The effect of credit risk and capital adequacy on the profitability of rural banks in the Philippines

• Published in: Scientific Annals of Economics and Business Vol. 64; no. 1; pp. 83 - 96
• Main Authors: Mendoza, Rufo, Rivera, John Paolo R
• Format: Journal Article
• Language: English
• Published: Editura Universităţii »Alexandru Ioan Cuza« din Iaşi 01.03.2017; The Publishing House of the Alexandru Ioan Cuza University of Iasi; De Gruyter Open; Editura Universităţii „Alexandru Ioan Cuza” din Iaşi / Alexandru Ioan Cuza University of Iasi Publishing house
• Subjects: Business Economy / Management; capital adequacy; credit risk; Economic development; G00; G21; G210; profitability; return on assets; return on equity; profitability; capital adequacy; credit risk; return on equity; return on assets
• ISSN: 2501-1960; 2501-3165; 2501-3165
• DOI: 10.1515/saeb-2017-0006

This paper examines the credit risk and capital adequacy of the 567 rural banks in the Philippines to investigate how both variables affect bank profitability. Using the Arellano-Bond estimator, we found out that credit risk has a negative and statistically significant relationship with profitability. However, empirical analysis showed that capital adequacy has no significant impact on the profitability of rural banks in the Philippines. It is therefore necessary for the rural banks to examine more deeply if capital infusion would result in higher profitability than increasing debts. The study also implies that it is imperative for the banks to understand which risk factors have greater impact on their financial performance and use better risk-adjusted performance measurement to support their strategies. Rural banks should establish credit risk management that defines the process from initiation to approval of loans, taking into consideration the sound credit risk management practices issued by regulatory bodies. Moreover, rural banks need to enhance internal control measures to ensure the strict implementation of internal processes on lending operations.