Examining the Impact of Capital Adequacy on Bank’s Profitability in Sierra Leone

The recent global pandemic and geopolitical tensions have sparked a renewed focus on financial systems stability, prompting central banks worldwide to take proactive steps to shield their populations from potential external disruptions. Among the initiatives undertaken by the Bank of Sierra Leone is...

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Bibliographic Details
Published in:Economic insights, trends and challenges trends and challenges, 2024-02, Vol.2024 (1), p.61-70
Main Author: Jalloh, Mamoud Abdul
Format: Article
Language:English
Subjects:
Bank reserves
Banking industry
Capital requirements
Central banks
Commercial banks
Corporate governance
Credit risk
Loans
Nonperforming loans
Pandemics
Profitability
Profits
Regulation of financial institutions
Regulatory reform
Return on assets
Stockholders
Systems stability
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Summary:The recent global pandemic and geopolitical tensions have sparked a renewed focus on financial systems stability, prompting central banks worldwide to take proactive steps to shield their populations from potential external disruptions. Among the initiatives undertaken by the Bank of Sierra Leone is a phased increase in the minimum paid up capital of domiciled banks, initially set at 85 million new Leones (approximately 5.5 million USD) to be implemented over three years. Current evidence indicates that banks' average Return on Assets (ROA) is 2.97%, with some banks facing losses. The Capital Adequacy Ratio (CAR) has an average of 59.29%), suggesting generally strong capital positions, though there is considerable variability. This study thus examines whether capital adequacy significantly affects the profitability of domiciled banks in Sierra Leone. Using data spanning 2009Q1-2022Q4, the result shows that a 1% increase in capital adequacy leads to a 0.307% increase in ROA. However, excess capital reserve negatively affects bank profit. Furthermore, l%o increase in total asset (proxy for bank size) increases banks' profitability by 0.017%. Conversely, the presence of non-performing loans (NPLs) had a detrimental effect on profitability, as elevated NPL levels heightens credit risk and necessitates high provisions for bad loans. As a result, this study emphasizes the need for a prudent implementation of the new capital requirement as over-capitalization could reduce profitability and dividend payouts to shareholders. The relatively high non-performing loans poses a risk of diminishing banks' profits and asset quality, especially during periods of financial crisis.
ISSN:2284-8576
2284-8584
DOI:10.51865/EITC.2024.01.06