Proposal

Download as docx, pdf, or txt
Download as docx, pdf, or txt
You are on page 1of 21

Table of Contents

1.1 Background of the Study......................................................................................1


1.2 Problem Statement...............................................................................................3
1.3 Objectives of the Study........................................................................................5
1.4 Rationale of the Study..........................................................................................6
1.5 Limitation of Study..............................................................................................6
1.6 Theoretical Review..............................................................................................7
1.6.1 The Capital Buffer Theory............................................................................7
1.6.2 Trade-Off Theory..........................................................................................7
1.6.3 Theory of Moral Hazard................................................................................8
1.7 Empirical Review.................................................................................................8
1.8 Research Methodology.......................................................................................10
1.8.1 Research Design..........................................................................................10
1.8.2 Population and Sample and Sampling Design............................................11
1.8.3 Nature and Sources of Data.........................................................................11
1.8.4 Research Framework and Definition of Variables......................................11
1.8.5 Method of Analysis.....................................................................................13

References

ii
1

1.1 Background of the Study


Banking has become an important feature, which renders service to the people in
financial matters, and its magnitude of action is extending day by day. The capital
structure of banks is highly regulated. Capital adequacy helps bankers and regulators
to absorb any shocks that the bank may experience. Capital plays an important role in
reducing the number of bank failures and losses to depositors. Capital adequacy plays
a crucial role for reducing different risk components in banking industry, and it is
necessary to reduce moral hazard and competitiveness. Furthermore, banks must have
enough capital to provide funds for its internal needs and for expansion as well as
ensure security for depositors. Adequacy of capital is also affected by expected
economic conditions of the entire economy. According to the (Christian, Moffitt &
Suberly, 2008) capital adequacy measures provide significant information regarding a
firm's returns; while a few of the individual variables representing asset quality and
earnings are informative. Size and growth and loan exposure measures do not appear
to have any significant explanatory power when examining returns.

Capital adequacy has become one of the most significant factors for assessing the
soundness of banking sector. Raise and utilization of funds are the primary functions
of commercial banks. As such, commercial banks collect a large amount of deposits
from general public. The depositors think that depositing their money in a bank is safe
and relaxing. But, what does happen if the bank does not have enough capital funds to
provide a buffer against future, unexpected losses? Therefore, capital must be
sufficient to protect a bank’s depositors and counterparties from the risks like, credit
and market risks. Otherwise the banks have to use all the money of depositors in their
own interest and depositors have to suffer loss (Vaidhya, 2014).

Basel III reforms are the response of the Basel Committee on Banking Supervision
(BCBS) to improve the banking sector’s ability to absorb shocks arising from
financial and economic stress, whatever the source, thus reducing the risk of spill over
from the financial sector to the real economy. Basel III reforms strengthen the bank-
level i.e. micro prudential regulation, with the intention to raise the resilience of
individual banking institutions in periods of stress. Besides, the reforms have a macro
prudential focus also, addressing system wide risks, which can build up across the
banking sector. These new global regulatory and supervisory standards mainly seek to
2

raise the quality and level of capital (Pillar 1) to ensure that banks are better able to
absorb losses on both a going concern and a gone concern basis, increase the risk
coverage of the capital framework, introduce leverage ratio to serve as a backstop to
the risk-based capital measure, raise the standards for the supervisory review process
(Pillar 2) and public disclosures (Pillar 3) etc. The macro prudential aspects of Basel
III are largely enshrined in the capital buffers. Both the buffers i.e. the capital
conservation buffer and the countercyclical buffer are intended to protect the banking
sector from periods of excess credit growth (Nepal Rastra Bank, 2021).

The study is based on the capital funds of the banks which are supposed to be
adequate as per the NRB directive no. 1, which is related with the capital adequacy
norms for commercial banks. The norms basically emphasize on the basic
requirement of the capital fund that a commercial bank should possess. The
fundamental objective of the norms is to safeguard the interest of the depositors as per
these norms; bank capital has been divided into two categories which are generally
known as Tier-1 and Tier-2.

The Basel Committees on Banking Supervision’s (BCBS) recommendations on


capital accord are important guiding frameworks for the regulatory capital
requirement to the banking industry all over the world and Nepal is no exception.
Realizing the significance of capital for ensuring the safety and soundness of the
banks and the banking system, at large, Nepal Rastra Bank (NRB) has developed and
enforced capital adequacy requirement based on international practices with an
appropriate level of customization based on domestic state of market developments.
With a view of adopting the international best practices, NRB has already issued the
Basel III implementation action plan and expressed its intention to adopt the Basel III
framework, albeit in a simplified form. In line with the international development and
thorough discussion with the stakeholders, evaluation and assessment of impact
studies at various phases, this framework has been drafted. This framework provides
the guidelines for the implementation of Basel III framework in Nepal. The Basel III
capital regulations continue to be based on three-mutually reinforcing Pillars, viz.
minimum capital requirements, supervisory review of capital adequacy, and market
discipline of the Basel II capital adequacy framework (Nepal Rastra Bank, 2021).
3

Capital adequacy generally affects all entities. But as a term, it is most often used in
discussing the position of firms in the financial section of the economy, and precisely,
whether firms have sufficient capital to cover the risks that they confront (Abba,
2013). This has forced regulators to define several control procedures and issue new
reforms in order to avoid insolvency in the banking sector. Capital adequacy ratio is
the ratio of an eligible regulatory capital (tier 1 and tier 2) to its risk weighted assets
(Apostolic, Christopher & Peter, 2009).

Athanasoglous, Brissimis and Delis (2005) stated capital is essential and critical to the
perpetual continuity of bank as a going concern. A minimum amount of capital is
required to ensure safety and soundness of the bank. It is also required to build trust
and confidence of the customers. A bank with a sound capital position is able to
pursue business opportunities more effectively and has more time and flexibility to
deal with problems arising from unexpected losses thus achieving increased
profitability. (Nepal Rastra Bank, 2021) a capital is required by a bank as a cushion
to absorb losses, which should be done by shareholder and to finance the
infrastructure of the business.

The effect of the capital adequacy on bank profitability cannot be underestimated


since adequate capital directly and automatically influences the amount of funds
available for loans, which invariably affects the level and degree of risk absorption.
Despite its many roles and diverse functions, it is clear that bank capital is acting as
protective cushion against losses precipitated by certain kinds of uncertainties
(Gardner, 1981). This views looks at capital as a constraint to avoid default and
capital also acts as a cushion to protect depositors and others creditors against losses
at the operating and liquidation stages. Thus, this study aimed to analyze the capital
adequacy position of commercial banks in Nepal.

1.2 Problem Statement


An adequate capital fund is required to safeguard the money of depositors. The
adequacy and inadequacy of bank capital directly affects the banking transaction. The
adequacy of bank capital is the most important aspect of a bank. The bank should pay
attention to many things for the adequacy of capital. The capital adequacy ratio is
derived on the basis of total risk weighted assets (TRWA). Banks shall maintain a
4

minimum total capital (MTC) of 8.5 percent of total risk weighted assets (RWAs) i.e.
capital to risk weighted assets (CRAR). Banks must maintain proper liquidity in order
to be able to pay it is obligations in the short run and maintain adequate profitability
to enhance solvency and to gain trust by customers and shareholders. Banks should
maintain it is earning assets, such as loans and advances, bonds, government
securities, stocks. As well as, banks are required to generate revenues to meet
operating costs, maximizing shareholders’ wealth, and show management efficiency
(Nepal Rastra Bank, 2021).

Berger (1995) found evidence for a positive relationship between the ratios of capital
to assets and returns on equity. The study further, argued that a higher capital ratio
(with reduced risk of bankruptcy) should reduce a bank’s cost of funds, both by
reducing the price of funds and the quantity of funds required, thus improving a
bank’s net interest income and hence profitability. Smirlock (1985) found a positive
and significant relationship between size and bank profitability. Additionally,
Pasiouras and Kosmidou (2007) also found that larger banks might have a higher
degree of production and loans diversification than smaller ones. Naceur and Goaied
(2008) studied the banking performance of twelve Tunisian deposit banks over the
period of 1995-2005 and found a significant positive relationship between size and
return on assets. Similarly, Sinkey and Greenawalt (1991) concluded that larger banks
are more profitable than smaller ones.

Banks with higher capital are capable of absorbing any negative shocks and assumed
to possess less insolvency. Higher capital may also incentivize shareholders to
monitor management activities; therefore lower the probability of taking an excessive
risk by managers. On the other hand, the risk-return hypothesis states that there is a
direct relationship exist between risk and return; a higher capital ratio decreases the
risk of the firms and leads to lower performance of the banks (Budathoki & Rai,
2020).

The management efficiency is measured by how much they gain profits. The bank
may expose into insolvency if it fails to generate profits. Profitability is a key target
for all financial institutions as banks must keep adequate liquidity amounts so as to
maintain the continuity. They are one of the most important sources Key to generate
5

capital. Without profits banks are not be able to attract external capital to strengthen
its investments and co-existence with the competition (Shrestha & Niraula, 2021).

In the context of Nepal, Pradhan and Bhattarai (2016) revealed that there is negative
impact of financial leverage on return on assets, return on equity as well as net interest
margin of banks. Debt to equity has negative relationship with return on equity and
net interest margin. Udas (2007) revealed that there was significant impact of NRB
directives of capital adequacy on the various aspects of the commercial banks and it
also helped in maintaining the stability of commercial banks in the financial market
and to uplift the banking sectors in Nepal to international standard.

Marahatta et al. (2016) indicated that higher the quality of assets, bank size and
liquidity of banks, higher would be the return on assets. Further, Joshi (2004)
analyzed financial performance through the use of appropriate financial tools and to
show the cause of change in cash position of the two banks. The study found that
liquidity and banks loan are positively related to bank profitability. Karki (2004)
found the positive relationship between capital adequacy and profitability. Joshi
(2004) found that liquidity and banks loan are positively related to banks profitability.
Similarly, Maharjan (2007) revealed that the capital adequacy and liquidity is
positively related to the bank profitability.

The above discussion reveals that there is no consistency in the findings of various
studies concerning capital adequacy, cost income and banks performance. Therefore,
this study has been conducted to analyze the capital adequacy position and its impact
on profitability of Nepalese commercial banks. This study has the following issues;
 What is the level of capital adequacy of commercial banks in Nepal?
 What is the level of profitability of commercial banks in Nepal?
 How capital adequacy affect the profitability of commercial banks?

1.3 Objectives of the Study


The main objective of the study is to find out the capital adequacy position of
commercial banks in Nepal and the specific objectives will be as follows:
 To examine the capital adequacy level of commercial banks in Nepal.
6

 To analyze the profitability position of commercial banks in Nepal.


 To evaluate the impact of capital adequacy ratio, loan deposit ratio, debt to
equity ratio, and bank size on profitability ROA and ROE of commercial
banks in Nepal.

1.4 Rationale of the Study


The importance of this study stems from being one of the limited studies describing
the capital adequacy of the two Saudi banks which are holding large capital. This
study will be a source of help for a number of entities, individuals, researchers and
institutions, in order to maintain their investments and achieve the greatest possible
return in exchange for carrying less loss, as well as it is also important for the
depositors to check and reassure on the recovery of their deposits on the one hand and
interest imposed on it on the other hand. It will be important for the owners in order to
maximize their shareholders' wealth and to maximize the profits of their investment,
in addition to the need for banking institutions to manage success and failure to enable
them to take action and precautionary measures to protect them from financial
leverage and operating leverage risk, also officials of institutions benefit from this
study by taking preventive measures to avoid the financial crises affecting the national
economy.

The main objective of this study is to examine the effect of capital adequacy into the
profitability of commercial banks, so as to highlight the role played by these banks to
strengthen the profitability of the Nepalese banking system. So, this thesis will be a
new study in the field of banking sector. Thus, the thesis has of course presented some
results which reflect the capital structure and position of commercial banks of Nepal.

1.5 Limitation of Study


The present study will be subject to following limitations:
 Among 27 commercial banks, only five commercial banks namely Nabil Bank
Limited, NIC Asia Bank Limited, Nepal SBI Bank Limited, Himalayan Bank
Limited and Everest Bank Limited are taken as the sample of the study
 Only ten years’ data from fiscal year 2011/12 to 2020/21 are covered by the
study.
7

 Only the effect of capital adequacy of the bank is evaluated in this study and
the qualitative and external variables that affect the performance of the bank
have not been considered in the study.
 For analysis purpose, secondary data is used through published reports of the
banks are used and the reliability of the data depends on the report.

1.6 Theoretical Review


1.6.1 The Capital Buffer Theory
In line with the capital buffer theory banks aim at holding more capital than required
(i.e., maintaining regulatory capital above the regulatory minimum) as insurance
against breach of the regulatory minimum capital requirement. The capital buffer is
the excess capital a bank holds above the minimum capital required. The capital
buffer theory implicates that banks with low capital buffers attempt to rebuild an
appropriate capital buffer by raising capital and banks with high capital buffers
attempt to maintain their capital buffer. More capital tends to absorb adverse shocks
and thus reduces the likelihood of failure. Consequently, portfolio risk and regulatory
capital are assumed to be positively related. Banks raise capital when portfolio risk
goes up in order to keep up their capital buffer (Brealey & Myers, 2003).

1.6.2 Trade-Off Theory


The trade-off theory of capital structure refers to the idea that a company chooses how
much debt finance and how much equity finance to use by balancing costs and
benefits. The classical version of the hypothesis considered a balance between the
dead-weight costs of bankruptcy and tax saving benefits of debt. It states that there is
an advantage to financing with debt, the tax benefits of debt and there is a cost of
financing with debt, the costs of financial distress (Kraus & Litzenberger, 1973).

Expected costs associated with financial distress takes a substantial bite out of a firm
value providing an opposing force to the tax advantage of additional debt. On the
other hand, it is argued that capital is very costly. Investors demand a premium to
compensate for increased bankruptcy risk associated with the probability of financial
distress and proportionately low capital ratio. In order to generate an “adequate”
return on equity, commercial banks have to incur higher risks to receive higher risk
8

premium on their investments the higher the level of capital. Thus, increased risk
requires greater proportions of equity in the firm’s capital structure to prevent an
inefficient cost of capital. The net effect of this negative incentive effect and the
buffer effect is ambiguous. It is possible that the default risk increases as the level of
capital is increased (Brealey & Myers, 2003).

1.6.3 Theory of Moral Hazard


Moral hazard occurs when central banks, governments, or supervisory agencies lead
economic agents to believe that they will get involved to protect an institution and its
creditors in case of any failure. The moral hazard theory predicts that when capital
requirements force banks to increase capital, they will react by also increasing risk.
Better capitalized banks have less moral hazard incentives and are more prone to
adopt careful practices to reduce costs (e.g. shareholders may be more active in
controlling bank cost or capital allocation). Regulators can also force banks to
increase the amount of capital commensurably with the amount of risk taken. Holding
additional capital buffers above the regulatory minimum for banks with higher levels
of risk aims to avoid the costs associated with having to issue fresh equity at short
notice (Groop & Heider, 2010).

1.7 Empirical Review


Pradhan and Parajuli (2017) analyzed impact of capital adequacy and cost income
ratio on performance of Nepalese commercial banks. This study examined the effect
of capital adequacy and cost income ratio on the performance of Nepalese commercial
banks. The regression models are estimated to test the significance and effect of
capital adequacy and cost income ratio on the performance of Nepalese commercial
banks. The study shows that there is positive relationship of bank size with return on
assets. This indicates that larger the banks, higher would be the return on assets.
However, the study shows that there is negative relationship of capital adequacy, cost
income ratio, equity capital to total assets ratio and liquidity ratio with return on
assets. This indicates that increase in capital adequacy ratio, cost income ratio, equity
capital to total assets ratio and liquidity ratio leads to increase in return on assets.
Similarly, the study observed that higher the equity capital to total assets, lower would
be the return on assets. Similarly, the study observed that there is a negative
relationship of cost income ratio and liquidity ratio with return on equity. This
9

indicates that higher the cost income ratio and liquidity ratio, lower would be the
return on equity. The regression results show that bank size has positive impact on
bank performance. However, the study reveals that capital adequacy ratio, cost
income ratio, and equity capital to total assets has negative impact on return on assets.

Okoye, Ikechukwu, Leonard, Chinyere and Christian (2017) analyzed effect of capital
adequacy on financial performance of quoted deposit money banks in Nigeria. the
objective of this study was to ascertain the effect of capital adequacy on financial
performance with a focus on selected quoted deposit money banks in nigeria. the data
were subjected to statistical analysis using pearson coefficient of correlation, multiple
regression analysis, variance inflation factors, multicollinearity, heteroskedasticity test
and hausman test. The result of this study revealed that there is a positive and
significant relationship between capital adequacy and financial performance. it was
also empirically verified that capital adequacy has a statistically significant effect on
financial performance on deposit money banks at 5% level of significance.

Gautam (2019) investigated impact of capital adequacy and bank operational


efficiency on profitability of Nepalese commercial bank. This study examined the
impact of capital adequacy and bank operational efficiency on profitability of
Nepalese commercial banks. Descriptive and fixed effect regression was used to
analyze the data. The study is conducted using panel data of 9 commercial banks
operated in Nepal with 90 observations for the period 2007/08 to 2016/17. The
dependent variable is return on asset while the independent variables are capital
adequacy ratio, operation efficiency, loan to deposit, bank size and equity ratio. The
study revealed that CAR and OEOI has negative significant relation whereas, EQR
has positive significant relation with the profitability of sampled commercial bank.

Ramadhanti, Marlina and Hidayati (2019) examined the effect of capital adequacy,
liquidity and credit risk to profitability of commercial banks. The stduy was
conducted to determine the effect of capital adequacy, liquidity and credit risk toward
profitability. The sample for this study was selected using the method of purposive
sampling and obtained 27 banks. Data analysis was done using Microsoft Excel and
hypothesis testing in this research using Data Panel Regression Analysis with the E-
Views program. This study found that capital adequacy (CAR) has a significant
10

positive effect on profitability (ROA), liquidity (LDR) has a positive and significant
effect on profitability (ROA), credit risk (NPL) has a negative effect and significant to
profitability (ROA).

Chalise (2019) examined the impact of capital adequacy and cost-income ratio on
performance of Nepalese commercial banks. This study aimed to analyze the impact
of capital adequacy and cost-income ratio on performance of Nepalese commercial
banks. The descriptive research designs have been adopted for the study. The study is
conducted using panel data of 10 commercial banks operated in Nepali economy with
100 observations for the period 2007/8 to 2016/17. The dependent variables is return
on asset which measure bank performance while the independent variables are bank
size, Debt-equity ratio, cost-income ratio, Equity ratio, Total capital adequacy. For the
purpose of this study, the secondary data have been used. Fixed Effect Model (FEM)
of panel data analysis is used as a major tool of analysis the regression results
revealed that Cost-income ratio has negative significant impact on banks performance
and total capital adequacy has negative insignificant impact with bank performance
(ROA) whereas debt-equity ratio and bank size has positive insignificant impact with
bank performance and equity ratio has positive significant impact on bank
performance which indicates that higher equity ratio the higher would be bank
performance. This study concludes that there is negative impact of cost-income and
capital adequacy on bank performance.

1.8 Research Methodology


Research Methodology can be understood as a science of studying how research has
been done. It looks into the research design, nature and sources of data, population
and sample and sampling design, research framework and definition of variables and
method of analysis. For the purpose of achieving the objectives of the study, the
applied methodologies are used. The research methodology used in the present study
is briefly mentioned below.

1.8.1 Research Design


To achieve the specific objective of the study, descriptive and casual research design
is used. Descriptive research used in the study supports to analyze the capital
adequacy and profitability position of the sample banks and find out the recent
11

position of the banks through average value, standard deviation, maximum and
minimum which describe the characteristics of data of sample banks and casual
research design supports to analyze the effect of capital adequacy on profitability of
banks in the study.

1.8.2 Population and Sample and Sampling Design


At present, there are 27 commercial banks operating in Nepal. They constitute the
population. Among of them, only five commercial banks; NABIL, NICA, NSBL,
HBL and EBL are taken as sample for the study of the analysis of capital adequacy
and its effect on profitability. Purposive sampling technique is used in this study
because these banks are top five in terms of profitability as well as high capital
amount in Nepalese context.

1.8.3 Nature and Sources of Data


This study will be mainly depends on the use of secondary data of NABIL and
NICA and the data for the study are collected from the published annual reports of
the banks from year 2011/12 to 2020/21. Besides the annual reports various other
sources of data have also been used for the purpose of the study plan documents,
newspaper, magazine, economic journals, NRB reports etc.

1.8.4 Research Framework and Definition of Variables


The review of various previous studies and literature the conceptual frame work for
the study was developed.

Independent Variables Dependent Variables

Capital Adequacy Ratio


Profitability of Banks
Loan to Deposit Ratio
ROA

Debt to Equity Ratio ROE

Bank Size

(Source: (Pradhan & Parajuli, 2017; Gautam, 2019; Shrestha & Noraula, 2021)
12

Capital Adequacy Ratio (CAR)


Capital adequacy ratio is the ratio which determines the bank’s capacity to meet the
time liabilities and other risks such as credit risk, operational risk etc. In the simplest
formulation, a bank’s capital is the cushion for potential losses, and protects the
bank’s depositors and other lenders. It is expressed as a percentage of a bank’s risk
weighted credit exposures (Pradhan & Shrestha, 2016). It is a measurement of a
bank's available capital expressed as a percentage of a bank's risk-weighted credit
exposures. Is used to protect depositors and promote the stability and efficiency of
financial systems around the world.

Loan to Deposit Ratio


Also termed as credit to deposit ratio measures the bank’s capability to fulfill its
financial obligations through deposits (Rijal, 2019). Higher the ratio higher would be
the risk for bank as banks reserve will decline by advancing more loan however lower
the ratio indicates that bank may not be earning much. It is expected to have positive
relationship with banks profitability

Total Debt to Total Equity Ratio


Debt/Equity ratio is a debt ratio used to measure a company's financial leverage,
calculated by dividing a company’s total liabilities by its stockholders' equity. The
D/E ratio indicates how much debt a company is using to finance its assets relative to
the amount of value represented in shareholders' equity. It also shows the extent to
which the shareholders equity can fulfill a company's obligations to creditors in the
event of liquidation. The debt to equity ratio measures the riskiness of the firm's
capital structure in terms of the relationship between the funds supplied by creditors
and investors (Fraser & Ormiston, 2022). Shah and Khan (2007) analyzed that
profitability is negatively correlated to debt to equity ratio.

Bank Size
Bank size is generally used to capture potential economies or diseconomies of scale in
the banking sector (Bhattarai, 2017). Larger banks tend to be more active in markets,
have a greater product and have better possibilities for diversification (Lehar, 2005).
Natural logarithm of total assets of the banks is used as a proxy for bank size. It is
expected to have positive relationship with banks profitability.
13

Return on Assets
Return on Assets is the yield or return on total assets invested in the operations of an
organization. It measures organization profitability, equal to a fiscal year’s earnings
divided by its total assets expressed as a percentage. Investors usually look for banks
with higher return on assets. In this study the bank performance is only measure by
return on assets (Chalise, 2019). For banks with similar risk profiles, ROA is a useful
static for comparing bank profitability as it avoids distortions produced by differences
in financial leverage (Sinkey and Joseph, 1992). It is more suitable for comparing the
banks in the same industry than other measures of performance. Thus, return on assets
(ROA) is chosen as the performance measure for this study.

Return on Equity
The ROE is said to measure the rate of return on the bank's shareholders equity
and it is calculated by dividing banks net income after tax by total equity capital
which includes common and preferred stock, surplus, undivided profits, and
capital reserve (Molyneux & Thornton, 1992). ROE is what the shareholders
look in return for their investment. A business that has a high return on equity is
more likely to be one that is capable of generating cash internally. Thus, the
higher the ROE the better the company is in terms of profit generation. ROE
reflects how effectively a bank management is using shareholders’ funds
(Khrawish, 2011).

1.8.5 Method of Analysis


In order to ascertain actual financial position of any firm, various analytical tools
can be used. It is true that suitable or appropriate tools, according to the nature of
statement and data make the analysis more effective and significant for
achieving these objective basically two sorts of tools can be used, financial and
statistical the researcher has therefore, applied these tools extensively.

Arithmetic Mean
The arithmetic mean or simple mean of set of observations in the sum of all the
observation divided by the number of observations. It is the best value, which
represent to the whole group mean is the arithmetic average of a variable. Arithmetic
mean of a series is given by:
14

Mean ( – ) =
Where,
– = denotes arithmetic mean, n denotes the no. of periods and x1, x2
…… x are the individual observations.

Standard Deviation
Standard deviation is defined as the positive square root of the mean of square of the
deviation taken from the arithmetic mean. It indicates the ranges and size of deviance
from the middle or mean. It measures the absolute dispersion. Higher the standard
deviation higher will be the variability and vice versa. Dispersion measures the
variation of the data from the central value. In other words, it helps to analyze the
quality of data regarding its variability. It is calculated as:
Standard Deviation (SD) =

Co-efficient of Variation
Standard deviation is the absolute measure of dispersion. The relative measure of
dispersing based on the standard deviation is known as the measurement of coefficient
of standard deviation. The percentage of measure of co-efficient of so is called co-
efficient of variation. Less CV is the more uniformity and consistency and vice versa.
Only standard deviation is not appropriate to compare two pairs of variables but also
CV is capable to compare two variables independently in terms of their variability. It
is calculated as under:
Coefficient of Variation (C.V.) =  100%

Coefficient of Correlation
Correlation coefficient is defined as the association between the dependent variable
and independent variable. It is a method of determining the relationship between these
two variables. If the two variables are so related change in the value of independent
variable cause the change in the value of dependent variable then it is said to have
correlation coefficient.
Correlation Coefficient (r) =

Hypothesis Test (Paired t-test)


15

For this study, t-test for significance of an observed and sample correlation coefficient
is used. Set up Hypothesis
Null hypothesis (H₀); ρ = 0 i.e. the correlation between the considered variables are
not significant in the population.
Alternative Hypothesis (H₁); ρ ≠ 0 i.e. the correlation between the considered
variables are significant in the population.
Test statistic under H₀;
t= 
Where,
r = Sample correlation between two variables
n = No of Pair of observations
Level of significance: Level of significance is ∝ = 5% and
Decision: If p-value for the calculated correlation coefficient is less than the
significance level the null hypothesis is rejected concluding the coefficient is
significant in the population and if p-value for the calculated correlation coefficient is
greater than the significance level null hypothesis is accepted concluding that the
coefficient is not significant in the population.

Regression Analysis
In statistical modeling, regression analysis is a set of statistical processes for
estimating the relationships among variables. It includes many techniques for
modeling and analyzing several variables, when the focus is on the relationship
between a dependent variable (ROA and ROE) and one or more independent variables
(bank size, loan and advance to total deposit ratio, total debt to total equity ratio and
capital adequacy ratio). More specifically, regression analysis helps one understand
how the typical value of the dependent variable (or 'criterion variable') changes when
any one of the independent variables is varied, while the other independent variables
are held fixed (Yadav, Dhakal, Tamang, Shrestha, & Panta, 2010).

Regression Equation:
ROA = β0 + β1CAR + β2LDR + β3DER + β4SIZE + e
ROE = β0 + β1CAR + β2LDR + β3DER + β4SIZE + e
Where,
16

ROA = Return on Assets


ROE = Return on Equity
β0 = Intercept value of regression equation
β1 = Coefficient of Capital Adequacy Ratio
β2 = Coefficient of Loan to Deposit Ratio
β3 = Coefficient of Debt Equity Ratio
β4 = Coefficient of Bank Size
CAR = Capital Adequacy Ratio
LDR = Loan to Deposit Ratio
DER= Total Debt to Total Equity Ratio
SIZE = Logarithm of Total Assets
e = Residual term of the regression equation
17

References

Abba, G. O., Zachariah, P., & Iyang, E. E. (2013). Capital adequacy ratio and
banking risk in the Nigeria money deposit banks. Research Journal of
Finance and Accounting, 4(17), 17–25.
Apostolic, R., Christopher, D., & Peter, W. (2009). Foundations of banking risk. John
Wiley and Sons, Incorporation, 2(5), 1-18.
Apostolic, R., Christopher, D., & Peter, W. (2009). Foundations of banking risk. John
Wiley and Sons, Incorporation, 2(5), 1-18.
Athanasoglous, P. P., Brissimis, S., N., & Delis, M. D. (2005). Bank-specific,
industry specific and macroeconomic determinants of bank profitability.
Journal of International Money and Finance, 19(6), 813-832.
Athanasoglous, P. P. (2005). Bank-specific, industry specific and macroeconomic
determinants of bank profitability. Journal of International Money and
Finance, 19(6), 813-832.
Berger, A. N. (1995). The profit-structure relationship in banking-tests of market-
power and efficient structure hypotheses. Journal of Money, Credit and
Banking, 27(2), 404-431.
Bhandari, D. (2003). Banking & insurance: principle & practice. Kathmandu: Aayush
Publications.
Brealey, R., & Myers, S. (2003). Principles of corporate finance, 7th edition. New
York: McGraw-Hill.
Chalise, S. (2019). The impact of capital adequacy and cost-income ratio on
performance of Nepalese commercial banks. SSRG International Journal of
Economics and Management Studies (SSRG-IJEMS), 6(7), 78-83.
Christian, C., Moffitt, J., & Suberly, L. (2008). Fundamental analysis for evaluating
bank performance: What variables provide the greatest insight into future
earnings. Journal of Banking and Accounting, 22(1), 17-24.
Christian, C., Moffitt, J., & Suberly, L. (2008). Fundamental analysis for evauating
bank perforance: What variables provide the greatest insingt into future
earnning. Journal of Banking and Accounting, 22(1), 17-24.
Dangol, R. (2009). Accounting for business. Kathmandu: Taleju Pustak Bitarak.
Fraser, L. M. & A. Ormiston, (2022). Understanding Financial Statements (11 th ed.).
New Jersey: Pearson Prentice Hall
18

Gardner, E. P. M. (1981). Capital adequacy and banks prudential regulations. Journal


of Bank Research Autrum, 11(1), 39-51.
Gautam, S. K. (2019). Impact of capital adequacy and bank operational
efficiency on profitability of Nepalese commercial bank. SSRG
International Journal of Economics and Management Studies (SSRG-
IJEMS) 6(8), 213-218.
Groop, R., & Heider, F. (2010). The determinants of bank capital structure. Review of
Finance, 14(4), 587-622.
Hersugondo, H., Anjani, N., & Pamungkas, I. D. (2021). The role of non-performing
asset, capital, adequacy and insolvency risk on bank performance: a case study
In Indonesia. The Journal of Asian Finance, Economics and Business, 8(3),
319-329.
Horngren, C. (1992). Cost accounting and management emphasis. New Delhi:
Prentice Hall of India Pvt. Ltd.
Joshi, R. K. (2004). Liquidity ratio and profitability of the banks. The Journal of
Nepalese Business Studies, 2(4), 12-18.
Karki, L. (2004). Liquidity ratio with loan and advances. Journal of Nepalese
Business Studies, 2(4), 32-45.
Khrawish, H. (2011). Determinants of commercial banks performance: Evidence
from Jordan. International Research Journal of Finance & Economics,
81(9), 148–159.
Kraus, A., & Litzenberger, R. (1973). A state-preference model of optimal financial
leverage. Journal of Finance, 23(1), 911-922.
Maharjan, M. (2007). Impact of liquidity in the economy. Journal of Management,
9(2), 34-41.
Marahatta, S., Devkota, S., Shrestha, S. D., Pradhan, S., & Bhandari, S. (2016).
Determinants of banks. performance: A case of Nepalese commercial banks.
Nepalese Journal of Management, 3(1), 82-94.
Molyneux, F., & Thornton, K. (1992). Factors influencing the profitability of
domestic and foreign commercial banks in the European Union.
International Business and Finance, 21(3), 222-237.
Naceur, S. B., & Goaied, M. (2008). The determinant of commercial bank interest
margin and profitability: Evidence from Tunisia. SSRN Electronic Journal
5(1), 54-66.
19

Nepal Rastra Bank. (2021). Retrieved from https://nrb.org .np/bfr/circular/2072-


73/2072_73_For_A_,_B_&_C_ClassCircular_ 11 Attachment %20New%20
Capital%20Adequacy%20Framework%202015.pdf.
Okoye, A., Ikechukwu, E., Leonard, N., Chinyere, O., & Christian, O. (2017). Effect
of capital adequacy on financial performance of quoted deposit money banks
in Nigeria. International Conference on African Entrepreneurship and
Innovation for Sustainable Development, 841-863.
Pasiouras, F., & K. Kosmidou (2007). Factors influencing the profitabiity of domestic
and foreign commercial banks in the Eurpoean Union. Research of
International Business and Finance, 21(2), 222-237.
Pradhan, R. S., & Bhattarai, M. (2016). Financial leverage and firm performance: A
case of Nepalese commercial banks. Nepalese Journal of Business, 3(1), 1-
14.
Pradhan, R. S., & Parajuli, P. (2017). Impact of capital adequacy and cost income
ratio on performance of Nepalese commercial banks. International Journal of
Management Research, 8(1), 6-18.
Pradhan, R. S., & Shrestha, A. K. (2017). The impact of capital adequacy and bank
operating efficiency on financial performance of Nepalese commercial banks.
Nepalese Journal of Management , 3(3), 1-11.
Ramadhanti, C., Marlina, M., & Hidayati, S. (2019). The effect capital adequacy,
liquidity and credit risk to profitability of commercial banks. Journal of
Economics Business and Government Challenges, 2(1), 71-78.
Rijal, S. (2019). Impact of liquidity on Nepalese commercial banks profitability. The
Lumbini Journal of Business and Economics , 7(1), 89-96.
Rury, D., Maria, R., & Imanuel, M. (2020). The moderating role of capital adequacy
in the effect of liquidity on the profitability of Islamic banking. Journal of
Business and Management, 3(2), 115-125.
Shah, A., & Khan, S. (2007). Determinants of capital structure: Evidence from
Pakistani panel data. International Journal of Business Research, 3(4), 265-
282.
Shrestha, B., & Niraula, D. (2021). The consequence of credit performance and
capital adequacy: evidence from commercial banks in Nepal. A Peer Reviewed
Journal of Interdisciplinary Studies, 7(1), 1-12.
20

Sinkey, J., & Greenawalt, M. (1991). Loan-loss experience and risk taking behavior at
large commercial banks. Journal of Financial Services Research, 5(1), 43-59.
Sinkey, J., & Joseph, F. (1992). Commercial bank financial management, in the
financial-service industry, (4th ed.). Ontario: Macmillan Publishing Company.
Smirlock, M. (1985). Evidence on the (NoN) relationship between concerntration and
profitability in banking. Journal of Money, Credit and Banking, 17(1), 69-83.
Udas, C. K. (2007). Evidence about capital adequacy and its significance to
commercial banks. Journal of Banking and Finance, 8(5), 69-75.
Vaidhya, S. (2014). Banking management. Kathmandu: Taleju Publication Pvt. Ltd.
Yadav, R., Dhakal, B., Tamang, G., Shrestha, H., & Panta, K. (2010). Statistical
methods. Kathmandu: Asmita Books Publishers and Distributors (p) Ltd.

You might also like