IMPACT OF CAPITAL STRUCTURE ON PROFITABILITY OF DEVELOPMENT BANKS IN NEPAL

Abstract

This study investigates the impact of capital structure on the profitability of development banks in Nepal over a nine-year period from 2070/71 to 2078/79. Utilizing data from nine development banks, the study employs both descriptive and causal-comparative research designs to analyze the relationship between capital structure variables are equity to total assets (ETTA), liabilities to total assets (LTTA), liquidity, bank size, inflation, and gross domestic product (GDP) and profitability indicators are return on assets (ROA) and return on equity (ROE). The analysis reveals a strong positive correlation between ROA and ROE, suggesting that banks more efficient at generating income from assets tend to offer higher returns to equity. Interestingly, while a higher equity ratio (ETTA) correlates negatively with ROE, indicating that higher equity may not always enhance profitability, a higher proportion of liquidity to total assets (LTTA) is associated with increased profitability for both ROA and ROE. Further, liquidity is positively and significantly related to profitability, highlighting the advantage of liquid banks in capitalizing on profitable opportunities and managing short-term obligations efficiently. The study also finds that larger banks tend to be more profitable, reflecting potential benefits from economies of scale. Conversely, the impact of inflation and GDP growth on profitability appears more complex, with inflation showing a positive but not statistically significant relationship with ROA, yet a significant positive relationship with ROE. GDP growth presents a positive but not statistically significant effect on both ROA and ROE. These findings underscore the importance of a balanced capital structure, liquidity management, and scale in enhancing the profitability of development banks in Nepal, while also pointing to the nuanced influence of macroeconomic factors.Keywords: Capital Structure, Profitability, Leverage ratio, Interest rate, Economic Condition.