The impact on bank profitability: Testing for capital adequacy ratio, cost-income ratio and non-performing loans in emerging markets

Abstract

Following the methodology applied by Nguyen (2020), this paper tests for the potential impact of capital adequacy ratios on bank profitability in a Jordanian context by using static panel data for a sample of 24 banks covering the period 2008–2018. Furthermore, the study examines the viability of various potential determinants of profitability led by primary bank-specific variables: cost-income ratio, bank size, debt ratio, and non-performing loans. The main objective is to assess if and how capital adequacy ratios have had any measurable effects along with other bank-specific variables on bank profitability that is determined by the return on assets (ROA) and return on equity (ROE). The study’s main takeaway is that ROA is negatively correlated with the four capital adequacy ratios. However, mixed results are observed when ROE is used as a proxy for bank profitability. ROE is positively affected by both core capital to risk-weighted assets ratio and total capital to risk-weighted assets ratio. On the contrary, ROE is negatively affected by the core capital to total assets ratio and total equity capital to total assets ratio. It can be argued that the most significant finding in this paper is that the impact on bank profitability differs according to the proxy used for capital adequacy. Furthermore, the cost-income ratio is inversely related to both bank profitability measures and both bank profitability measures are inversely affected by the non-performing loan ratio.