.821

FOREX

-.329

-1.646

Interest rate

-.545

-.440

Liquidity risk

.085

.222

Credit risk

.649

.271

Adjusted R Square .741

F 5.583

Significance .094

N= 9

Dependent Variable: RETURN ON EQUITY

Simultaneously multiple regression was conducted to investigate the best predictors about the independent and dependent variables. So in multiple regression the results were statistically insignificant. N= (1, 9) F = .008, p < .067 and so on and total multiple regression is F = 5.583 > P = .094. The adjusted R square value was .741. 74% of variation is explained by the variation in credit risk equity market risk liquidity risk foreign exchange risk and interest rate risk. And estimated regression equation is:

Y=23.985+.002x1-.329x2-.545x3+.085x4+.649x5

CONCLUSION:

This research article employ the cross sectional model to investigate the impact of financial risk management on the financial performance of the public sector commercial banks of Pakistan. In this study, we identify the relationship between risk factors and further look at the impact of interaction of financial risk management and risk factors on the financial performance. The results can provide insight for management to manage risk and the authority to supervise financial institutions about the financial risks matters.

Major empirical results can be summarized as follows. First, the variation in the financial performance in terms of return on equity (ROE) is about 70% due to the independent variables i.e. credit risk, equity market risk, liquidity risk, foreign exchange risk and interest rate risk. Second, the interest rate risk has strong and significant negative relationship with the return on equity (ROE). The negative relationship between them is due to the fact that the banks’ interest income is lesser than their interest expense while the State Bank of Pakistan is keep on increasing the bank rate and less advances are made to general public and more are lend to the GOVT. which makes default more often. Further, FOREX has also negative relationship with return on equity (ROE). The negative relationship between them is due to the basic reason that Pakistan’s currency is keep on devalued by the authority which negatively affects the foreign exchange reserves of the banks. The effect of market index on return on equity (ROE) is not found significant as the market capitalization of the public sector commercial banks has been fall and devalued due to recent crisis. Furthermore, the liquidity risk is measured through the liquidity ratio of the liquid assets to the total assets and the results shows that liquidity risk has positively related with return on equity (ROE) i.e. the more the bank have liquidity the more will be the return on equity (ROE) as they would have more money in hand to be spend upon the operations so to earn more returns. The credit risk shown that it has positive relation with the return on equity (ROE) as the bank took more credit risk and avoids anticipated default risk in providing loans the return will be more and vice versa.

Our study and general findings are in line with the studies of the past researchers which were reviewed in the literature review of this article. But some result may differ from the general prospective as our study is limited to the Pakistan’s public sector commercial banks and also there are some factors regarding financial performance which have not been taken into account such return on assets (ROA) so the result might have more accurate than those results.

As compared to the past, now banking sector is clearly surfacing to a higher level of risk management. But there are still areas for improvement. Before the areas of potential value added are enumerated, however, it is worthwhile to reiterate an earlier point. The risk management approaches used in financial institutions is less precise and significantly less analytical

Print Email Download

Share This Essay

Did you find this essay useful? Share this essay with your friends and you could win £20 worth of Amazon vouchers. One winner chosen at random each month.

Request Removal

If you are the original writer of this essay and no longer wish to have the essay published on the UK Essays website then please click on the link below to request removal:

Request the removal of this essay.


More from UK Essays

Need help with your essay?

We offer a bespoke essay writing service and can produce an essay to your exact requirements, written by one of our expert academic writing team. Simply click on the button below to order your essay, you will see an instant price based on your specific needs before the order is processed:

Order an Essay - via our secure order system!