Capital structure and financial performance of commercial Banks in Rwanda: Case Study of selected commercial Banks, 2010-2019

Abstract

Raising money for investment to keep up with competitive environment at the same time maintaining a healthy capital structure in a company to ensure its financial stability is one of challenging decisions managers are confronted with. Managers should be aware of the financial leverage of their businesses in order to avoid any financial distress and whether it affects the financial performance of the firm. Thus, this study was to assess the level of influence of capital structure on financial performance of five selected commercial banks in Rwanda. To achieve that objective, debt to equity ratio and debt to asset were used to characterize capital structure while financial performance was measured using Return on Equity, Return on Asset, and Net Interest Margin. The study used annual time series data from 2010-2019 in five major commercial banks in Rwanda. By the use of R-program for statistical computing, trend analysis was performed to examine capital structure and financial performance of five selected major commercial banks. In addition, correlation analysis and Ordinary Least Square linear regression analysis were performed to explore the relationship between capital structure and financial performance. Findings showed that there was positive and statistically significant linear association between ROE and D/E in Bank of Kigali and Equity banks while there was a negative relationship found in BPR Atlas Mara. The results showed an unstable up-and-down (fluctuation) movement in capital structure indicating that there was no targeted optimum debt to equity ratio (leverage ratio) that any banks aimed to reach –which is contrary to what static trade-off theory of capital structure would predict. In addition, financial performance was also unstable with fluctuation movements in all five banks which indicates a somewhat risky environment for investment. In regard to the relationship between capital structure and financial performance, the results indicate that there is no common and definite answer to whether the capital structure affect the financial performance. That is to say, the relationship between capital structure and financial performance varies depending on each bank. The findings of this study show that the relationship between capital structure and financial performance is firm specific and cannot be generalized in the banking industry. As such, each bank should analyse its capital structure and its impact on financial performance and take appropriate actions.