An Evaluation of the Relationship between Banks’ Regulatory Capital Adequacy Ratios and Profitability in the South African Banking Sector

Abstract

Background and Purpose: Banks are required to hold minimum capital amounts due to in- country regulation, which reflects the ability of the Bank to absorb unexpected losses and demonstrate resilience. This is driven by a function of risk-weighted assets and the Bank’s risk profile and appetite. Method: A quantitative research approach, utilising descriptive statistics and panel regression analysis was run on data over a twenty-year period (2002 – 2022), for 14 locally controlled Banks in South Africa. In addition to the afore-mentioned evaluation, the following relationships with profitability were also assessed: size, liquidity, management efficiency, implicit costs, cost efficiency, inflation and business cycle. Results: The analysis revealed a statistically significant positive relationships between capital adequacy ratios and profitability in South Africa; specifically, a statistically significant positive relationship between Tier 1 and Total Regulatory Capital ratios with ROA. Implications: The significant positive relationship mentioned above is attributed to strong resilience in the South Africa Banking sector, with high capital buffers over regulatory minimums and the ability to earn revenue during uncertain times. Continued oversight by Regulators on capital adequacy and macroeconomic indicators and risks is encouraged and Bank management is urged to continue to maintain healthy capital ratios and metrics, and effectively stress test and manage risks. Significance: This study contributes to the limited research on capital holdings and profitability of South African banks. The insights on capital holdings make a practical contribution to decision-making by bank management, investors and regulators regard capital holdings.