The Effect of Capital Adequacy ratio on the profitability of Commercial Bank in Bangladesh.

Abstract

This study investigates the impact of capital adequacy and other financial and macroeconomic variables on the profitability of private commercial banks in Bangladesh. Using panel data collected from 10 listed banks over the period 2014 to 2023, the analysis employs various econometric techniques including Fixed Effects, Random Effects, Generalized Least Squares (GLS), and Pooled Ordinary Least Squares (OLS). Profitability is measured by Return on Assets (ROA) and Return on Equity (ROE), while independent variables include Capital Adequacy Ratio (CAR), Non-Performing Loan (NPL) ratio, Equity Capital to Total Asset Ratio, Bank Size, Total Loan to Total Deposit ratio, GDP growth, inflation, and interest rate spread. The findings reveal that the Capital Adequacy Ratio shows limited significance in simpler models but becomes positively associated with profitability in the GLS model, suggesting its conditional importance. The NPL ratio and high equity levels negatively affect profitability, while interest rate spread and bank size are significant positive contributors. Macroeconomic variables such as GDP growth show a mild positive impact, while inflation negatively influences bank earnings. Diagnostic tests confirm the presence of heteroscedasticity, autocorrelation, and cross-sectional dependence methods. Overall, the study concludes that bank profitability is shaped by a combination of internal financial practices and external economic conditions. It recommends that banks maintain an optimal capital structure, improve credit risk management, use digital technology for efficiency, and align financial strategies with economic trends. The research contributes to a deeper understanding of how capital adequacy and related variables influence the performance of commercial banks in emerging economies