IMPACT OF INFLATION RATE AND EXCHANGE RATE ON THE PROFITABILITY OF FINANCIAL INSTITUTIONS: A PANEL DATA ANALYSIS FROM PAKISTAN

Abstract

annual balance sheets, statements and reports of respective banks, State Bank of Pakistan and IMF were the data source. ARDL model was applied as an estimation technique. The return on assets was used as a proxy for profitability while real GDP and interest rate were used as control variables. The results of this study showed that inflation has a negative and significant influence on return on assets (ROA). Theoretically it revealed that due to inflation, when purchasing power of general public declines they can save less money and it effect the saving amounts in banks deposits and hence disbursed less loans to individuals for investment. Exchange rate influence the profitability positively and significantly. The economic growth impact on profitability is positive and significant on 1% level. ECM coefficient measures the speed of adjustment in disequilibrium and its value was -0.632 indicating that any change in inflation and exchange rate is corrected by 62.36% per year. The study suggested that government should maintain more flexible exchange rate for price stability. The role of financial institutions in economic growth and should strengthen by lower interest rate for prospective entrepreneurial activities. Keywords: inflation, exchange rate, profitability, financial institutions, return on assets.