Determinants of Profitability and Risk-taking in Pakistani Commercial Banks: Dynamic GMM Approach

The study used interest rate, exchange rate and banks size as variables of study. The panel data of 22 Pakistan commercial banks about2009 to 2020, STATA Panel Ordinary Least Square (OLS) and general methods of moments (GMM) estimator is used, and results indicate that in Pakistani banks management efficiency is has high power over sharehold - er to make profits and involve in risk taking projects. Bank size increase highlights better performance but and a disadvantage to use funds in investments for future growth. Diver - sification in banks is not a helpful factor to bring change in risk portfolios during financial crises. The liquidity inverse relation causes less availability of resource to boost financial performance and default lending result in credit risk. High proportion of assets utilized for personnel expense raise risk-taking ratio for operation in Pakistan. Banks should avoid the adverse selection of risks with proper performance policy, as to safeguard from hostile eco - nomic situations.


Introduction
For the past two decades, finance sector of Pakistan, have faced a lot of advancement in global competition and risk-taking.(Khan & Khan, 2018) Banking sector needs an efficient setup to compete globally so that banks can regularly strive to improve the efficiency and performance.(Jiang et al., 2023) By taking excessive risk of bank managers or banks executives ________________________ *Professor, School of Management, Huazhong University of Science and Technology, Wuhan 430074, China.Email: zhchjun@hust.edu.cn** Assistant Professor, Management Science DHA Suffa University, Karachi, Pakistan.Email:shumaila.meer@dsu.edu.pk***Visiting lecturer IBS department KUST, Kohat, Pakistan.Email:atifnadeem398@gmail.com **** Lecturer, Management Science DHA Suffa University, Karachi, Pakistan.Email:samina.parveen@dsu.edu.pk

Determinants of Profitability and Risk-taking in
Pakistani Commercial Banks: Dynamic GMM Approach can maximize the shareholders' wealth.An important question arises for exploration into the role of monetary policy in banking performance efficiency?(Isayas, 2022) used bank size as one of the determinants of bank's profitability in Ethiopia by using GMM approach.( Khan & Khan, 2022) A positive and significant effect have been identified by this research on Bank's profitability.(Shah et al., 2018) The significance / scope of this research is associated with different stakeholders as banking institutions, policy makers, researchers in their respective domains to study about the banking sector of Pakistan.(Zaheer e t al., 2023) However, underdeveloped countries like Pakistan lacks in the aspect.( Khan et al., 2022) The present study aims to know how financially efficient and profitable Pakistani banking system is by including internal and external macroeconomic variables by risk-taking practices for a period of 2009 from 2009 to 2018.The study is first to research the bank risk-taking and financial performance as well as, firm-specific, regularity and macroeconomic factors in Pakistan.(Jamile t al., 2022) Another scope of this research is associated with different stakeholders including banking institutions, policy makers, researchers in their respective domains to study about the banking sector of Pakistan whether profitability and risk-taking have effect on the stability of financial sector of Pakistan.The main objective of the current study shown below;

1.1
Research objectives 1.To determine the impact of banks' financial performance from Return on Equity (ROE).2. To identify the effect of Z Score, a proxy for risk taking.
What is the issue statement or research question?What are the objectives?What is the motivation?"

The concept of financial performance/ profitability
Profitability and growth of the financial sector lead to economic progress and wealth of the country.Interest rates are insignificant to be highly negatively significant to ROE.The project can bear high risk-taking and low profit, done by the borrowing to increase assets at risk, U. R. (2010), and (Ongore & Kusa, 2013).

The concept of risk-taking behavior
The method of Z-Score (Boyd, 1993) is used to measure banking risk; the active banks take more risk.The work by (Zheng et al., 2017) mentions an increase in bank stability.In emerging countries, the Z-Score is a measure of commitment of capital with high explicit deposit and decide the market discipline (Haq et al., 2014).
The assets of a bank grow with time and management efficacy is required to keep the issue in control (Havrylchyk, 2006).The strategies of a bank decide the management efficiency regarding the profitability, especially of the diversified bank.Managers can increase the risk of operations when capacity is high, and diversification is beneficial when a manager has the skill to manage the mixture of business activities.Size is an important variable a proxy for total assets.To determine the performance of the bank as the economies of scale are obtained with increase in size reduce and efficiency to collect information to start a business (Stiglitz et al., 2010).The logarithm of assets of bank is proxy of bank size.(Lassoued et al., 2016).Bank's financial stability plays a crucial role in stabilizing the economy of BRICS (Brazil, Russia, India, China and South Africa) and banks' profitability is the main ingredients (Sain, 2023).Banks are exposed to high risk-taking when the burden of leverage and regulatory requirements increase (Le, 2022).A big bank diversifies risk with the opportunity to take vast kinds of loans (Zheng et al., 2017).
The diversification strategy of a bank is beneficial in the form of different financial services.The activities that carry no interest are harmful to banks, result in volatile nature but less profit from lending practice.The noninterest business decreases the risk-adjusted profits and shows the dark version of diversification.(Rashid et al., 2021) The investment opportunity increase with the increase in diversified products, the risk-adjusted return can increase.(Rasmussen et al., 2005) The two facets of diversification is the direct interaction of the diversification effect and increase in noninterest income and the inverse relation between the diversification effect the income earned (Stiroh, 2006).The return of a bank decrease as the industry and sector loan diversifies.The banks that indulge in low risk earn the inefficient return of risk or produce just marginal environment.(Sharjeel et al., 2023) The assets that are formed in to banks, are diversified may not result in good management performance.For managerial efficiency decreases new sector is introduced in the loan portfolio and raise bank risk (Acharya et al., 2016).(Adem,2022) identified that diversification plays crucial role for banks of emerging and developing to reduce its risk that leads to the overall improvement of financial strength.(Khanji et al., 2022) The central bank has information for the bank default risk and liquidity of the bank to practice the function of last resort lender at the time of crisis.as a depositor withdraw money the government bank issues funds to poor cause liquidity issue and have an impact on private banks too (Bart,2023;Song et al., 2013).The ratios measure the efficiency of operations of banks (Cornett et al., 2010).A research was conducted to explore whether profitability of Indian commercial banking sector is affected by risk (Khan et al., 2023)ng measure or it.The study identified that higher credit has significant impact on the profitability of the banking industry.(Nafees et al., 2021).
As stated in the instruction of central bank of Pakistan, CAR was regulated as proxy of risk to banks.(Shuaib Ahmed, 2022) The banks have to follow the instructions as separate entity and on consolidation stand.The CAR value can be increased or decreased based on deposit insurance scheme to cartel risk.CAR is a measure of capital at bank, a backup as secure deposit and bank consistency.The expected risk on risk weighted assets is lower for banks with less capital.As CAR is lowered ex-ante the investment on asset as collateral reduces.(Khan & Zaman, 2023) Exchange rate is an important price value at a macroeconomic front for international transaction and a determinant to measure return on investment and risk-taking behavior.(Akbar et al ., 2009) The exchange rate volatility in an economy is troublesome for international business.(Miao et al., 2022) The ideal recommendation for the government is to upholding restrictions on appreciation of currency against foreign exchange rate.Exchange rate fluctuations has ripple down effect on macroeconomic variables like real interest rate.EXR is also beneficial for the growth of a country for international business and services Elhussein and Osman (2019).

Materials and Methods
In this study, dependent variable profitability and bank risk-taking behavior credit risk, diversification, liquidity, and personal expense to total loan ratio.Furthermore, macro-economic variables include real interest rate exchange rate.The quantitative data was gathered from Bureau Van Dijk's Bank focus.Further, real interest rate and exchange rate data was gathered from WDI database.The selection of significant bank specific variables is due to limited availability of data for commercial banks of Pakistan in the form of profitability and bank risk (Cui et al., 2018).The research was carried out to analyze the profitability and bank risk implication in commercial banks of Pakistan.Panel data was used to run panel dynamic estimator GMM model for the year 2010 to 2017 reason being the coverage of timeframe after the 2008s global financial crisis (GFC) described by the period, July 2007 to March 2009 (Dungey & Gajurel ,2015).
Logically the source of information (data) used in this research positivism viewpoint and deductive methodology.The theory proposed in the paper by (Zhu & Yang, 2016) suggests high value of return on assets shows the firm is efficient.Significant proxy bank liquidity is taken in this study which indicates that incase of solvency/ default or fulfillment of payments how quickly bank can meet the required level of monetary policy.Ordinary Least Square (OLS) estimation is used (Perhiar et al., 2020(, The fixed effect (FE) model removes time-variant individuals and gives a distinctive worth in a discrete unit of the data and measure individual effect (Ullah et al., 2020), (Perhiar et al., 2020).The Z-Score analyses is a formula developed to know the bankruptcy or financial problems of a company with the combination of financial ratios and statistics (Boyd & Prescott, 1986) state that Z-Score Research PAKISTAN BUSINESS REVIEW is a measure of risk indicating the default and profitability.In another early study, (Stiglitz et al., 2010) study to measure bank insolvency risk.Risk index and Z-Score are substantially identical.

Model specification
The following econometric models are established based on the variable above explanation and review of the literature; ROE is dependent variable in the Eq.(I) to account as a performance measure similarly in the Z-Score the dependent variable Z-Score is a proxy for risk.I is a subscript of commercial banks there are i=1, 2….22 for Pakistani active commercial banks and t=2009...2020.α, β are estimation parameter and εi,t is error term.

Results and discussion
Table 2 represents the descriptive statistics of variables, based on the central tendency and variability of the data to help demonstrate the complete sample of the study.Also, standard deviation, minimum and explains the variability or flexibility and range of the data.

Table 2 Descriptive Statistics
The table ostensibly yields a total data set comprising 264 data points, detailing descriptive statistics, reports a minimum and maximum observation count of 113 and 176o observations, due to some missing data for some banks and years.

Table 4 Pearson Matrix Z-SCORE
Table 3 & 4 present the Pearson's correlation coefficient for Pakistan.The tables show the multicollinearity does not cause any problem in the model as the dependent and independent variables in two separate models (Gujarati & Porter, 2003).

Results of ordinary least square (OLS)
The first section showcases the influence of bank performance and risk-taking for the 22 active commercial banks of Pakistan (Zheng et al., 2019).The second section shows the effect of bankruptcy of commercial banking.

The determinants impact on financial performance by ROE
Management efficiency is positively and significantly correlated to ROE (Havrylchyk, 2006).Size has a significant and positive correlation with ROE (Stiglitz et al., 2010).Diversification is insignificantly positively correlated to ROE and has a significant positive impact of diversification on earnings (Stiroh, 2006).Also, an inversely significant correlation is seen between diversification and ROE for Pakistani banks (Acharya et al., 2016) Liquidity is positive and significantly correlated to ROE (Barth, 2003;Song et al., 2013).Personnel are positive and significantly correlated to ROE for banks (Ramlall, 2009) Arellano-Bond test for AR (1) in first differences: z = -0.81Pr> z = 0.418 Arellano-Bond test for AR (2) in first differences: z = -0.77Pr> z = 0.440 Sargan test of over identification.Restrictions: chi2 (7) = 16.45Prob> chi2 = 0.021 (Not robust, but not weakened by many instruments. Results shows that management efficiency has positive and significant relationship on return on average asset that means that absence of efficiency by managers will strongly affect ROE.Size of banks is positively significant correlated to ROE (Havrylchyk, 2006).Size of banks has a significant and positive correlation with ROE (Stiglitz et al., 2010).Diversification is significantly negatively correlated to ROE Also; an inversely significant correlation is seen between diversification and ROE for Pakistani banks (Acharya et al., 2016) Liquidity is positive and significantly correlated to ROE (Barth, 2023;Song et al., 2013).Personnel are positive and significantly correlated to ROE for banks (Ramlall, 2009).Real interest rate has positive and significant relationship on ROE.Capital adequacy ratio of banks is positively correlated to ROE (Havrylchyk, 2006).Exchange rate is significantly negatively correlated to ROA for Pakistani banks (Acharya et al., 2016).Results of Z-Score OLS Models.

Risk-taking behavior impact insolvency or bank default
Table 7 shows the OLS results of bank risk-taking in the case of diversification variable an inversely significant correlation is seen between diversification.

Table 8
Results of Z-Score GMM Models Arellano-Bond test for AR (1) in first differences: z = -1.79Pr> z = 0.073 Arellano-Bond test for AR (2) in first differences: z = 0.54 Pr> z = 0.591 Sargan test of overidentification.Restrictions: chi2 (7) = 7.46 Prob> chi2 = 0.382 Hansen test of overid.Restrictions: chi2 (7) = 1.98 Prob> chi2 = 0.961 Management is positively significant to Z-Score, and size is significant and positively correlated with Z-Score (Konishi & Yasuda, 2004;Laeven, 2009).There is an inversely significant relationship visible between diversity and Z-Score.Liquidity is an important factor which needs to be considered as it can inversely affect the Z-Score.Regression result tells that relationship between personnel expense and Z-Score is positively significant which says presence of PER will adversely affect the dependent variable.RIR of is positive in the relationship (Uhde & Heimeshoff, 2009).CAR of banks positively insignificant to risk and exchange rate is negative but it's significant.

Conclusion and Policy Implications
The basic aim of the study is to determine the insolvency/ default risk and bank performance in Pakistan under monetary policy of interest rate.(Khan et al., 2022) Ordinary Least Square approach is used to know the effect on bank risk-taking behavior, the administration and managers have more power than shareholders to influence the use of funds to run government-based banks or spend money on social or public activities for the interest of political concerns.(Jiang et al., 2023) The size as to keep the fact in control that large banks have opportunities to diversify and tendency when needed to face risk in time of financial crisis.(Jalees et al., 2015) The banks of Pakistan have less total asset size to change the portfolio of risk and have risk aversion strategy.Pakistan being a developing country has a low level of GDP, and the factor hinders the bank to indulge in bank risk taking the practice of making investments at the time of growth of economy with the fear of the adverse impact of facing default risk and getting bankrupt.(Khan et al., 2021) The real interest rate at the high rate offered by bank makes a borrower invest with risk in order to reimburse loan payment at a high value.(Jalees et al., 2023) Domestic banks maintain a risky portfolio with more assets in the form of a loan and earn a higher return on assets.(Zaman et al., 2023) The diversification strategy with respect to portfolio mentions the risk a bank takes decreases when income is generated from various less volatile sources, by achievement of economies of scale to measures banks' performance.(Miao et al., 2022) The diversified loans offered to industry and different sectors lower the return of bank and make risky loans, for Pakistani bank that adopt risk behavior.
Pakistan is an emerging economy with GDP growth in a positive direction and boosts credit demand ultimately to bank performance.The real interest rate is positive and significantly correlated to ROE for banks.(Ali et al., 2023) As the lending rate increase the bank performance improves , as the lending rate increase make a customer deposit to bank as the money is demand for business to overcome the expense, banks in response raise the rate of interest to increase income ultimately the customer in order to cover the extra cost.(Mubarik et al., 2021) In conclusion banks provide purposeful and Powerful board people, betterment in timings, correctness and extent of reporting in bank reports and to be attentive to interests of minor shareholders.(Zaman et al., 2023) The accounting mode of standards with security in proper methods, laws of corporation, balanced judicial scheme and systematic adjustments in all to ensure the process of well performing banking governance and management of risk for healthy banking sector.(Miao et al., 2020) Independence of the risk management assembly can perform an important role and also can accelerate role in the deduction of default risk.(Khanji et al., 2022) .

Table 6
Results of ROEGMM Model