The Relationship Between Capital Adequacy and Bank Performance

Abstract

This study examines the relationship between capital adequacy and bank performance, with a focus on key performance indicators such as Return on Assets (ROA), Return on Equity (ROE), and Net Interest Margin (NIM), using data from banks spanning from 2015 to 2023. The findings suggest a positive correlation between higher Capital Adequacy Ratios (CAR) and enhanced bank stability, with banks maintaining higher capital buffers demonstrating lower risk of insolvency. However, the relationship between CAR and profitability presents a nuanced view. While increased CAR is generally associated with improved ROA, it does not show a strong direct impact on NIM, indicating that high capital adequacy may not significantly constrain banks' net interest income in certain market conditions. The study also identifies the impact of macroeconomic factors, including GDP growth and inflation, on performance indicators. GDP growth positively correlates with ROA, suggesting that a growing economy boosts bank profitability, whereas inflation exerts a negative influence on ROE, reflecting the pressure of rising costs on profit margins. This research contributes to the understanding of how capital adequacy impacts both the stability and profitability of banks, offering valuable insights for regulators, bank managers, and policymakers in shaping strategies that balance regulatory requirements with bank performance.