Examining the Bank-Specific and Macro-Economic Factors Influence Capital Adequacy Ratio in Pakistan

Abstract

Capital adequacy ratio is considered a dominant factor in the banking system because it identified its strength against riskiness. This study empirically investigates the relationship between bank-specific and macro-economic factors on CAR using 26 banks for 2006 to 2018 period in Pakistan. The bank-specific factors cover bank’s size, loan loss reserves, and leverage significantly influence capital adequacy. At the same time, interest rate appears to be a significant macro-economic variable that affects the banks’ capital adequacy. When we include both bank-specific and macro-economic factors, liquidity risk significantly impact CAR. This study splits the sample into public, private and foreign bank, and find that NPLs of public banks negatively affect CAR. However, net interest margin of foreign and local banks is a significant factor that increases the banks’ capital base and positively affects CAR. Furthermore, leverage of local banks is a significant determinant which illustrates that investment in risky assets reduces the CAR. Also, find that financial crisis impacts capital to risk-weighted assets of the local banks. The study explores that large banks are more diversified than small banks and ROA, NPL, leverage, loan loss reserve and Crisis are important factors that cause large banks’ CAR. To test the robustness of the results, the equity to assets ratio (ETA) is used as a dependent variable. Results suggest that ROE and market capitalization significantly impact ETA with some other factors that influence the CAR.