The Determinants of Capital Adequacy in the Jordanian Banking Sector: An Autoregressive Distributed Lag-Bound Testing Approach

Abstract

The current study aims to examine the determinants of the capital adequacy ratio (CAR) in the context of Jordanian banks through a literature review and analysis of empirical evidence. The aggregate data were obtained from Globaleconomy.com, the Financial Soundness Indicators, the Central Bank of Jordan, and World Bank Data covering the period from 2003 to 2021. The aggregate data were analyzed using autoregressive distributed lag (ARDL), utilizing Econometric Views (EViews) software. The empirical results suggest a short-run causality relationship running from banks’ credit-to-deposits ratio, banks’ leverage ratio, banks’ liquidity ratio, and one-year-lagged ROE to the CAR. The results also suggest the existence of short-run causality running from the capital-to-assets ratio, one-year-lagged capital-to-asset ratio, liquid-assets-to-deposits ratio, and coverage ratio to CAR. In addition, the results show the leverage ratio and liquidity ratio as having positive long-run associations with CAR. A positive and significant long-run association was also found between CAR, on the one hand, and the capital-to-assets ratio and the liquid assets to deposits ratio; the coverage ratio, on the other hand, showed a negative and statistically significant long-run association with CAR. The pairwise Granger causality test results reveal that liquid asset to deposits, money supply, profitability, and the capital-to-assets ratio Granger cause CAR. The study findings emphasize the importance of understanding the factors impacting CAR, the direction of the influence, the magnitude of the influence of the determinants of CAR in emerging economies such as Jordan and taking appropriate measures to safeguard the stability and resilience of the banking industry.

Exploring Influencing Factors on Capital Adequacy in Commercial Banks

“…This reveals that capital adequacy is significantly affected by leverage, liquidity risk, real GDP, net profit, and inflation. On the other hand, it explores the determinants of CAR in both the short and long term [7]. According to the study by Gharaibeh [7], in the short run, factors such as the credit-to-deposits ratio, banks' leverage ratio, banks' liquidity ratio, one-year-lagged return on equity (ROE), capital-to-assets ratio, one-year-lagged capital asset ratio, liquidassets-to-deposits ratio, and coverage ratio significantly affect CAR.…”

“…On the other hand, it explores the determinants of CAR in both the short and long term [7]. According to the study by Gharaibeh [7], in the short run, factors such as the credit-to-deposits ratio, banks' leverage ratio, banks' liquidity ratio, one-year-lagged return on equity (ROE), capital-to-assets ratio, one-year-lagged capital asset ratio, liquidassets-to-deposits ratio, and coverage ratio significantly affect CAR. However, in the long run, only the leverage, liquidity, capital-to-assets, and liquid-assets-to-deposits ratios significantly affect CAR.…”