THE IMPACT OF CAPITAL STRUCTURE ON PROFITABILITY OF BANKS IN MALAWI
Date
2020-09-30
Authors
SADDICK, LOUISS MCMILLAN CHIDA
Journal Title
Journal ISSN
Volume Title
Publisher
UNIVERSITY OF MALAWI
Abstract
The relationship between capital structure and firm profitability is under researched in
Malawi and most African countries. The theoretical explanation of the subject dates
back to the Modigliani and Miller capital structure irrelevance theory of 1958 which
states that the capital structure decision of a firm has no impact on profitability and
firm value. Most recent theories suggest an existence of an optimal combination of
debt and equity that maximises profits. Literature from different countries has
produced mixed results on the subject. Using data of six banks from 2005 to 2016,
this study examines the impact of capital structure on bank profitability in Malawi.
Specifically, it examines the impact of debt equity ratio on profitability of banks in
Malawi. We use the Arellano and Bover General Method of Moments estimator to
estimate a dynamic panel model of the relationship between capital structure and bank
profitability. Evidence shows that debt equity ratio has no impact on profitability
measured by return on assets but has positive impacts on return on equity. The square
of debt equity ratio is positive and significant on return on assets but insignificant on
return on equity. The findings reject the existence of an optimal debt equity ratio in
the Malawi banking sector. This study concludes that debt in Malawi has a positive
impact on bank profitability. As debt increases, bank profitability measured by return
on equity also increases. Banks should therefore focus on financing assets through
debt than equity as it positively affects return on equity.