DETERMINANTS OF CAPITAL ADEQUACY RATIO: AN EMPIRICAL STUDY OF PRIVATE COMMERCIAL BANKS IN ETHIOPIA

Abstract

Capital adequacy rules are safety controller for regulators and banks' clients/shareholders to reduce expected risks faced by commercial banks .These rules are applied compulsory by all banks internationally. Applying these rules will achieve rational management and governance. This paper examines empirically the determinants of Capital Adequacy Ratio of Private commercial Banks in Ethiopia. The study period covered the year from 2011 to 2016 on which thirteen Private Commercial Banks are selected based on availability of six years data. The study use secondary data which is gathered from annual reports of the banks under study. Panel data regression is used in this study to analyze relationships between the dependent and independent variables. The dependent variable is Capital Adequacy ratio (CAR) and independent variables are selected from internal and external factors. Internal variables are Bank size (SIZE), ),Return on Asset (ROA), Return on Equity (ROE), DAR (Deposit to Asset Ratio), Loan to Asset Ratio (LAR), Loan to Deposit (LTD), Loan Loss Provision (LPR) , Leverage (LEV), Revenue power ratio and Equity Ratio (EQR) and external variables are–Real Gross Domestic Products (GDP) and inflation rate (INF). In order to select the best model that fit for the study Hausman specification test has been made and based on the result on which the probability is less than 5%, random effect model is selected as the best model for the study. The result of the random effect model for the study reveals that Size, Return on Asset, GDP and Inflation had negative and significant impact. On the other hand return on Equity, Loan Loss Provision and Equity Asset Ratio had positive and significant impact. The result indicates that Deposit Asset Ratio, Loan to Deposit, Leverage, Revenue Power and Loan Asset Ratio were have no significant impact on Capital adequacy ratio of private commercial Banks in Ethiopia. Except Return on Asset and Loan Loss provision shows the expected sign.