Capital adequacy, asset quality and profitability: a study on conventional banks in Bangladesh

Abstract

This study examines the relationship between capital adequacy and asset quality with profitability. Capital is main factor of banks and adequate capital works as the insurance and confidence factor for the banks. If NPL of banks increases, the cost of funding cannot be recovered. This increased cost of funding decreases the ROA, ROE, and NIM in Bangladesh. Provision kept due to increased NPL creates an obstacle in the case of lending, which ultimately decreases the profit. Profitability is also affected by bank size. It is easier for banks to achieve economies of scale if they have large asset size but incapability of achieving economies of scale will lower the profit of banks. In this study a sample size of 20 conventional banks out of 34 have been selected covering the period 2009 to 2018. This study uses the capital adequacy ratio, equity to asset ratio, bank size, NPL to total loan, and loan loss provision to total assets as proxies for capital adequacy, and asset quality. Return on assets, return on equity and net interest margin are used as proxies for banks‘ profitability. Capital adequacy is considered as the main driver of many financial institutions. KMO and Bartlett‘s test, Descriptive Statistics, Analysis of Variance (ANOVA), Coefficient Analysis, Correlation analysis, Trend Analysis has been used in this study. For multiple regression analysis three regression models are developed. Equity to asset is positively related with ROA, ROE, and NIM. NPL to total loan, loan loss provision to asset have a negative impact on profitability. Though CAR and bank size are negatively related to ROA and ROE, they are positively related to NIM fulfilling the expected results and hypothesis.