Capital Adequacy Ratios as Predictors of Financial Distress: Evidence from Commercial Banks of Pakistan

Abstract

This study is conducted to predict the financial distress in the commercial banks of Pakistan. “Fixed Effect Panel Regression” is used to analyze that whether CAR’s are good predictors for the financial distress or not. CAR’s which are used as predictors of financial distress are; core-capital to risk-weighted-assets (CRWA) ratio, total-capital to risk-weighted assets (TCRWA) ratio and core-capital to total-deposit (CTD) ratio. For financial distress, zscore is used to measure the probability of financial distress. Sixteen commercial banks were taken as a sample for the financial distress prediction from the year 2000 to 2018, total time span of ten years. Descriptive statistics, correlation analysis and regression analysis were used for the assessment of the results. The results show that ZS and CRWA have a weak and positive correlation with each other, which indicate that with the increase in ZS; CRWA is also increasing. Z-score also has a weak and positive correlation with CTD. Instead, z-score and TCRWA have a negative sign which indicates that they have a very weak negative correlation and with the decrease in TCRWA the ZS will decrease. CRWA has a positive and moderate correlation with TCRWA and CTD. While in regression analysis, t-values of all the independent variables are significant which means that CRWA, TCRWA and CTD are significant measures for the prediction of financial distress. Hence, we concluded that all the ratios of capital adequacy used in the study are good measure to predict the financial distress in the commercial banks of Pakistan. Hence, we conclude that all the ratios of capital adequacy used in the study are good measure to predict the financial distress in the commercial banks of Pakistan. The findings of the study are consistent with the findings of many previous studies which includes Kinyariro et al., (2016), Karugu et al., (2018), Nasieku (2014), Poghosyan and Cihak (2009) and Abdelbary (2019).