The impact of capital structure on financial performance: Empirical evidence from listed commercial banks in Tanzania

Abstract

Using data of five Commercial Banks listed in Tanzania (DSE) this study examines the impact of capital structure on financial performance over a period of ten (10) years spanning from 2015 to 2024. The financial leverage, equity capital, retained earnings, and firm size were used as key determinants of financial performance as represented by Return on Assets (ROA). The study was founded on the Pecking Order Theory which associates firms’ financing decisions on a hierarchy of funding sources. Panel regression analysis was employed to assess the relationship between the explanatory variables and ROA. The findings reveal that, both, financial leverage, equity capital, retained earnings and firm size have a significant positive effect on bank performance (at R² = 0.783) signifying that 78.3% of variation in profitability is explained by these variables. Results imply, that, financial leverage enhances returns through effective debt utilization, while equity capital and retained earnings provide stability and internal financing. Additionally, larger banks benefit from economies of scale. The study concludes that optimizing the capital structure is crucial for improving financial performance while mitigating financial risks. It recommends that bank managers strategically balance debt and equity, retain sufficient earnings for reinvestment, and leverage growth opportunities to enhance operational efficiency and sustain long-term profitability. Furthermore, policymakers should support regulatory frameworks that promote sound capital structure management in the banking sector.