Regulatory Capital, Leverage, and Financial Performance : Understanding Interrelationships in the case of Primary (Urban) Cooperative Banks

This paper examines the relationship of financial performance of Primary (Urban) Cooperative Banks’ (UCBs) with their regulatory capital as measured by the capital to risk-weighted assets ratio (CRAR), and financial leverage as approximated by their ratio of assets to net worth. It also makes a comparative assessment of the efficacy of using the leverage ratio as a simplified measure of capital adequacy instead of the capital to risk-weighted asset ratio. The analysis, based on a 3-year pooled data sample of 140 well-distributed UCBs, shows that UCBs with higher leverages do gain in terms of their return on equity (ROE) but do not show superior financial performance in terms of gross and net non-performing assets (GNPA, NNPA), net interest margin (NIM), return on assets (ROA), and cost-income ratio (CIR). Unlike the leverage ratio, the regulatory capital ratio (CRAR) does not fit as an explanatory variable for return on equity. The analysis indicates that optimal leverage is seen somewhere in the moderate range of 10 to 20, which can help the UCBs to post a stable and good financial performance