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Monetary Policy and Profitability of Commercial Banks in Uganda

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Document pages: 29 pages

Abstract: Background: Economic theory suggests that monetary policy through interest ratesaffects bank profitability. There is limited empirical evidence on therelationship between monetary policy and profitability of commercial banks inUganda. Objective: This study seeks to examine the effect of monetarypolicy on the profitability of commercial banks in Uganda. Methodology: The study adopts a causal relationship research design. Data, covering 9 years from 2010-2018, was collected from all theregistered commercial banks which were in operation over the study period.Various monetary policy variables are included in the empirical model aspredictor variables. Return on Assets is used as a measure of bank profitability. A dynamic two-step System Generalized Method of Moments panelestimator is applied to estimate the empirical model. Findings: Estimates show that monetary policy in terms of its link to the lending rate has a significant causaleffect on Return on Assets, suggesting that interest rate changes predict bankprofitability of commercial banks in Uganda. Further, results show that a rise in core inflation has a significantnegative causal effect on the banks’ profitability and that there is asignificant lagged effect of Return on Assets. The 91-day treasury bill rate and money supply were insignificant in predicting bank profitability. Originality: Unlike previous related studies which have focused on major advanced economiesand a limited number of studies which have considered only a few developingcountries like Nigeria and Kenya, the current study provides empirical evidenceon the link between monetary policy and commercial bank profitability inUganda. Practical Implications: Policy makers in the financial sectormay use the study results as a basis of implementation of appropriate monetarypolicy actions that enhance the profitability of Uganda’s commercial banks. Forinstance, the central bankshould promote low and stable core inflation in order to enhance bankprofitability, and should ensure that the monetary policy transmission tointerest rates is efficient.

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