Bank Profitability, Shariah Status and Regime-Switching Strategies: Evidence from Pakistan Stock Exchange-Listed Banks

Abstract

Purpose: This study investigates the impact of Pakistan Stock Exchange-listed banks profitability and Shariah compliance status on superior investors wealth, who are differentiated based on their risk profile such as such as Risk Averse, Risk Neutral, Risk Taker (RA, RN, RT) and further investigating which strategy from Regime-Switching and non-Regime Switching is bitterly amplify these associations.

Methodology: By adopting quantitative approach, this study focuses on 20 commercial banks listed on the Pakistan Stock Exchange (PSX). Secondary data comprising of daily closing balances of  banks’ stocks is taken from a reliable source Business Recorder, the one-month KIBOR rates from the State Bank of Pakistan (SBP), and KSE_ALL benchmark from the official website of PSX. The period spans November 18, 2015, to December 31, 2025, selected to align with Shariah segregation stated by PSX. Three data streams were developed, the Whole-Sample (November 18, 2015, to December 31, 2025), the In-Sample (November 18, 2015, to February 12, 2017), and the Out-Sample (February 13, 2017, to December 31, 2025). The data streams are processed by using statistical analysis like 'Descriptive Analysis' and 'OLS Regression' by using MS-EXCEL. Descriptive statistics and OLS regression were performed using MS-EXCEL while forecasting of Out-Sample data was executed through ‘Filtered Probability’ using MATLAB version R2018a.

Findings: Across the whole-sampled data, top profitable banks segment has higher mean value (0.0454%) with standard deviation (1.218%) than bottom profitable banks segment .218%) than the bottom-profitability portfolio (0.0347% and 1.425%). Moreover, Shariah compliance banks segment performed better with mean value (0.0600%) but with a high standard deviation (1.837%) than conventional banks segment (0.0379% and 1.169%).  In forecasts of out-sampled data with initial investment of Rs. 1, the growth in observes in top profitable banks segment are RA=Rs. 2.246, RN=2.050 and RT=2.418 under regime-switching model and bottom banks Rs. 2.081, Rs. 1.893, and Rs. 2.291 respectively.  The results reveal that all investors (RA, RN, and RT) generate superior wealth in top profitable banks as compared to bottom profitable banks. Furthermore, results confirm that the Islamic banks outperform conventional banks across all risk profiles of investors. These results substantiate that both profitability and Shariah compliance positively impact on wealth maximization for all investors by risk profile.

Practical Implications: The qualified results and hypotheses of the research will be helpful for investors in portfolio management strategies and the regulators in developing regulations to save the interest of stakeholders.

Originality: This is a unique work done on wealth maximization of investors by risk profile having investment in the Banking sector of PSX. This type of study is never conducted early. So, it is unique work done.

Keywords: Risk Averse, Risk Neutral, Risk Taker, Wealth Maximization, Top Profitable Banks and Bottom Profitable Banks, Islamic Banks, Conventional Banks, Regime Switching Model, Non-Regime  Model, Ending Wealth, Sharpe Ratios, Random Matrix Theory, MATLAB.