The relationship between interest rates, credit risk and profitability of commercial banks in South Africa

Abstract

This research investigates the relationship between interest rates, credit risk, and profitability of commercial banks in South Africa over a 20-year period from 2002 to 2022. The study focuses on seven listed commercial banks, utilising secondary data and employing panel data analysis with Feasible Generalised Least Squares (FGLS) regression to correct for heteroskedasticity and autocorrelation. The objectives were to examine the effects of interest rates on credit risk and profitability, as well as the effect of credit risk on profitability. The findings reveal a non-linear relationship between interest rates and credit risk, with regression analysis showing an insignificant relationship. This suggests that interest rate changes may not significantly influence credit risk. Bank-specific factors such as size and capital adequacy were found to strongly influence credit risk. Regarding interest rates' effect on profitability, a weak positive linear relationship was observed, but regression analysis indicated an insignificant relationship. Credit risk was found to have a significant positive impact on profitability at the 1% significance level, highlighting its importance for bank profitability. Overall, the study concludes that bank-specific factors play a pivotal role in credit risk and profitability, emphasising the need for banks to focus on these factors for effective risk management and profitability enhancement. The positive correlation between profitability and economic growth suggests that South African banks are more profitable under favourable economic conditions. The study's contribution lies in providing empirical evidence and insights to aid banks in developing strategies to navigate interest rate environments and enhance financial stability, as well as assisting policymakers, including the South African Reserve Bank, in monetary policy execution.