Implications of Financial Leverage for Bank Profitability

Abstract This study discusses the implications of financial leverage (debt) as a financing model compared to equity capital in Ghana's banking sector. It highlights the examination of Risk-Adjusted Return on Assets (RAROA) and Risk-Adjusted Return on Equity (RAROE) as response variables in the established financing model, with three explanatory variables: bank credit risk, liquidity risk, and bank capital sufficiency. The analysis of the data revealed several findings, including an inverse relationship between bank profitability (as measured by RAROA) and credit risk. This suggests that effective risk management practices can reduce volatility and improve profitability for banks. Additionally, the use of equity capital provides full control over business ownership compared to debt capital, although it may have a contractionary effect on ploughed-back accrued income. Based on the analysis, the recommendation is to have a moderate use of equity capital over debt capital. This suggests that a balanced approach, combining both debt and equity financing, can be beneficial for banks in Ghana's banking sector. Financial decisions and capital structure considerations can vary depending on various factors, including industry dynamics, the regulatory environment, and individual company circumstances.