The Impact of Capital Structure on Profitability of Commercial Banks in Ethiopia
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Date
2015-06
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Addis Ababa University
Abstract
The choice of capital structure is one of the most important strategic financial decisions of firms.
Since financing decisions influence profitability and hence firm’s value, this study examines the
impact of capital structure on profitability of core business operations of commercial banks in
Ethiopia. In order to meet the objectives of this study a quantitative panel data methodology was
employed. The panel data were obtained from the audited financial statements of eight
commercial banks and National Bank of Ethiopia for the period of twelve years (2001/02 –
2012/13). The panel data fixed effect estimation model was applied for the data analysis through
EViews 8.1 statistical package. It was observed that 89% of the total capital of commercial banks
in Ethiopia in the period under study was made up of debt. Of this, 75% constitute deposit and
the remaining was non-deposit liabilities. This has reaffirmed the fact that banks are highly
levered institutions. The findings revealed that capital structure as measured by total debt to asset
had statistically significant negative impact, whereas deposit to asset had statistically significant
positive impact on profitability of core business operations of commercial banks. Moreover, loan
to deposit, spread and asset size also had statistically significant and positive relationship with
profitability. However, growth found to have statistically insignificant impact on profitability.
Therefore, banks should give due consideration to manage their debts properly, mobilize deposit
sufficiently, increase loan advances, spread, and size in their financing decisions. Furthermore,
banks also advised to reduce non-deposit debt financing and raise equity financing so that to
keep costs of financing at minimum level and hence optimize profitability and the value of
banks. Besides, the policy maker, National Bank of Ethiopia also recommended reconsidering to
raise the minimum capital requirement for banks. Finally, future researchers also recommended
assessing the overall performance of banks and other business sectors in the area of this research
Key words: Banks, Capital structure, Profitability, core business operation, and panel data.
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Keywords
Banks; Capital structure; Profitability; core business operation; and panel data.