Capital structure and financial performance of commercial banks in Rwanda

Abstract

Since the traditional theory, the conundrum on whether capital structure affect the value and cost of capital of the firm has remained unsolved. Thus, this study assessed the influence of capital structure on financial performance of five selected commercial banks in Rwanda.  The study used a time series data from 2010-2019 in five major commercial banks in Rwanda. Capital structure was measured using debt to equity ratio and debt to asset while financial performance was measured using Return on Equity, Return on Asset, and Net Interest Margin. 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 indicate a somewhat risky environment for investment. In Bank of Kigali and Equity bank, the two main ratios namely: return on equity ratio and debt to equity ratio have well proven that    the more levered BK and Equity are, the higher return to investors. Differently to BPR Atlas Mara, there was a negative relationship between the two ratios; ROE and D/E. The findings showed that there is no relationship between Return on Asset, Net Interest Margin and Debt to Equity in all bank’s ratio proved the Modigliani and Miller irrelevancy theory of capital structure. To the finance managers of the banks this means that they can design, change their banks capital structure up to desired leverage and that will not the effect of their financial performance.