Effects of Accounting Financial Ratios on Capital Adequacy Ratio in the Banking Network

Abstract

The adequate capital is a main requirement for protecting the health of the banking system. Each bank or credit institution should always keep the proper ratio between the capital and the risk of their assets in order to ensure the stability and sustainability of its activities. The main function of such ratio is to support the bank, the depositors and creditors against unexpected losses. Previous studies on the relationship between financial and capital adequacy ratios have found different results. This study investigates the relationship between accounting financial ratios and capital adequacy ratio of the banking network. The data of three bank groups are evaluated using panel data analysis during 2006-2011. In both public and private commercial banks, the findings indicate a significant positive relationship between the size of the bank and capital adequacy ratio, and significant negative relationship between financial leverage and capital adequacy ratio. Within private banks group, return on assets and return on equity have significant positive and negative relations with capital adequacy ratio, respectively. Within public commercial banks, return on assets and return on equity have significant negative and positive relations with capital adequacy ratio, respectively. With respect to F-statistic, the findings indicate no relationship between financial accounting ratios and capital adequacy ratio in 95% confidence level among the bank group of article 44, which necessitates paying attention to capital adequacy ratio.

Keywords

• capital adequacy
• financial leverage
• return on assets
• return on equity