An Evaluation Of Capital Adequacy Ratios As Indicators Of Bank Performance

ABSTRACT

The study is an evaluation of capital adequacy ratios as indicators of bank performance with

major focus on determining effectiveness of these capital adequacy ratios in indicating

performance of banks. Twelve commercial banks formed the research population with secondary

dataset obtained from end of year financial statements and annual reports for the period 2009 to

2012 based on judgemental technique. An explanatory research design was used in conjunction

with an econometric panel regression model to establish the relationships between capital

adequacy ratios and bank performance as well as to empirically investigate whether non-risk

based capital ratios outperform their risk-weighted counterparts in indicating performance. Panel

data obtained was presented in form of tables and was analyzed using regression analysis with

the aid of an econometric statistical package. The GLS method used revealed that leverage ratio

is more related to commercial bank performance than the risk-weighted ratio and gross revenue

ratio is statistically insignificant in indicating bank performance. This relationship brought a

revelation that simple measures of capital adequacy have better indicative power and provide

useful financial information that regulators can use as a starting point in assessing financial

condition of banks. For the period under investigation, non-risk based CARs; particularly

leverage ratio outperformed the risk-weighted ratio in indicating bank performance in

Zimbabwe. Bank regulators and commercial banks themselves can therefore derive substantial

benefits from the use of simple capital ratios as a supplementary requirement. Overall, capital

adequacy ratios alone were to a lesser extent effective in indicating bank performance pointing to

the need to consider other variables that explain performance of banks. Therefore, policymakers

should exercise great care not to too heavily rely on a single tool, but balance the benefits and

costs of any indicator to leverage other policies at regulatory disposal.