Capital adequacy of Basel III and bank profitability: a case of developing countries

Abstract

This study examines the effects of bank capital adequacy and asset quality on banks’ profitability in developing countries. The study further examines whether there are significant differences in the levels of bank profitability in Africa versus other developing countries, and cross sectional 2018 data on 235 banks in 50 developing countries are used in an Ordinary Least Squares (OLS) regression analysis. Tier 1 Capital Ratio and 100% less the Impaired Loans Ratio are used as proxies for Capital Adequacy Ratio and Asset Quality respectively.

Bank capitalisation and asset quality are found to have positive effects on profitability as measured by return on average assets (ROAA) in the sample of developing countries’ banks. These positive relationships are found to be consistent in the groups comprising all the sampled banks, as well as the relatively high and low capitalised banks. Moreover, we found that African banks higher ROAA measures except in instances where the banks have relatively low levels of capitalisation.

Furthermore, bank capitalisation is found to be a positive determinant of bank profitability as measured by net interest margin (NIM); especially for banks that are relatively highly capitalised. Bank asset quality is found not to have any impact when profitability is measured as NIM.

Based on the findings of this study, we recommend that the policies and bank regulations that enforce increased bank capital adequacy and bank asset quality levels. These policies can be implemented in conjunction with prescriptive methods to improve individual borrowers’ quality so as to curb the potential for bank disintermediation arising from financial exclusion.