THE IMPACT OF CAPITAL STRUCTURE ON PROFITABILITY OF COMMERICAL BANKS IN ETHIOPIA

Abstract

This study attempts to find out the compositions of capital structure and their relationship with the profitability of commercial Banks in Ethiopia. The study used a six years (2012-2018) panel data of a sample of twelve commercial banks as a major data input. By employing an explanatory research design, the study mainly tried to investigate the relationship between capital structure and profitability using a dependent variable (ROA), independent variables: debt to equity ratio (DER), debt to asset ratio (DAR), loan to deposit (LD) and interest coverage ratio (ICR) and control variables: bank size, spread and growth. After the raw were collected and processed, results were computed, analyzed and presented using panel data analysis, descriptive statistics and correlation analysis methods and fixed effect regression output model. To check the validity of the research method and results CLRM and Hausman specification tests were conducted. The findings have shown that the capital structure of the sampled commercial banks was composed of more debt (86.31 %) than equity. The regression analysis results have revealed that DER had negative and statistically significant impact on ROA at 1% significant level where as DAR, ICR AND SIZE had positive and statistically significant effect on ROA at 1%, 5% and 1% significant levels respectively. The study has also revealed a positive relation between DAR and profitability and DAR was found to be a significant variable in influencing the profitability of commercial banks in Ethiopia. On the other hand, LD, spread and growth had a similar negative but insignificant relation with profitability. The study concludes that capital structure had a significant impact on the profitability of commercial banks in Ethiopia and recommends that to become more profitable and attain optimal capital structure and firm value the commercial banks in Ethiopia should use tax exempted amount as an additional re-investment opportunity, maintain the right proportion of debt and equity in capital structure and give greater attention to the variables: DER, DAR, ICR and SIZE which were found to be strongly related to their performance.