Determinants of Capital Adequacy Ratio of Commercial Banks in Ethiopia

Capital adequacy implies the conventional assessment of the minimal level of capital, according to certain parameters, which reflect the dimension of banking activity and of related risks, capable to provide a correlation between the supposed obtained benefits and potential loss caused by a certain risk level. Since Capital adequacy ratio (CAR) is the ratio that is set by the regulatory authority in the banking sector, and this ratio can be used to test the health of the banking system. Thus, this study examines the relationship between capital adequacy ratio and firm specific (profitability, deposits, loan loss reserve, leverage, net interest margin, size and liquidity) determinants of capital adequacy ratio of Ethiopian commercial banks. In order to investigate these issues a quantitative method research approach is utilized, by using documentary analysis. More specifically, the study uses twelve years (2002 - 2013) data for eight banks in Ethiopia. The study used ordinary least square model to analyse the data by eviews 6 econometric software. The findings show that deposits, leverage, loan loss reserve and liquidity of the banks are important determinants of capital adequacy ratio of commercial banks in Ethiopia. However, management quality, profitability and size of banks are found to have no statistically significant impact on the capital adequacy ratio of banks in Ethiopia. The analyses indicated that the variables of deposits, liquidity, leverage, and loan loss reserve were significantly related to capital adequacy ratio. Therefore, banks should pay greater attention to these significant variables in determining their capital adequacy ratio Keywords: Capital adequacy ratio, Ethiopian Commercial Banks, Panel data analysis