Abstract
Capital Adequacy Ratio (CAR) plays a very important role in the financial success of banks and acts as a buffer to prevent and absorb any unexpected losses. This study examines explanatory variables that influence CAR for nine banks in Botswana. Multiple linear regression was used for analysis, with CAR as the dependent variable and thirteen financial ratios as the independent variables. The study period is 2015-2019. Based on the data for this period, it was established that out of the thirteen financial ratios utilised, only four were found to have significant impact on the CAR of the nine banks under study, which are: Asset to Equity Ratio (A E), Return on Equity (ROE), Non-Performing Loans Ratio (NPL RATIO) and the Cost-to-Income Ratio (C I). The A E Ratio was found to be the most influential driver of the CAR and the NPL Ratio was found to be the least influential driver of the CAR for the banks under study.
Highlights
Capital adequacy ratio is an important measure of “Safety and Soundness”, sufficient capital is required by banks as it acts as a buffer to prevent and absorb any unexpected losses
Capital adequacy ratio refers to the amount of equity capital and other securities which a bank holds as reserves against risky assets
The sum of the Tier 1 Capital and Tier 2 Capital is divided by the Risk Weighted Assets (RWA) as shown in the equation below: Capital Adequacy Ratio (CAR) = Tier 1 Capital + Tier 2 Capital
Summary
Capital adequacy ratio is an important measure of “Safety and Soundness”, sufficient capital is required by banks as it acts as a buffer to prevent and absorb any unexpected losses. Mishkin (2013) states that banks have to make decisions about the amount of capital they need to hold for the following three reasons:. Tier 1 Capital is the core capital and it can absorb a reasonable amount of loss without forcing the bank to stop its trading It includes shareholders’ equity and retained earnings. Risk Weighted Assets (RWA) are a key measure in risk management, and they are used to determine the minimum amount of capital that must be held by banks in order to reduce the risk of insolvency. Banks can increase their capital adequacy ratios by either increasing the amount of regulatory capital held, or by decreasing their RWA (Das & Amadou, 2012).
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