Title:

Report on Impact of Capital Adequacy on Profitability Under Basel Accord:

Evidence From State-owned Commercial Banks of Bangladesh.

Research Hypothesis
This study has been conducted on the basis of a couple of hypothesis, those are given as follows:
H1: There is a significant relationship between capital adequacy ratio and bank’s profitability.
Banks have to hold a minimum level of capital as per the guideline of the regulators. So, it may
have impact on the profitability.
H2: There is a significant impact of operating efficiency on profitability. Operating expenses
covers the major portion of cost of a bank. That’s why level of operating expense may affect the
profitability of a bank.
H3: Size of bank’s asset has significant effect on the magnitude of profit. Bank with large
volume of asset may enjoy economies of scale. As a result, profitability is also related to the
asset size of a bank.
H4: There exists a significant relationship between total loans and profitability. Loans and
advances are a major source of income to a bank. Bank converts the deposits of its customers
into either loan or investment. So, it has a significant impact on profitability.
H5: Debt to total asset ratio has a significant effect on profitability. Deposit covers the major
portion of debt to a bank. Bank has to pay interest to its depositors. So, profitability depends on
the effective use of this debt.

Model Followed

In this study, two widely used proxies for profitability; Return on Asset (ROA) and Return on
Equity (ROE) have been considered as a response variable in two separate models to evaluate
the effect of different explanatory variables including the capital adequacy ratio under Basel II.

ROA= f (RCRWA, OVRHDTA, LNTA, TLOTA, DBTA)

ROE= f (RCRWA, OVRHDTA, LNTA, TLOTA, DBTA)
Here, five explanatory variables have been used to assess their effect on the bank profitability
in the context of commercial banks in Bangladesh. Variables include capital adequacy ratio
(RCRWA), operating efficiency ratio (OVRHDTA), log of total bank assets (LNTA), total
loans to total asset (TLOTA) and debt to total asset (DBTA). ROA and ROE as response
variable, the basic core panel regression models are given as follows:

ROAit = a0 + b1 RCRWA it + b2 OVRHDTA it +b3 LNTA it + b4 TLOTA it + b5 DBTA it + εi (M1)

ROAit = a0 + b1 RCRWA it + b2 LNTA it + b3TLOTA it + b4 DBTA it + εi (M2)
ROAit = a0 + b1 RCRWA it + b2 OVRHDTA it + b3 TLOTA it + b4 DBTA it + εi (M3)
ROAit = a0 + b1 RCRWA it + b2 OVRHDTA it +b3 LNTA it + b4 DBTA it + εi (M4)
ROAit = a0 + b1 RCRWA it + b2 OVRHDTA it +b3 LNTA it + b4 TLOTA it + εi (M5)
As like ROA, above five models have been testified against ROE as a response variable, which is
also considered as a proxy to quantify bank’s profitability.

Summary Statistics of the variables

Descriptive Statistics
Title of the N Minimum Maximum Mean Std. Variance
variables Deviation
ROE 30 -1.38138 .25976 -.0276876 .28998108 .084
ROA 30 -.07292 .02281 .0004809 .01788156 .000
RCRWA 30 -.29080 .26550 .0847867 .12219938 .015
OVRHDTA 30 .31056 17.44415 1.2136531 3.07684177 9.467
LNTA 30 10.67078 12.09384 11.5100755 .44177177 .195
TLOTA 30 .30480 .94150 .5476296 .20897842 .044
DBTA 30 .42303 .96505 .8149568 .19025968 .036
Valid N 30

Model Judgment
Determinants of profitability (ROA)

Title of the Model M1 Model M2 Model M3 Model M4 Model M5

variables coefficients coefficients coefficients coefficients coefficients
RCRWA .090 .089 .099 .107 .103

OVRHDTA .000 --- -2.286 9.251 .000

LNTA .007 .007 --- .004 .005

TLOTA -.016 -.016 -.004 --- -.006

DBTA -.014 -.014 -.001 .001 ---

constant -.066 -.064 -.005 -.060 -.062

R-square .507 .507 .488 .498 .502

Adjusted R- .404 .428 .406 .417 .422

square
Durbin- 1.607 1.619 1.629 1.663 1.660
Watson d
statistic
F-statistic 4.938 6.422 5.959 6.195 6.289

P-value .003 .001 .002 .001 .001

N 30 30 30 30 30

Determinants of profitability (ROE)

Title of the Model M1 Model M2 Model M3 Model M4 Model M5

variables coefficients coefficients coefficients coefficients coefficients
RCRWA 1.436 1.329 1.727 1.566 1.504

OVRHDTA .013 --- .009 .013 .013

LNTA .224 .209 --- .205 .215

TLOTA -.123 -.117 .261 --- -.071

DBTA -.070 -.069 .349 .043 ---

constant -2.619 -2.426 -.612 -2.574 -2.602

R-square .397 .380 .319 .395 .396

Adjusted R- .271 .281 .210 .298 .299

square
Durbin- 1.750 1.872 1.713 1.777 1.767
Watson d
statistic
F-statistic 3.155 3.838 2.923 4.073 4.099
P-value .025 .014 .041 .011 .011

N 30 30 30 30 30

Output tables from SPSS

Variables Entered/Removeda
Mode Variables Variables Method
l Entered Removed
1 DBTA, . Enter
OVRHDTA,
LNTA,
RCRWA,
TLOTAb
a. Dependent Variable: ROA
b. All requested variables entered.

ANOVAa
Model Sum of Squares df Mean Square F Sig.
1 Regression .005 5 .001 4.938 .003b
Residual .005 24 .000
Total .009 29
a. Dependent Variable: ROA
b. Predictors: (Constant), DBTA, OVRHDTA, LNTA, RCRWA, TLOTA

Variables Entered/Removeda
Variables Variables
Model Entered Removed Method
1 DBTA, LNTA, . Enter
RCRWA,
TLOTAb
a. Dependent Variable: ROA
b. All requested variables entered.

ANOVAa
Model Sum of Squares df Mean Square F Sig.
1 Regression .005 4 .001 6.422 .001b
Residual .005 25 .000
Total .009 29
a. Dependent Variable: ROA
b. Predictors: (Constant), DBTA, LNTA, RCRWA, TLOTA

Variables Entered/Removeda
Variables Variables
Model Entered Removed Method
1 DBTA, . Enter
OVRHDTA,
RCRWA,
TLOTAb
a. Dependent Variable: ROA
b. All requested variables entered.

ANOVAa
Model Sum of Squares df Mean Square F Sig.
1 Regression .005 4 .001 5.959 .002b
Residual .005 25 .000
Total .009 29
a. Dependent Variable: ROA
b. Predictors: (Constant), DBTA, OVRHDTA, RCRWA, TLOTA

Variables Entered/Removeda
Variables Variables
Model Entered Removed Method
1 LNTA, . Enter
OVRHDTA,
DBTA, RCRWAb
a. Dependent Variable: ROA
b. All requested variables entered.

ANOVAa
Model Sum of Squares df Mean Square F Sig.
1 Regression .005 4 .001 6.195 .001b
Residual .005 25 .000
Total .009 29
a. Dependent Variable: ROA
b. Predictors: (Constant), LNTA, OVRHDTA, DBTA, RCRWA

Variables Entered/Removeda
Variables Variables
Model Entered Removed Method
1 TLOTA, . Enter
OVRHDTA,
LNTA, RCRWAb
a. Dependent Variable: ROA
b. All requested variables entered.

ANOVAa
Model Sum of Squares df Mean Square F Sig.
1 Regression .005 4 .001 6.289 .001b
Residual .005 25 .000
Total .009 29
a. Dependent Variable: ROA
b. Predictors: (Constant), TLOTA, OVRHDTA, LNTA, RCRWA