Effect of Capital Adequacy on the Profitability of Selected Commercial Banks in Rwanda

Yonny Pascal Ekwa Mezui
University of Kigali
Email: ekwamezui@gmail.com

Abstract: This study examined the effect of capital adequacy on the profitability of selected commercial banks in Rwanda. Specifically, the study aimed to assess the effect of Capital Adequacy Ratio on bank profitability, examine the influence of Tier 2 Capital Ratio on bank profitability, and analyze the effect of Internal Capital Quality Ratio on bank profitability, while controlling for non-performing loans. The research adopted an explanatory research design using panel data methodology to analyze secondary data from eight commercial banks operating in Rwanda from 2018 to 2024. Bank profitability was measured using the Return on Assets (ROA) and Return on Equity (ROE) as key performance indicators. Data analysis employed data transformation from annual data to quarterly (Q1-Q4) data. Rigorous diagnostic tests were conducted, including the Im-Pesaran-Shin (IPS) test for stationarity, Pedroni test for cointegration, correlation matrix, Breusch-Pagan test for heteroscedasticity, Wooldridge test for autocorrelation, and the Durbin-Wu-Hausman test for endogeneity. The findings revealed that Capital Adequacy Ratio had a statistically significant negative effect on bank profitability (β = – 0.1176, p = 0.000). Conversely, Tier 2 Capital Ratio demonstrated a statistically significant positive effect on profitability (β = 0.1677, p = 0.000). Internal Capital Quality Ratio, a proxy, measured as retained earnings to total equity, also exhibited a statistically significant positive effect on profitability (β = 0.0427, p = 0.000). The control variable, non-performing loans ratio, showed a negative and statistically significant relationship with profitability (β = -0.1124, p = 0.000).