The Effect of Debt Financing on the Performance of Six Private Banks in Ethiopia
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Date
2024-06-25
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A.A.U
Abstract
This study was conducted to investigate the impact of debt financing on the performance of six private banks, during the period of 2012-2022. To this end, the study adopts explanatory research design and a mixed research approach incorporating secondary and primary data and 6 sample private banks were purposively chosen from a pool of over 30 banks currently operating in Ethiopia. Data analysis was carried out using panel data analysis and the data were analyzed using descriptive statistics, correlation analysis, linear assumptions, and robust least squares regression models. The findings revealed that the debt-to-asset ratio (LOG_TDA) had a positive coefficient, indicating that an increase in total debt relative to assets led to a positive impact on Return on Assets (LOG_ROA). This suggests that leveraging debt for investments or operations can potentially boost profitability for these banks. Conversely, the negative coefficient for the debt-to-equity ratio (LOG_TDE) signaled that a higher reliance on debt relative to equity could decrease LOG_ROA, indicating the importance of maintaining a balanced capital structure. Moreover, the positive coefficient for the interest coverage ratio (LOG_ICR) highlighted that an enhancement in the banks' ability to cover interest expenses with their earnings resulted in a higher LOG_ROA. A strong LOG_ICR indicated the banks' improved capacity to fulfill their debt obligations, thereby strengthening their financial stability and performance. Additionally, the positive impact of firm size (LOG_TOTAL ASSETS) on LOG_ROA suggests that larger banks benefit from economies of scale, leading to better performance. The results supported the pecking order theory of capital structure and stressed the importance of managing debt levels, interest coverage, and firm size for optimal financial performance. The study recommended that the banks prioritize equity financing over debt to maintain a balanced capital structure and enhance profitability. Strategic leverage of debt, coupled with effective management of capital structure, interest coverage, and firm size, can help optimize financial performance and ensure long-term success in the banking sector.