THE ROLE OF FINANCIAL RATIOS ON INVESTMENT DECISION IN THE

BANKING SECTOR IN TANZANIA

2020

i
THE ROLE OF FINANCIAL RATIOS ON INVESTMENT DECISION IN THE
BANKING SECTOR IN TANZANIA

BY

GODWIN I.E MAPHILIPA.

A Dissertation submitted to Mzumbe University Dar-es-salaam Campus College

in Partial Fulfilment of the Requirements for the Award of Master of Business
Administration in Corporate Management (MBA-CM) Degree of Mzumbe
University

2020

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 CERTIFICATION

We, the undersigned certify that, we have read and hereby recommend for acceptance
by the Mzumbe University this research report titled “The Role of Financial Ratios
on Investment Decision in the Banking Sector in Tanzania”, in partial fulfillment of
the Requirements for the Award of the Degree of Master of Business Administration
in Corporate Management (MBA-CM) of Mzumbe University.

______________

Major supervisor

______________

Internal Examiner

Accepted for the Board of MUDCC

__________________________________________________________

DEAN DIRECTOR /FACULTY/DOCTORATE/SCHOOL/BOARD

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 DECLARATION AND COPYRIGHT

I, GODWIN I.E MAPHILIPA declare that this research report is my original work
and it has not been presented anywhere or will not be presented to any other institution
of higher learning for degree or similar award.

Signature _________________________

Date _____________________________

COPYRIGHT

This dissertation is a copyright material protected under the Berne Convention, the
Copyright Act 1999 and other international and national enactments, in that behalf, on
intellectual property. It may not be reproduced by any means in full or in part, except
for short extracts in fair dealings, for research or private study, critical scholarly review
or discourse with an acknowledgement, without the written permission of Mzumbe
University, on behalf of the author

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 ACKNOWLEDGEMENT

The accomplishment of this research is the result of the contribution and support from
a number of people who deserve my sincere thanks. I, first of all, thank the Almighty
God for granting good health throughout the preparation of this work.

I also thank my supervisor Dr. Janeth Patrick Swai for her guidance, instructions, as
well as support throughout this report. I am very grateful for her friendship and advice
when working under her guidance.

I also, thank my friends Richard Kidubo and Steven Mwelele for their support and
advice on research issues. I also extend my gratitude to the academic staff from
Mzumbe University, particularly from the Master of Business Administration in
Corporate Management (MBA-CM)’sexecutive class for their challenging discussions
throughout the academic period.

Lastly, but with high importance, I would liketo thank my family especially my lovely
wife and my children for encouraging me in my studies and for tolerating my absence
during my studies.

Thank you all!

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 LIST OF ABBREVIATION AND ACRONYMS

ADF Augmented Dickey Fuller

BOT Bank of Tanzania

CV Critical Values

DSE Dar-es-Salaam Stock Exchange

DW Durbin Watson

P-value Probability value

PCA Principal Component Analysis

ROA Return on asset

ROE Return on Equity

ROCE Return on Capital Employed

WLSR Weighted Least Squire Regression

VIF Variance Inflation Factor

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 ABSTRACT

The study assesses the role of financial ratios analysis on investment decisions within
the banking sector. Specifically, the study assesses the role of financial ratios in
investment decisions making on a number of branches and human resources.
Independent variables involved in the study are liquidity ratios (liquid assets to deposit
ratio,) profitability ratios (return on equity).The study used secondary data that was
collected from Dar es Salaam Stock Exchange and from annual reports ofsampled five
selected commercial banks for the period of seven years from 2010 to 2016.The data
included information contained in annual reports and financial statements.
The study used Principle Component Analysis (PCA) of Factor Analysis to extract
variables with high factor load which could clearly influence dependent variables. After
that, Weighted Least Squire Regression (WLSR) analysis was used to identify
independent variables (extracted financial ratios) with a significant relationship with
dependent variables (investment decision).
The results obtained indicated that liquid assets to deposit-borrowing ratio had negative
insignificant power to predict investment in both numbers of branches and the number
of human resources. Net Loans to deposit and borrowing has negative significant power
to predict investment decision in both branches and human resources. Meanwhile,
return on equity was found to have positive significant power to predict investment in
both branches and human resources. The remained proxies/variables of financial ratios
were noted to be unreliable in explain investment decision in the banking sectors since
they were eliminated through PCA
With these statistical results, the study revealed that financial ratios had both negative
and positive significant effects on influencing investment decisions within the banking
industry in Tanzania. Other prior studies on the Roles of Financial Ratio analysis in
banking sector shows inconclusive or contradictory on the actual roles of the financial
ratio analysis.The study recommends that the Bank of Tanzania (BOT) should
deliberately speed up the sensitization campaign of the Tanzanian commercial banks
to focus on ratios analysis as among the best tool in the effective decision.

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 TABLE OF CONTENTS

CERTIFICATION ......................................................................................................... i

DECLARATION AND COPYRIGHT......................................................................... ii

ACKNOWLEDGEMENT ........................................................................................... iii

LIST OF ABBREVIATION AND ACRONYMS ....................................................... iv

ABSTRACT .................................................................................................................. v

TABLE OF CONTENTS ............................................................................................. vi

LIST OF TABLES ....................................................................................................... xi

LIST OF FIGURES .................................................................................................... xii

CHAPTER ONE ........................................................................................................... 1

GENERAL INTRODUCTION ..................................................................................... 1

1.1 Introduction ................................................................................................ 1

1.2 Background of the study ............................................................................ 1

1.3 Statement of the problem ........................................................................... 3

1.4 General objective of the study ................................................................... 4

1.4.1 Specific objectives of the study ................................................................. 4

1.4.2 Research Questions .................................................................................... 4

1.5 Significance of the Study ........................................................................... 4

1.6 Scope of the study ...................................................................................... 5

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1.7 Organizational of the study ........................................................................ 5

CHAPTER TWO .......................................................................................................... 7

LITERATURE REVIEW ............................................................................................. 7

2.1 Introduction ................................................................................................ 7

2.2 Concept of commercial bank ..................................................................... 7

2.3 Concept of investment ............................................................................... 8

2.3.1 Investment decesion ..................................Error! Bookmark not defined.

2.3.2 Human resource investment in a bank ....................................................... 8

2.3.3 Branch investment in a bank ...................................................................... 9

2.3.4 Concept of financial ratio ......................................................................... 10

2.3.5 Liquidity ratios ......................................................................................... 10

2.3.6 Liquid assets to deposit ratio .................................................................... 11

2.3.7 Net loans to deposit ratio ......................................................................... 11

2.3.8 Net loans to total assets ratio.................................................................... 12

2.3.9 Profitability ratios .................................................................................... 12

2.3.10 Return on assets ....................................................................................... 13

2.3.11 Return on equity ....................................................................................... 13

2.3.12 Cost to income ratio ................................................................................. 13

2.3.13 Efficiency ratios ....................................................................................... 14

2.3.14 Earnings ratio ........................................................................................... 15

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2.4 Theoretical review .....................................Error! Bookmark not defined.

2.4.1 Basic accounting theory ............................Error! Bookmark not defined.

2.4.2 Cost principle theory ................................................................................ 17

2.4.3 Matching principle theory………………………………………………...19

2.4.4 Modern portfolio theory…………………………………………………..20

2.5 Empirical review ...................................................................................... 18

2.6.0 Specific overview………………………………………………………..21

2.6.1 Liquidity ratio analysis and investment decision making ........................ 20

2.6.2 Efficiency ratio analysis and investment decision making ...................... 22

2.6.3 Profitability ratio analysis and investment decision making ................... 25

2.7 Study gap.................................................................................................. 27

2.8 Conceptual framework ............................................................................. 27

2.9 Hypotheses ............................................................................................... 30

CHAPTER THREE .................................................................................................... 34

RESEARCH METHODOLOGY................................................................................ 34

3.1 Introduction .............................................................................................. 34

3.2 Study area ................................................................................................. 34

3.3 Research design........................................................................................ 34

3.4 Population of the study ............................................................................ 35

3.5 Sampling procedures and sample size ..................................................... 35

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3.6 Data collection methods ........................................................................... 36

3.6.1 Documentary review ................................................................................ 36

3.6.2 Variables definition and measurement ..................................................... 36

3.7 Data analysis ............................................................................................ 37

3.7.1 Principal Component Analysis ................................................................. 37

3.7.2 Regression analysis .................................................................................. 38

3.8 Validity of the data ................................................................................... 39

3.9 Reliability of the study…………………………………………………..39

3.10 Limitation of the study ............................................................................. 40

CHAPTER FOUR ....................................................................................................... 42

DATA ANALYSIS AND DISCUSSION .................................................................. 42

4.1 Introduction .............................................................................................. 42

4.2 Descriptive statistics of study variables ................................................... 42

4.3 Analysis of the study results .................................................................... 45

4.3.1 Principal component analysis of the independent variables .................... 45

4.3.2 Relationship between financial ratios and investment on bank branches 47

4.3.3 Relationship between financial ratios and investment on human

resources……………………………………………………………… 49

4.4 Discussion of the study results ................................................................. 50

4.4.1 The effect of liquidity ratios on investment decision making .................. 51

4.4.2 The effect of profitability ratios on investment decision making ............ 52

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4.4.3 The effect of efficiency ratios on investment decision making ............... 54

4.5 Conclusion ......................................................................................................... 55

CHAPTER FIVE ........................................................................................................ 56

STUDY SUMMARY, CONCLUSION AND RECOMMENDATION ..................... 56

5.1 Introduction .............................................................................................. 56

5.2 Summary of the study .............................................................................. 56

5.2.1 The effect of liquidity ratios on investment decision making .................. 57

5.2.2 The effect of profitability ratios on investment decision making ............ 57

5.2.3 The effect of efficiency ratios on investment decision making ............... 57

5.3 Conclusion of the study............................................................................ 58

5.4 Implication of the study ........................................................................... 58

5.5 Recommendation of the study.................................................................. 58

5.6 Area of the further study .......................................................................... 59

REFERENCES ........................................................................................................... 60

x
LIST OF TABLES

xi
 LIST OF FIGURES

Figure 2.1: Conceptual framework of the study...................................................31

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 CHAPTER ONE

GENERAL INTRODUCTION

1.1 Introduction

This chapter presents the background of the study, statement of the problem, research
objectives, and significance of the study, organization of the study as well as the
limitations of the study. This is a general introduction to the topical area. It is a
general/broad statement that provides an overview of the area involving the study.

1.2 Background of the study

Decision making process requires information on both financial and non-financial

information. The most important financial information needed in the process of
business decision comes from financial accounting (Kigadiye, 2014; Qurramine, 2015).
Basically, financial accounting gathers, processes and analyses raw data and converts
them into suitable information for investment decision making. However, the financial
information contained in the financial statements does not provide useful and
understandable information to users without being analyses and interpreted.

Pandey (2010) argued that financial ratios (ratio analysis) are fundamental factors that
determine the decision in the business operations. The most used financial ratios have
been liquidity ratios, efficiency ratios and profitability ratios (Mrisho, 2014).
Successive firms use financial ratio analysis to compare themselves with other firms so
as to pinpointtheir weaknesses and make an improvement (Kibacho, 2014). For the
business institutions or organization to be sustainable it requires effective management
of the financial resources and proper plan. Financial ratios analysis is a useful tool for
managing financial resources and planning for better business operations. Through
financial ratios analysis of the company, one can identify weaknesses and strengths that
can lead to the establishment of strategies and initiatives for the betterment of the
company (Almumani and Abdelkarim, 2014).

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Financial ratios analysis is an acceptable tool for analyzing a firm and its performance
over time. Financial analysts and researchers combine key financial ratios (quantitative
measures) over time and across industries alongside with qualitative measures to gain
insight regarding the firms (Barnes, 1987 and Nkoba, 2010). Hoskin (2017) mentioned
that ratios are used to represent outcomes of decisions made by the firm and the results
of outside conditions surrounding the firm. Therefore, financial ratios seem to be a very
important tool in investment decision making for the firms.

The effective performance of an organisation dependsmuch on the number of human

resources who can deploy the available assets to generate income (Abdulrahman,
2011). Proper decisions on human resources investment can be reached when there is
an effective analysis of financial ratio compared concurrently with human resource
ratio like productivity ratio(Alshati, 2015).

Likewise, opening a different branch has meaning on banking and it is considered

anextension of its normal business to gain more revenues and thus increase its
profitability which will enhance the liquidity of the company (Burja 2011). Despite that
fact,the opening of a new branch of a bank needs proper evaluation of a number of
factorssuch as economic factor, social factor and political factor, but the financial
factors are also very importantin analysis mechanism (Caddy, 2000).

With reference from Mercy (2014), financial institutions use financial ratios as a
guiding factor for making decision in their operations to make investment decisions.
Financial ratios help the banking industry to determine the loan provision rate as well
as how far banks can open new branches as well as how they can employ new
employees to meet an increased bank operation (Erasmus,2015).Unfortunately, there
are limited studies that had been empirically examined whether financial ratios analysis
form the basis of investment decisions in Tanzanian banking industry. Therefore, it is
upon this background, the researcher is amplified to find out the influence of financial
ratio analysis on investment decision making, particularly on the opening of new
branches and the number of people to employ in banking sector in Tanzania.

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1.3 Statement of the problem

For the business institutions or organization to be sustainable it requires effective

management of the financial resources and proper plan (Kigadye, 2014 and
Qurramine,2015). Financial ratios analysis is a useful tool for managing financial
resources and planning for sustainable business operations. Through financial ratios
analysis, the company can identify weaknesses and strengths that can lead to the
establishment of strategies and initiatives for the betterment of the company
(Almumani and Abdelkarim, 2014).

Tanzania banking industries have been facing several managerial difficulties,

particularly ineffective investment decisions for lack of financial interpretations
especially through the use of ratio mechanism(Almumani and Abdelkarim,
2014).Zawadi (2013) which said the commercial banks is 80% efficiency, which
contradicts with other studies done on the banking industry in Tanzania.

Despite the fact that there are number of studies which have been done on the role of
financial ratios on investment decisions in Tanzania; most of the previous studies have
been done on manufacturing industries, and most of them assessing the impact of
financial ratio analysis against performance of the firm in general.However, the results
that are meaningful to the manufacturing industry might be meaningless to the banking
industry, because financial reporting in banking is significantly different from most
other manufacturing and service industry.The empirical review from prior study which
assesses on whether banks in Tanzania use ratios to determine the number of branches
to be opened and the number of human resourcesto be employed for decision making
have been contradicting. Other studies say there are positive contributions, other
studies deny. According to survey, closure of some Banks in Tanzania are associated
with inefficiency in the use financial ratio analysis in decision making. Therefore, this
study intended to assess the role of financial ratio in decision making in the banking
sector in Tanzania to evaluate the contradicting part from prior studies.Particularly, the
study focuses on assessment of the liquidity, efficiency as well as profitability ratios.

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1.4 General objective of the study

To assess the role of financial ratio analysis on investment decisions in the banking
sector in Tanzania, to achieve whether financial ratios positively or negatively
influence decisions making in banking industry in Tanzania.

1.4.1 Specific objectives of the study

The study dealt with the following objectives:

i. To determine the effect of liquidity ratio analysis on investment

decision,whether positively or negatively influence decision making.

ii. To determine the effect of profitability ratio analysis on investment decision,

whether positively or negatively influence decision making.

iii. To determine the effect of efficiency ratio analysis on investment decision,

whether positively or negatively influence decision making.

1.4.2 Research questions

The study aimedto answer the following objectives:

i. What is the effect of liquidity ratios on investment decision?

ii. What is the effect of efficiency ratios on investment decision?

iii. What is the effect of profitability ratios on investment decision?

1.5 Significance of the Study

This study has both theoretical and practical contributions. Theoretically, the study
adds to the body of knowledge on the roles of financial ratio analysis towards decision

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making. The study provides some guidance to different stakeholders and decision
makers in the banking sector in Tanzania.

To researchers, this study will be a source of interest for academic researchers to study
and explore contributions of financial ratios in investment decisions when there is the
need to conduct further specific research. The information presented in this study
encourages the government and non-governmental organizations to fund researches in
this area for more in-depth studies.

This study gives invaluable information to players in the banking sector on the best
ways to manage investments and reduce selection of nonperforming loan portfolios.
Good management of investment decisions within the firm based on the findings and
recommendations of this study enhance shareholders’ wealth through the increase of
profits and dividend earnings.

1.6 Scope of the study

This study was conducted in the banking industry in Tanzania. Five commercial banks
were selected to represent the rest of banks in this industry. Their financial ratios
(independent variables) for the thirteen years were fetched as well as their investment
decisions (dependent variables). The study specifically looks on the liquidity ratio,
efficiency ratio, and profitability ratio as well as thenumber of branches and human
resources.

1.7 Organizational of the study

This research report has five chapters whereas the first chapter has presented the
general introduction of the study by showing the background of the study, statement of
the problem, research questions and objectives as well as the significance and scope of
the study.

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The second chapter of this study has presented the literature review by showing the
definition of key terms, theoretical arguments on the study variables, empirical
literature review with existing literature gap as well as the conceptual framework.

The third chapter based on the methodologies applied in the study. This chapter
presents research strategy, design, population, sampling design, methods of data
collection and analysis as well as trustworthiness of the study.

The fourth chapter based on the presentation of the study findings, analysis and
discussion of the study results. The last chapter based on the conclusion and
recommendation of the study.

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 CHAPTER TWO

LITERATURE REVIEW

2.1 Introduction

The chapter carried the definition of the keywords, theoretical and empirical review,
study gap and conceptual framework of the study.

2.2 Concept of commercial bank

This is a financial institution providing financial services for businesses to

organizations and individuals. The main services offered by banks are cash saving and
deposit, money transfer, loan and several other trade finance services (Parry, 2019). In
commercial banks, the objective is to receive the deposit as a security agent while they
anticipate the percentage return from thedepositors or they increase in value at an
acceptable cost. The bank then reinvests the deposited fund and earns higher returns
from borrowers. In this way, the banks depend on financial ratios analysis so as to
identify and evaluate its financial position (Tugas, 2012).

Tanzania banking industry host both foreign and local commercial banks. Commercial
banks in Tanzania are owned by a group of individuals, some are publicly owned and
some are Parastatal (own by the government) institutions. Data from several banks’
profitability studies in Tanzania have shown, Tanzanian banks have been growing
slowly since 2014 (Wanke, et al). This makes Tanzanian banking industry unattractive
for the investors to trust investing their money in Tanzanian banks. Likewise, business
people may be doubted to deposit their money in the bank institutions which are facing
a risk of bankruptcy. Such data are also discouraging in the sense that poor development
of the banking industry is an indication of the reduced monetary depth in the country.
That, in turn, led to a shortage of external financing to the companies within the
country. This might be contributed by lack of consistency, and proper ratio analysis of
financial reports to assess the weaknesses and strengths for immediate remedy.

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2.3 Concept of investment

There are several definitions of investment but all of them bearsimilar meanings.
Investment is the process where real assets are deployed to generate income or revenue
to an organization (Caddy, 2000). In other words,the investment can be referred to as
the act of adding capital today so as to increase revenues tomorrow. Therefore,an
investment can be defined as the money allocation to the organization inputs with an
expectation of having income generation in the future (Kisu, 2014; Omare, 2016).
Investment, in finance sense, is monetary goods/assetsthat are bought with the trust,
that it will produce a profit in the future or it will appreciate and be sold at a higher
price.

This study defined investment as the action of committing capital or money in the
business operations with the aim of attaining some additional earnings. The additional
earnings obtained from investing can come in different forms such as appreciation,
interest earnings, or profit. Kibacho (2014) stressed that investment activities are long
term activities that deal with heavy turnover and have a high amount of risk. This is
because the value of the investment may go down or even disappear completely. Kisu
(2014) added that one of the main tools to build wealth in an organization or by an
individual person is the investment, but it should be used wisely since it is a risky tool.

2.3.1 Investment decision

A decision is a choice made from a list of alternative suggestions, in a given context in

order to influence certain action(s) that will bring the best results (Higgins, 2012).
According to Kisu (2014)decision making is the process of selecting the best way or
method to perform an action that will take the matter/situation to the conclusion or
resolution very fast and accurately than the available alternative methods. The decision
is done prior to action and is based on the preferences or values of possible alternative
options. The decision represents what should be or not be done (Emekekwue, 2008).
Decision making can take several important steps to arrive at the final choice. In

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making a decision, decision makers highlight several suggested options and assess for
their suitability through reasoning systems (Agala et al., 2014).

Investing decision is referred to as the choice of investment portfolio from the list of
portfolios with respect to the available budget and payback period (Sanjeev, 2006). It
involves the injection of capital in the business operations, purchase of raw materials,
machines and assets to mention a few. Also, investment decision in a business
environment involves the selection of number and character of people/workforce to
carry out investment activities and opening of new branches. Each investment associate
with its amount of risk. It has been proclaimed by several economists that investment
with great risk might result in a great profit or great loss (Emekekwue, 2008; Kisu,
2014).

2.3.2 Human resources investment in a bank

Human resource is among the major assets of any organisation. The effective
performance of an organisation much depends on the number of human resources as
well as their quality. Human resource quality heavily depends on the education
achieved and training offered to employees. Always firms want to effectively use their
human resource through effective human resource management (Abdulrahman, 2011).

In the context of the banking industry, effective human resource investment can be
reached only when its liquidity is effective enough. It should be noted that human
resource investment decisions are not only in terms of hiring new employees or adding
the number of employees but it is also in terms of training and developing employees,
therefore an organisation spend the amount of money on human resource
investment.Alshati, 2015 argued that proper decisions on human resources investment
can be reached when there is an effective analysis of financial ratios. The profitability,
liquidity, and efficiency of the firm would depend on the quality of human resources
managing the firms’ decision making. The reverse is the same that the quality of human
resources depends on the firm’s profitability, liquidity and efficiency which should be
properly analysed and interpreted using financial ratios.

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2.3.3 Branches investment in a bank

In the banking industry, one of the key factors which are considered as the banks
development is an expansion of the bank through different channels such as opening
new branches. Opening new branches is regarded as a factor that can bring the bank
closer to the potential customers in the market thus increasing its profitability (Burja,
2011). The opening of new branches must be well calculated and see whether a bank
can be in a better financial position to effectively operate the new branch. One of the
key factors considered in the opening of new bank branches is the financial
performance and position of the bank. It is through financial ratio analysis that the bank
can open new branches in consideration of its liquidity. But banks must be careful
where they build or open a branch as all markets are not equal (Caddy, 2000).
Investment decision in the opening of new branch is assumed as capital budgeting
decisions that take the shape of acquiring several assets like building, plant, and
machinery which entails for an increase of revenue in the future to cover costs and
release profits. This decision requires proper analysis of financial informationusing
ratio analysis techniques.

2.3.4Concept of financial ratios

A financial ratio is a relative degree of two-digitvalues that are obtained from an

organization’s financial statements which are mostly used in accounting.Kabera,
(2009), defined that financial ratio analysis is a quantitative analysis of information
contained in a company’s financial statements. Ratio analysis is used in different
aspects to evaluate the company’s operation, performance, and investment decision
making. For the purpose of this study,the investment decision is referred to the opening
of new branches and human resources. Ratio analysis is always identified in decimal
values such as 0.10, or in percentage form as 10% (Emekekwue, 2008). To that end,for
the purpose of this study, financial ratios have been categorized into three main groups
as liquidity, profitability and efficiency ratios.

2.3.5Liquidity ratios

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Liquidity refers to the ability of the firm to meet its obligations as they become due.
This means at which rate assets of the firm are transformed into cash to meet the
liabilities(Emekekwue, 2008). According to Khidmat and Rehman (2014), the
management of liquidity is very important for the management of an organization. It
gives the organization’s capacity to settle short term liabilities, which include operating
expenses and financial obligations occurring within the organization in the short term.
Liquidity management is attained through the proper use of assets. Liquidity ratios
involve liquid assets to deposit ratio, net loans to total assets ratio, net loans to deposit
ratio. Liquidity ratios measure a firm’s ability to pay off its debts as they come due
using the firm’s current or quick assets. When the ratio is high, it indicates that the bank
is more liquid, signifying that investment in opening more branches and human
resources is possible.

2.3.6Liquid assets to deposit ratio

The ratio of liquid assets to deposit represents the value of liquid assets (assets easily
converted to cash) to short-term funding plus total deposits.Liquid asset to deposit ratio
= Total liquid assets / Total deposits. The ratio may be expressed as a percentage (%),
decimal points or proportional. Liquid assets include cash and cash equivalents, due
from banks, trading securities and at fair value through income, loans and advances to
banks, reverse repos and cash collaterals. Deposits and short term funding include total
customer deposits (current, savings, and other negotiated term) and short term
borrowing (money market instruments, and other deposits) (Khalad, 2011).This link of
the ratio and number of investments is this: when the numbers of liquid assets are high,
it will raise the ratio, hence encourages the bank to open more new branches and hence
more human resources will be required.

2.3.7Net loans to deposit ratio

The loan-to-deposit ratio compares the total bank loans to its total deposit and
borrowing to assess its liquidity for the same period (Hoskin, 2017). In other words, it
can be said that the loan-to-deposit ratio is used to assess a bank’s liquidity by

11
differentiating a bank’s total credit with its debit for a comparable period. This ratio is
expressed in percentage and when the ratio is too high it indicates that the bank may
fail to have sufficient liquidity to pay for any unforeseen financial liabilities.
Conversely, when this ratio is very low, it indicates that the bank might not earn as
much income as it could be (Kieso, et al., 2001). At this point, it expresses that the bank
is not able to earn income from the interest; hence it will have the low capacity to invest
more in new branches and employ more human resources.

2.3.8Net loans to total assets ratio

This ratio measures the total liability of the bank or company as a percentage of total
amounts of the assets of the banks/company (Kwei, 2014). The loan or debt to total
assets ratio is a measurement representing the percentage of a corporation’s assets
financed with loans or other debt obligations lasting more than one year. This ratio
provides a general measure of the long-term financial position of a company, including
its ability to meet financial requirements for outstanding loans. When this ratio is very
high it indicates that the bank is leverage and its liquidity is low. The banks become at
high risk of bankruptcy when this ratio increases and reduces its ability to open new
branches and employ more staff.

Kwei (2014) narrated that a year-over decrease in the loan to total assets ratio may
suggest a company is progressively becoming less dependent on debt to grow its
business. With the ultimate objective to consider the general utilization position of the
company, it proposes the business has a decently abnormal state of danger, and at last,
it will not be able to repay its commitments. This makes banks more doubtful about
propelling the business and creates more suspicious about obtaining shares with high
value.

2.3.9Profitability ratios

Profitability ratios are used to find out how the firm utilizes its assets and control
expenses to generate a satisfactory rate of return. This ratio also used to indicate the

12
ability of managers in operating the company (Emekekwue, 2008). Profitability ratios
that were analysed in this study are the following:

2.3.10Return on assets

Return on asset (ROA) can be considered as the ratio used to determine the amount of
profit generated from the business. This ratio used as an indication of the ability of the
firm to utilize its assets to generate profit (Emekekwue, 2008). The return on assets
ratio assists to value how effectively an entity offers its stakeholders for their
investment. Its computations involve findings of revenue or turnover and taking out all
costs used in earning the revenue, then taking the balance as numerator to the value of
assets used to generate the revenue. The ratio can be expressed as a fraction or as a
percentage. The interpretation of the ratio is that: When the ratio is high, it means that
the total net income exceeds total assets. This is desirable because it permits the bank
to open more branches and hire more personnel.

2.3.11Return on equity

Return on equity, also known as return on average common equity explains how the
firm generates incomes from the invested funds (Kieso, et al., 2001). This ratio is
computed by dividing net income by common stockholders’ equity. When the ratio is
high, it implies the equity has generated a reasonable amount of income which may be
used to expand both branches and staff.

2.3.12Cost to income ratio

The cost-to-income ratio is a key financial measure, particularly important in valuing

banks. It shows a company’s costs in relation to its income. To get this ratio, divide the
operating costs (administrative and fixed costs, such as salaries and property expenses,
but not bad debts that have been written off) by operating income (Kieso, et al., 2001).
This ratio gives investors a clear view of how efficiently the firm is being run, the lower
the ratio the more profitable the bank will be. Therefore, the bank will opt to open more
branches and hire more staff if the ratio is low. Changes in the ratio can also highlight

13
potential problems: if the ratio rises from one period to the next, it means that costs are
rising at a higher rate than income, which could suggest that the company has taken its
eye off the ball in the drive to attract more business (Kamani, 2016).

2.3.13Efficiency ratios

An efficiency ratio is used to assess the effectiveness of the management in utilize the
company’s assets and available funds to generate income. The ratio can calculate the
quantity and usage of equity, repayment of liabilities, turnover of receivables, and the
broad utilization of inventory and machinery. These ratios compare assets of the
company to its profit or sales performance and explainthe ability of the company to use
what it owns to generate the most profit for shareholders and owners. The increase in
efficiency ratio can indicateeithera decrease in revenue or an increase in costs. Hence,
the bank may decide to open more branches and recruit more human resources when
the ratio is low.

Marković, et al. (2015) put it that efficiency can be viewed in terms of expenses
incurred in production or in terms of quantity produced. This leads to the two categories
of efficiency which are cost efficiency and technical efficiency. Efficiency ratio can be
mathematically expressed as:-

Efficiency Ratio = Expenses / Revenue

The efficiency ratio is the one that measures how well a company utilises its assets and
liabilities internally. The ratio calculates the turnover that is receivables of the firm, the
repayment of liabilities that is payables of the firm, the quantity and usage of equity
and the overall use of inventory and machinery (Mabwe, 2010). This ratio can also be
used to trace the performance and investment of commercial banks. The investment in
opening more branches and human resources is possible when the ratio is low. The
efficiency ratios comprise of inventory turnover ratio, asset turnover ratio and
receivables turnover ratio(Mustafa, 2014).

14
Power (2007) asserted that,the inventory turnover measures the firm’s capacity to
manage the inventory efficiently.The ratio is computed by dividing the cost of goods
sold by the average of inventory, the higher the ratio indicates that the firm is not
managing its inventory properly. Hence, the firm will not be able to open more
branches and hire more people.

The receivables turnover ratio measures how the company is efficient to collect its
debts and extend its credits. Normally the ratio is calculated by dividing a company’s
net credit sales by its average account receivables, generally, a higher ratio indicates
that the company is efficient in making collection from its debtors (Vincet, 2013).
Therefore, when the ratio is high investment in both items can be implemented.

2.3.14Earnings ratio

Earnings ratio estimates the prospects of the shares in the firm together with the
perception of the future market (Kieso, et al., 2001). Earnings are essential due to the
fact that management and investors want to know how profitable the company is, and
how profitable the company will be in the future. Therefore, managers would want to
know the profitability status of the company, through the use of earnings ratio, before
introducing a new business or invest some funds. This ratio also helps the management
of the company to predict the profit that will be obtained from the new
investment.Hence, the high ratio will encourage the bank to open more branches and
recruit more human resources.

2.4 Theoretical review

A theory is a preposition consisting of a set of interrelated statements made by theorist

which tend to suggest the occurrence of the event in the future based on the previous
situation (Kenneth, 2005). The theoretical review is considered as the review of
important suggestions or assumptions on the topic of interest that elaborate on how
things relate in the real world (Sekaran, 2000). In this section researcher present

15
theories which formed the basis of this study. The theories are basic accounting theory
and modern portfolio theory.

2.4.1Basic accounting theory

It is important for business owners and other stakeholders to understand basic

accounting concepts. The principles underlying these theories entail rise over time to
the actual practices employed by finance practitioners to ensure finances are properly
managed and tracked. There are several principles considered part of accounting
theory, comprising cost principle, matching principle, materiality, conservatism, and
monetary unit assumption. For the purpose of this study, the cost principle, and
matching principle are briefly discussed.

2.4.2 Cost principle.

This principle requires the recording of assets as soon as they are acquired, these can
range from things as small as office supplies and factory equipment to new franchises.
The most point here is to keep track records of all firms’ assets deployed into
operations, thus enabling them to have proper figures when making financial ratio
analysis.

2.4.3 Matching principle.

This principle demands that all business transactions associated with a certain type of
revenue be recorded together and reported as a unit. Under matching, principle theory
expenses are always reported in the same period associated with the revenue. Normally
this theory exists in the accrual method of accounting, which requires the expenses and
revenue to be recognised as they occur and not when they are earned or paid out. The
principle in this way will make the financial statement represent a specific period, and
hence the financial analysis will also represent the specific period, and enable the
management of the firm to make appropriate investment decisions.

16
2.4.4 Modern portfolio theory

Harry Markowitz developed a theory of portfolio selection in investment that wants

every investor to analyse risk associate with expected investment profit before
engaging in any investment. The theory was kept modified and its latest version, in
today’s economic science studies, is now called Modern Portfolio Theory (MPT). MPT
attempts to increase portfolio benefits for a given amount of risk or to reduce the
amount of risk for a given degree of portfolio benefits (Chirinko, 1993; Agala et al,
2014). Therefore, the theory wants investors to carefully make the choice of investment
strategies in such a way that their money will bring an optimal return. This can be
attained through consideration of various economic variables (Labatt and White, 2002).

The theory has been very important in the mathematical modelling of investment
decision making and profitability. The theory wants the management of an organization
to diversify company assets with respect to market risks and unique risks of the
organization under concern. The manager should use mathematical methods to
estimate, classify, and control profit and risks, in all types of investments they have
chosen. The theory assumes that information available from income statements, cash
flow statement and balance sheets can be used by manager in selecting and monitoring
investment portfolios (Gilchrist and Himmelberg, 1998).

MPT assumes that there is a numerical relationship between profit and risk and
therefore, managers or investors should concentrate onthe quantification of investment
information (Crotty, 1992). The MPT departed from Traditional investment theory
andintroduces financial ratios in making investment decisions. Thus, management of
an organization or company should put much emphasis on analysis of a few financial
ratios rather than collecting huge qualitative information (Gilchrist and Himmelberg,
1998). In so doing, it maintains the selection of an asset to invest is not done under
individual bases, rather the profitability of the entire organization is considered.

Kaplan and Zingales (2000) argued that the best factor to consider in making
investment choices is the profitability of the company because without profit the

17
company will not grow, and its stock will fall down. A company with increasing profit
will attract many investors since investors are sure of getting their dividends. Also, its
share prices will rise up irrespective of its liabilities. The profitable company according
toLabatt and White (2002), can use debt to increase shareholder’s profit even more.
Kaplan and Zingales (2000) added that the best profitability measures are those which
compare profit with equity, asset, sales, and liabilities. These include return on equity,
return on assets, return on capital employed and net profit margin.

Crotty (1992) contended that ration analysis, both profitability ratios and liquidity
ratios are the major tools the company should rely on deciding which investment
modality and time to commence investment. He referred ratio analysis as a judgmental
process to which past and current financial position of the company can be defined and
the future position can be estimated. Financial ratios provide the investors with a
hurriedly diagnostic look at the financial health of the company and play the role
todetermine the best possible strategy for growth and development (Bertolla and
Caballero, 1991).

Moreover, to recognize the financial trend of the company, the present ratios should be
compared with the foregoing ratios. Ratios can also be compared with ratios of other
companies in the same industry in order to verify the weaknesses and strengths of the
company with respect to the industrial average (Nkuhi, 2015). According to Marković
et al. (2015), although MPT has been extensively used in the financial sector its basic
assumption has been generally challenged. This study used financial ratios as suggested
by MPT to find out whether they had a relationship with investment decision making
in Tanzania banking industry.

2.5 Empirical review

General overview

This section presents different researches which had been done by different researchers
on financial ratios and investment decision. This was done so as to know what has been

18
done and what has not yet been done on this topic so as to know what the study could
cover.

Kosmidou et al. (2005) researched the role of liquidity on investment decision making
in domestic commercial banks of the United Kingdom for the period of 1995 – 2002.
The study came out with mixed results. It was found that there is a positive significant
relationship between decision making and net loan to total assets but there was no
significant relationship between investment decision making with a net loan to deposit
ratio and a total asset to deposit ratio.
Kabera (2009) conducted a study to find out the extent to which financial ratios have
been used to draw investmentdecisions in the firms in Nigeria. The main aim of the
study was to establish the role and limitations of financial ratios in investment decision
making. The study used a financial statement of 100 companies and several financial
ratios were used in decision making. The study identified that financial ratios were
essential in making reasonable investment decision making. The liquidity ratio was
noted to be considered quite different among companies. The variation in using
liquidity ratio was influenced by the decision to be made by the management of the
company. This shows that decisions over certain investment objectives could guide
analysis of liquidity ratio rather than liquidity ratio to guide decision making. This
makes contradictions which should guide the other, ratio analysis or investment
decision.
The study conducted by Podder (2012) narrated that there is no enough evidence of an
association between financial performance and business investment decisions in the
financial institutions within developing countries. It is important to note that how
financial ratios have been in use to judge operations strategies and investment decisions
in Tanzanian commercial banks is not well understood.

2.6.0 Specific overview

19
2.6.1 Liquidity ratio analysis and investment decision making

Kwok (2009) conducted a study on the role of financial ratios on the banks’ lending
decision. The findings reported that the level of liquidity is more important in decision
making concern lending business than the status of profitability. The study concluded
that the level of liquidity is very useful for the banks to decide how much should be
invested in the lending business and to which category of borrowers the bank should
lend. The study wanted managers and creditors in the financial institutions to make
adequate use of liquidity ratios in lending decisions in order to protect their institutions
from bankruptcy. The study also wanted other researchers to investigate more on the
usefulness of liquidity ratio on lending decisions, therefore, to provide insight into this
area. Although the study concluded the liquidity ratio to be used in decision making,
the study used the lending variable only without considering other factors like the
opening of new branches.

Kalanidis (2016) investigated the impact of the liquidity on the profitability and
decision making in 50 largest commercial banks in Europe during a period of 2009 -
2015. The study was conducted to assess the role of liquidity in post-financial crisis.
Data were collected from the banks’ balance sheets and analysed using the data envelop
analysis model. Regarding the relation between liquidity ratios and decision making,
the study reported that total loan to total liquid asset ratio had a positive significant
relationship. However, banks’ profitability seemed to be reduced because of high loan
to liquid asset ratio. An asset to deposit and loan to deposit ratios showed a negative
relationship with decision making. The study concluded that banks should mostly use
capital reserves techniques to maintain their liquidity levels and take action to minimise
debt financing.

The study by Demirguc-Kunt et al., (2003) examined the impact of liquidity ratios on
decision making in a sample of 1400 banks from 72 countries. The results of that study
indicated that a high level of loan to liquid asset ratio could associate with lower net
interest margins. They also reported the high loan to deposit that was associated with
lower interest income. Finally, the study reported lack of significant relationship

20
between liquidity ratios and bank decision making, the study thus disagree with other
research which concluded that there is a significant relationship between liquidity and
investment decision making (Kalanidis, 2016).

In Malaysia, Guru et al. (1999) used a sample of 18 commercial banks from 1990 to
1997 and examine the role of liquidity ratios on the lending and investment decision.
The results demonstrated that the loan to liquid asset ratio and loan to deposit ratio had
no significant power to predict decisions in the banks. An asset to deposit could predict
investment decisions but not lending decisions. The same results were supported by
Barth et al., (2003) who investigated the influence of liquidity ratios on 2300 banks
from 55 countries in Europe and Asia.

Ariffin (2012) investigated the relationship between decision making and liquidity
ratios in 12 big and 12 small commercial banks operating in Japanese financial market.
The study covered a period of 2006-2008 which was a period of financial crisis. The
study noted that during crisis liquidity ratios and investment decisions tend to behave
in the opposite ways. In particular, the increase of loan to liquid asset ratio could have
a worse impact on the banks’ liquidity.

Tugas (2012) examined the impact of current ratio, acid-test ratio and cash ratio in
assisting management in making effective investment decisions. The study was
conducted in Philippines. Their major source of data was annual reports of selected
from organizations in different sectors of the economy. Banks were among the selected
organizations in this study. The study used regression and correlation analysis in data
analysis. Their findings show that the three mentioned variables were crucial tools in
making investment decisions, especially in manufacturing organizations.

Naceur and Kandil (2009) used a sample of 28 commercial banks operating in Egypt
over the period 1989 to 2004. The study employed time series analysis and noted that
liquidity ratios had positive significant effects on the determination of when and how
much should be invested. There was a bidirectional relationship between liquidity score
and investment score.Therefore, the level of liquidity could predict the level of

21
investment at the same time level of investment could predict the level of liquidity.
However, government financial regulations were found to affect the equation between
liquidity ratios and investment decision making.

David and Samuel (2017) analysed the impact of liquidity on the managerial decision
making in commercial banks. Data were solicited in 44 banks from Nigeria. They sent
both structured and unstructured questionnaires to the management of banks by email.
Pearson correlation was used to test the hypothesis that managerial decisions were
significantly influenced by the level of liquidity and vice versa. This hypothesis was
conferred true. The study thus, contradicts with other research which concluded that
there is insignificant relationship between liquidity and investment decision making
(Kalanidis, 2016).

2.6.2 Efficiency ratio analysis and investment decision making

Firdaus and Hosen (2013) analysed financial information of Islamic banks in Indonesia
from 2010 to 2012. The study used Tobit regression model and noted that the efficiency
ratio was ranging between 71.21% and 94.73%. The study did not find any significant
relationship between efficiency ratio and banks’ decision making. However, a high
level of non-performing loans was reported to affect efficiency ratio. The study called
for the improvement of Islamic banks’ efficiency in Indonesia. Attheinternational level,
there is need also to find out the influence of efficiency ratios analysis in relation to the
opening of new branches and staffing of human resources.

Zeitun and Benjelloun (2013) assessed the efficiency of commercial banks operating
in Jordan. The study selected twelve biggest banks in the Jordanian stock exchange for
their study. The study covered a period of 2005 -2010. The study findings indicated
that eleven banks were inefficient since their efficiency ratios were very high. The only
bank which was found to be efficient was Arab Bank which had an efficiency ratio of
48%. The other banks had an efficiency ratio that ranges from 65.4% to 81.9%. The
study concluded that most banks were unable to manage their operating costs.

22
However, the global financial crisis was mentioned to have a negative impact on the
Jordanian commercial bank.

Hosen and Muhari (2014) examined the efficiency score of seventy three commercial
banks in rural areas of Indonesia for the period of 2011 to 2013. The study found the
average efficiency score was 65.23%. This result indicated that commercial banks were
able to earn profit within the rural areas in Indonesia. The study found a weak
correlation between efficiency ratio and banks’ decision making. It was also noted that
banks were continued to open more branches in the rural areas since operation costs
were not very high and banks could get satisfactory profit.

A study of Brazilian commercial banks was conducted by Wanke and Barros (2014)
with the aim of analysing cost efficiency, productivity and investment decision in a
number of branches and employees. The study noted that Brazilian commercial banks
were less cost-efficient since the mean efficient ratio was 63%. However, there was a
positive significant relationship between efficiency ratio and investment in a number
of employees but not branches. Efficiency was noted to have a positive significant
influence on both numbers of employees and branches. On the other hand, the study
revealed that private-owned banks were slightly better in cost-efficient than state-
owned banks. The studythus shows the results which differ with other research showing
inefficiency due to high operation costs, the most variable to determine the
efficiency.(Hosen and Muhari, 2014).

Shyu et al. (2015) examined the influence of efficiency on the investment decision of
56 commercial banks operate in Mainland China, Hong Kong and Taiwan. The study
covered a period of 2004 to 2013. The study used regression analysis to estimate the
influence of operational efficiency on investment decisions. The study found that
operational efficiencies could vary from location to location. Banks’ branches in
Taiwan and Hong Kong had very satisfactory operational efficiency ratios compare to
branches in Mainland China. Likewise, banks could open many branches in Taiwan
and Hong Kong than in the Mainland. The study concluded that operational efficiency
could contribute to the managerial decision on where to open branches.

23
Marković et al. (2015) conducted a study on thirty three commercial banks in Serbia.
The study assessed the efficiency of those banks for a period of four years from 2007
to 2010. The mean efficiency score was found to be 72%. Low technological
development in Serbia was connected to the inefficient of Serbian commercial banks.
Further, the study reported the absence of attributes of efficiency score on decision
making of the bank. Probably this was because of the short period for the analysis; the
findings could be different if they could use data over a long period.

Tyunin (2018) conducted a study in Russia with the aim of comparing the efficiency
of small and large commercial banks. The study used data envelop analysis (DEA) with
the help of a vector auto regression model and covered financial information of the
selected 200 commercial banks from 2013 to 2017. The banks found that large banks
operating in Russia were more efficient compare to small banks. The average efficiency
ratio for the large banks was 32.01% while for the small banks was 87.46%. The study
concluded that it is very expensive to operate a small bank with Russia’s financial
market since large banks could outperform small banks. Finally, the study identified
private banks were also ineffective compared to the banks which were directly or
indirectly owned by the public.

Zager and Zager (2006) assessed the influence of financial ratios on the security of
investment in Nigerian industries. They reported that efficiency ratio was significantly
related to the quality of the entire investment project, on the basis of determining sales
on the capital employed and inventory period. The study concluded that successful
investments are the ones secured from downfall through a regular calculation of the
efficiency ratio. Amedu (2012) also concluded that during the investment decision
making efficiency ratio play a vital role. Through this ratio, managers can predict the
future levels of investment profitability and liquidity. The financial statements enable
the investors to predict the future performance of the business and its profitability.

According to Amedu (2012), banks in Ghana invest millions of dollars in fixed assets
every year. He emphasized that, according to the nature of the banking industry, this
kind of investment would affect banks’ fortunes over several years. The study wanted

24
banks to invest highly in credit business because it has the potential to boost earning
and significantly increase the value of the banks. This is because of the low return on
fixed asset investments. The study wanted banks to have a clear observation of their
sales on capital employed (efficiency ratio) for each fixed asset, as well as other
banking investments before making further investment decisions.

Sandwell (2014) studied the role of accounting ratios in investment decision making in
pension fund institutions in Tanzania. The study used a case study design and included
Public Service Pension Fund (PSPF). Several account ratios were examined for their
role in the investment decisions. The study classified investment into three categories
which were expansion of new business (investment in new activity), expansion of
existing business (expand existing operations) as well as replacement and
modernization. The study noted that the debtor collection period and creditor payment
period which synonymously refer to efficiency ratio were among the ratios with a big
role in the investment decision in PSPF. The two ratios could significantly show the
financial healthand predict future size of this institution. The study conclusion differs
from other research which shows insignificant efficiency ratio in the investment
decisions. As noted at all levels,the international and local levels, there is a need to find
out the influence of efficiency ratios analysis in relation to the opening of new branches
and staffing of human resources.

2.6.3 Profitability ratio analysis and investment decision making

Baba (2013) applied multiple regression analysis to find out whether financial ratios
had an effect on the expansion of the firms in Malaysia for the period covering 2008 -
2012. The study collected financial statements and financial information from the top
100 leading companies. The study findings indicated that both profitability and
liquidity ratios had significant effects on the expansion of the firms. Firms could
expand their market areas (through the increase of workforce and distribution points)
with an increase of both profitability and liquidity ratios.

25
Agala et al. (2014) conducted a study titled “significance of financial ratio analysis in
decision making, a case of selected leading companies in Tokyo.” The study used
questionnaire and collect information from 40 different companies in Tokyo-Japan.
Managers and accountants were randomly selected from each company and recruited
to the study. The study noted that financial ratios analysis assist managers and
economic analysts in making quantitative judgement concerns the position of the
organization and profitability of the existing investments. The study noted that almost
all companies had a problem with absolute liquidity. However, through profitability
ratios, the management can decide whether to drop or continue with certain
investments. All studies on profitability ratios, none of the studies assesses the
influence of profitability with the opening of a new branch or the influence on human
resources.

Asgari and Shalafi(2016) assessed the impact of profitability ratios on decision making
within the banking sector. The study used panel data of twenty Iranian banks registered
in Tehran Stock Exchange. The study reported that profitability ratios return on equity
(ROE), return on assets (ROA), and return on capital employed (ROCE), provide an
appropriate guidance to the management and policy makers in deciding the right and
fit investment portfolios. Specifically, the study noted that ROA and ROCE have strong
predictive power to determineinvestment decisions of the banks rather than ROE. The
study called for the accurate calculations of profitability ratios in order to improve and
manage Iranian bank industry.

Nkuhi (2015) conducted a study on the role of financial management on investment

decision making in Tanga Port Authority. The study examined how financial ratios aid
investors in decision making. The study collected data from annual financial reports of
this authority. Profitability ratio, gearing ratio, and liquidity ratio were the ratios
evaluated in this study. It was found that profitability was a critical factor in investment
decision making. The study concluded that other government authorities should apply
financial management through the calculation of ratios in making investment decisions.

26
As noted earlier, all researches to assess the influences of financial ratio analysis on
investment decisions concluded with either significance or insignificance, and most of
the studies in Tanzania based on industry or manufacturing firms. Few studies in the
banking industry and with different conclusions, leaving a study gap for more research
to work on it.

2.7 Study gap

Scholars have assessed the roles of the financial ratios from different perspectives. For
instance, Kwok (2009) analyzed the role of financial ratios on banks’ lending decisions.
Demirguc-Kunt et al. (2003 and Kalanidis (2016) examined the influence of financial
ratios on profitability, to list a few. Some studies also link the financial ratios and
banks’ decisions. For example, Guru et al. (1999), Ariffin (2012), Tugas (2012) and
David and Samuel (2017), to list a few. However, all of these studies were done outside
Tanzania and they did not analyse how the financial ratios influenced investment
decisions in the number of branches and human resources.

Similar studies done in Tanzania include Samwel (2014), who studied the role of
accounting ratios in investment decision making in pension fund institutions in
Tanzania. The study used a case study design and was done in the Public Service
Pension Fund (PSPF). However, this study was done in the pension funds and not in
commercial banks. Moreover, the investment decisions were measured in terms of
growth of investment funds and the types of investment that included government
securities, fixed deposits, loans, and special government projects, equities, real estate,
and corporate bonds. The study concluded that there is a positive relationship between
ratios and decision making. The existence of the study gap motivated to conduct this
study entailed with a conceptual frameworking.

2.8 Conceptual framework

The study ofthe conceptual framework touches important features of how researcher
thought to establish a relationship between financial ratios and investment decision

27
making in the banking industry. It was assumed that investment decision was made
from the analysis of financial ratios and investment can be rejected or accepted base on
those ratios. Financial statements of profit and loss together with cash flows could help
to mathematically model the net future value of the investment.
The relationship of the variables in the conceptual framework is that they all use the
same financial report data covering the same period, or what is referred as accounting
period and that all ratios are expressed in the same measurement(percentage or decimal
points or proportional)Under liquidity ratio, liquid assets to deposit ratio and net loan
to deposit ratio, they all use the same denominator, (deposit), and net loan to total
assets, and net loan to deposit ratio, they all use the same numerator(net loan). They
both measure the liquidity of the firm.

Under profitability ratio, returns (profit) is the numerator on assets and equity for return
on assets ratio and return on equity ratio.The cost on income ratio stands alone under
profitability ratios.

Under efficiency ratio, we have two variables, expenses and income which measures
the efficiency; efficiency = expenses over income, and earnings ratio which measures
the profit to be earned by shareholder from the whole profit realised by the company.

All these are independent variables to dependent variables investment decisions in

assessment whether it influences decision making in the banking sector to have a
greater number of branches and number of human resources.

Need for more deposit, delivering closer services, and banks philosophies are
intermediate variables (control variables) between dependent variables and
independent variables

These are policies and regulations laid down by the government to be considered when
making investment decisions.
It was assumed that these financial ratios could have effects on the dependent variables
(investment in a number of branches and human resources). But that effect could be

28
possibly interfered by factors such as governing policies in the industry and
institutional investment policies. Therefore, these two variables (in the middlebox)
were considered as the control or intervening variables, because based on the policy or
regulations of the control variable, the decision may be made according to what the
policy suggests.
The conceptual framework continued to indicate that the eagerness to open investment
decisions in a number of branches and human resources could depend on the financial
ratios. Therefore, it was the aim of this study to establish the relationship between
investment decision (dependent variables) and financial ratios (independent variables).
Figure 2.1: Conceptual framework of the study
Financial Ratios

Liquidity ratios
Bank’
 Liquid assets to deposit
ratio
Bank decision
 Net loans to total assets  Number of Branches
ratio
 Net loans to deposit ratio

 Need for more deposits

Profitability ratios
 Return on assets  Delivering of closer
 Return on equity services
 Cost on income ratio  Bank philosophies

Efficiency ratios  Number of Human

 Efficiency ratio Resources
 Earnings ratio
Independent variable Control variables Dependent variables

Source: Researcher’s creation (2020)

29
2.9 Hypotheses

For the econometric study like this, it was better for the study to formulate and test
hypotheses. The study tested the following null hypotheses:

Hypothesis 1: liquidity ratios do not significantly predict investment in anumber of

branches within the bank industry.

Hypothesis 2: liquidity ratios do not significantly predict investment ina number of

human resources within the bank industry.

Hypothesis 3: profitability ratios do not significantly predict investment in a number of

branches within the bank industry.

Hypothesis 4: profitability ratios do not significantly predict investment in a number of

human resources within the bank industry.

Hypothesis 5: efficiency ratios do not significantly predict investment in a number of

branches within the bank industry.

Hypothesis 6: efficiency ratios do not significantly predict investment in a number of

human resources within the bank industry.

30
 CHAPTER THREE

RESEARCH METHODOLOGY

3.1 Introduction

This chapter presents the methodology. It stipulates the description of the area under
the study, research design, research approach, data types and sources, sampling and
sampling techniques, data collection techniques and analysis. It also presents the data
validity and reliability of the tools as well as ethical considerations

3.2 Study area

This study was conducted in the city of Dar-es-salaam. The study involved banks listed
in the Dar-es-Salaam stock exchange (DSE) market. Therefore, the study was centered
in the city of Dar-es-Salaam where all of the banks’ headquarters are located.

3.3 Research design

This was a descriptive survey. The descriptive survey is a research design that describes
the existing phenomena of a particular issue(Kothari and Garg, 2015).The research
design was used to describe the role of financial ratio analysis on investment decision
making. The researcher analysesthe financial records of banks listed under the DSE to
see how far the financial ratio has impacted their decision making. Descriptive research
is unique in the number of variables employed. Like other types of research, descriptive
research includes multiple variables for analysis. For the case of this study, a
descriptive study employed several variables such as liquidity ratio, profitability ratio
and performance (efficiency) ratio.

Descriptive research can be either quantitative or qualitative. The quantitative part of

this design involves collections of quantitative information that can be tabulated along
a continuum in numerical forms, such as scores on a test or the number of times a
person chooses to use a certain factor, or it can describe categories of information such
as gender or patterns of interaction when the aim is to establish a relationship between

34
variables(Saunders, Lewis, Thornhill, 2012).For the case of this study, the researcher
used quantitative approaches so as to have a clear picture of the findings.

3.4 Population of the study

Generally, in the various fields, a population of the study is a group of individuals or

items taken from the general population who share a common characteristic, such as
common experience, common function in an organization(Saunders et al, 2012). This
group may be studied for different reasons. For the case of this study, the population
comprised of all commercial banks operating in Tanzania from 2010 to 2016

3.5 Sampling procedures and sample size

The researcher purposely targeted banks that are listed under the DSE; they believed to
be reliable for this study. Purposive or judgemental sampling technique was used, and
the judgment of the researcher selected the cases that make up the sample. Purposive
sampling technique refers to the sampling techniques which enable a researcher to
select a sample based on his /her knowledge of the population, research elements, and
objectives. Purposive sampling is also based on the researcher’s judgment and purpose
of the study (Kothari and Garg, 2015).

Purposive sampling is a practical and efficient tool when used properly, and can be just
as effective as, and even more efficient than, random sampling. The danger with the
purposive method is that the researcher exercises judgment on the informant’s
reliability and competency. This is a relevant concern especially regarding key
informants on whom the data quality rest. It is critical to be certain of the knowledge
and skill of the informant when doing purposive sampling, as inappropriate informants
rendered the data meaningless and invalid(Kura, 2012). The study selected 5 leading
commercial banks in Tanzania that were listed in Dar es Salaam Stock Exchange. It
was the researcher believes that the leading banks, in terms of operation capitals, have
been using different measures in order to make strategic investment decisions(Kothari
and Garg, 2015).

35
Since all of commercial banks listed in Dar es Salaam stock exchange market werethe
subject of the study. All financial data relating to the financial performance of the
banks were taken from DSE and from annual reports of the selected banks. The
researcher collected the financial data of banks for the past seven years, from 2010 to
2016. The period was seen to be long enough to provide the researcher with adequate
data that could be used to make a conclusion on the roles of financial ratios on
investment decision making.

3.6 Data collection methods

The researcher used only secondary data for this study, therefore,the only documentary
review was applied as a method of data collection.

3.6.1 Documentary review/ Secondary data

Secondary data can be collected from reports or any composed or recorded materials
that are not set up at the demand of the researcher or with the end goal of the research
(Cooper and Schindler, 2006). Secondary data from financial records from selected
commercial banks under DSE were reviewed. The secondary data collected was those
in relation to the study variables for the period under investigation. These
datawereobtained from the Dar es Salaam Stock Exchange and respective banks’
financial statements. There were no hindrances in obtaining all this data as it is all
public information. Data on a yearly basis were collected over a range of seven years
(2010-2016), this period was considered sufficient.

3.6.2 Variables definition and measurement

There were three main variables to this study which are liquidity ratios, profitability
ratios, and efficiency ratios. The liquidity ratios measureliquid assets to deposit ratio,
net loans to total assets ratio and net loans to deposit ratio. The profitability ratios are
measured by return on assets. Return on equity and cost on income ratio and the
efficiency ratios used the following intermediates for efficiency ratios and earnings

36
ratios(Emekekwue,2008).The data used for measurement was derived from financial
statements. All of the variables were interval fixed yearly and continuous.

Table 3.1: Variables measurement

Core Control Variables Source of data Measurement

Variables and Scale
Independent variables
Liquidityratio Liquid assets to deposit ratio Financial Interval fixed in
analysis Net loans to total assets ratio Statements years
Net loans to deposit ratio

Profitability Return on Assets Financial Interval fixed in

ratio analysis Return on Equity statements years
Cost on income ratio
Efficiency Efficiency ratio Financial Interval fixed in
ratios Earnings ratio statements years

Dependent and control variables

Investment Number of Branches, Annual reports Interval and
decision Number of Human Resources continuous
making
Control Bank regulations and Annual report Descriptive only
variables investment policies with time frame
coverage

3.7 Data analysis

SPSS software was used to process and analyze collected data. Different tests/analyses
were applied to reach the conclusion of the study.

3.7.1 Principal Component Analysis

Principal Component Analysis (PCA) is the analysis thatmeasures the degree of inter-
correlation among study factors/variables. The analysis uses Kaiser-Mayer-Olkin
(KMO) and Bartlett’s Test of Sphericity (Bartlett’s test) to assess whether the variables
used are appropriate and adequate. The variables are considered appropriate when the
significant value (p< 0.5) of Bartlett’s Test is obtained. The adequacy of variables for
factor analysis is determined when the value of KMO is more than 0.6. Usually, the

37
index of KMO ranges from 0 to 1. When KMO is less than 0.6 it means that the
variables/factors are not adequate for data analysis (Pallant, 2001).
The study applied factor analysis under the extraction method of principal component
analysis with the rotation method of varimax. The varimax was considered appropriate
since it maximizes correlation within the factors and minimized across factors. Hence
clear factors can be extracted and clear interpretation can be made.

3.7.2 Regression analysis

The researcher ran Weighted Least Squire Regression (WLSR) analysis to settle the
relationship between extracted independent variables and dependent variables.
Moreover, regression analyses were the main way of assessing predictor variables for
the investment decision in the selected commercial banks. The regression
equation/model was used to link the independent variables to the dependent variable
asfollows:
Var9/Var10=a+β1Var1+β2Var2+β3Var3+β4Var4+β5Var5+β6Var6+β7Var7+β8Var8+ԑ….
equation 1

Var9 / Var10 = Investment decision making (either number of branches (var9) or

human resource (var10))

Var1= Liquid assets to deposit ratio

Var2= Net Loans to total assets ratio

Var3= Net loans to deposit ratio

Var4= Return on assets

Var5= Return on equity

Var6= Cost on income ratio

Var7= Efficiency ratios

Var8= Earnings ratios

a = is the constant term of the coefficient

38
Βi = 1…8was used to measure the sensitivity of the dependent variable Var9 or Var10)
to a unit change in the predictor variable Var1, Var2, Var3, to Var8 and ἐ is the error
term that captures the unexplained variation in the model.

A regression model was tested against heteroscedasticity, normality, autocorrelation,

and multicollinearity as recommended by Gujarat and porter (2010) and we found that
no serious problems were found.

3.8 Validity of the data

Validity is an explanation of correctness and accuracy of the data used in the research
study (Polit and Hungler, 1995). This definition is also reflecting on how the study tries
to express the reality and truth of the findings. Yin (1994) presented three kinds of
research study validity. These are constructing external and internal validity.

Construct validity illustrates the correctness of the studied concept. In another word,
constructive validity tends to ensure the obtained answers are correct. Through a re-
examination of the information entered in the analytical software as well as repetition
of analysis; the researcher ensured construct validity.

External validity refers to how best the findings of the study can be generalized beyond
the selected sample study. This study was conducted in the banking industry and
therefore the study findings can only be applied within the Tanzanian banking industry.
The study selected five leading banks in Tanzania which have branches almost in all
regions of the country. Therefore, the findings can be trusted to represent other banks
operating in Tanzania.

Internal validity concerning with truthiness of the fact that all independent variables
cause dependent variables. The study used longitudinal econometric data which have a
high chance of suffering from regression problem, especially multicollinearity. Hence
data was subjected in Principal Component Analysis in order to remove independent
variables with less influence. However, the study tested the hypothesis that showed that
independent variables were causing dependent variables.

39
 3.9 Reliability of data

According to Ary, Jacobs, and Sorensen (2010), reliability means the precision of data
based on the ability of the research tool to produce consistent results. Quansah (2017)
asserted that the coefficients of Cronbach alpha range from 0-1 and as the value of
coefficients are approaching 1 indicates that the data are more reliable. Creswell (2012)
affirmed that in order for the value of Cronbach alpha to be accepted, it should range
from 0.70 to 0.95. The Cronbach alpha statistics use the method known as test-retest
which measures the correlation among the variables. The findings from Table 3.2
shows that the mean value of Cronbach alpha is 0.7984, indicating that data were
reliable.

Table 3.2: Reliability Results

Variable Cronbach Alpha

Liquid assets to deposit-borrowing ratio 0.772
Net Loans to total assets ratio 0.713
Net Loans to deposit and borrowing 0.718
Return on Assets (ROA 0.762
Return on Equity (ROE) 0.830
Cost to income ratio (C/I) 0.755
Efficiency Ratio 0.742
Earnings Ratio 0.790
Number of Branches 0.954
Number of Human Resources 0.948
Mean 0.7984

3.10 Limitations of the study

There few possible limitations for this study: the first one is the lack of primary data in
the study. The study used only secondary data that were mainly taken from the annual
reports of the selected commercial banks. The disadvantage of using secondary data is

40
that data cannot be expanded, only available data may be used.It would be better if the
findings of secondary data could be boosted or supported with primary information.

The secondlimitation of doing this study was the lack of enough time. This is an
academic study and therefore it is limited by time. The study was supposed to be
completed within academic time frame which was not possible.

41
 CHAPTER FOUR

DATA ANALYSIS AND DISCUSSION

4.1 Introduction

In this chapter, researcher presented findings of the study as per specific objectives.
The presentation of the findings went hand in hand with the discussion of study results.
The chapter has three sections wherein, the first section presents thecorrelation analysis
of the study variables, the second section presentsan analysis of the study findings in
which researcher applied principal component analysis and weighted least squire
regression analysis, while the third section presentsa discussion of the study results that
relate with the study specific objectives.

4.2 Descriptive statistics of study variables

In this section, descriptive statistics of the study variables have been provided. The
statistics involved data collected for a period of seven years, from 2010 to 2016. Mean,
standard deviation, minimum and maximum values were calculated. It should be noted
that a standard deviation of greater than 1.5 indicates the very high variation of the
values from the mean; while the standard deviation of less or equal to 1.5 indicates the
values were closer to the mean. Table 4.1 carries a summary of descriptive statistics.

In interpreting the results var1 to var3 represent proxies of liquidity ratios which were
liquid assets to deposit ratio (var1), net loans to total assets ratio (var2) and net loans
to deposit (var3). The proxies for profitability ratios were returned on assets (var4),
return on equity (var5) and cost to income ratio (var6). Efficiency was measured by
efficiency ratio (var7) and earnings ratios (var8). Meanwhile, investment decisions of
the banks were presented by two empirical models which were a number of branches
(var9) and human resources/employees (var10).

42
Table 4.1: Descriptive statistics of study variables

Variables N Minimum Maximum Mean Std. Deviation

var1 35 0.042 1.456 0.646 0.414
var2 35 0.260 0.769 0.562 0.134
var3 35 0.102 0.996 0.635 0.206
var4 35 -0.017 0.356 0.039 0.062
var5 35 -0.118 0.293 0.131 0.101
var6 35 0.715 1.307 0.855 0.118
var7 35 0.048 0.948 0.480 0.278
var8 35 0.691 1.667 0.909 0.176
Branches (var9) 35 5 185 91.40 58.708
Employees(var10) 35 132 3432 1710 966

Source: Field Data (2020)

The results in table 4.1 indicate that the reviewed banks were not geared due to the fact
that the mean of net loans to total asset ratio was less than one. Whereby, the mean of
the net loan in selected banks was about 56.2% of the mean of total assets. Similarly,
mean of net loan to deposit ratio (which is equivalent to debt/equity ratio) was lessthan
one. This shows that selected commercial banks had low debt financing than equity
financing. The amount of loan in the reviewed banks was about 63.5% of the deposits.

Liquid assets to deposit ratio suggest the banks had a satisfactory amount of liquid,
which was about 64.6% of the deposits. Since liquidity ratios measuretheability of the
firm to repay its short terms liabilities (such as short-term debts, operation expenses,
and other short term obligations), it can be accepted that the reviewed commercial
banks were able to meet their short term obligations within the reviewed period (from
2010 to 2016).

Concerning the descriptive statistics of profitability ratio, it was found that the return
on assets was 3.9%, return on equity was 13.1% and the cost to income ratio was about
85.5%. Verfaillie and Bidwell (2000) together with Shyu et al., (2015) reported that the
good value for return on assets and on equity should be 5% and 20% respectively or
more. Hence, the findings show that the reviewed banks had earned a satisfactory

43
income from the equity but not assets within the seven years period under review. This
is depicted by a good mean value of return on equity and the bad (very low) mean value
of return on assets.

The mean cost/income ratio was very high at 85.5% which indicates that banks could
spend 0.855 unities to produce 1unit of profit. The suitable value of cost to income ratio
has been recommended not to exceed 70% (Verfaillie and Bidwell, 2000). Hence, the
reviewed banks were quite ineffective in terms of operational cost management.
General conclusion in respect of profitability ratios is that managers of the reviewed
banks were capable to ensure their banks got profit from equity shares purchased by
the investors/shareholders but not from existed banks’ assets. Hence, they have to
improve their management strategies in order to earn a satisfactory income from assets.
Also, they should work to minimize the cost/income ratio which was noted to be very
high than the recommended maximum value. Mercy (2014) reported that corporate
managers should keep the cost/income ratio as lower as possible.

On the other hand, the mean value of efficiency ratio was found to be 48%. The findings
of the efficiency ratio assumed that the reviewed banks had tried to earn more than they
spent. Verfaillie and Bidwell (2000) mentioned that companies try to lower their
efficiency ratios because the low the ratio the higher the profit. A suitable efficiency
ratio should be less than 50%. Although the efficiency ratio was found to be good still
the reviewed banks have a chance to improve efficiency ratio by decrease outputs and
increase inputs.

The findings continue to suggest that the stocks of reviewed banks were overvalued
within the reviewed period. This is because the mean earnings ratio was 90.9% which
is greater than the average earnings ratio of the entire banking industry. This suggests
investors overprice stocks of the reviewed commercial banks. According to BOT
(2017), the earnings ratio of the Tanzania banking industry has been ranging between
17.7% and 28.9%. The researcher of this study argued that the reviewed banks were
facing lower bankruptcy risk since they have shown to be well capitalized banks in the

44
industry. However, they can have access to cheaper funding that will increase their
profit.

4.3 Analysis of the study results

4.3.1 Principal component analysis of the independent variables

Principal component analysis (PCA) was used to extract independent variables which
highly explain dependent variables. In conducting PCA the following assumption are
important. KMO score greater than 0.5, factor load greater than 0.5, commonalities also
greater than 0.5, Bartlett test significant less than 0.5 and none of cross loading

Factors loaded for analysis were all eight independent variables; var1, var2 to var8
which presented variables for liquidity ratios, profitability ratios, and efficiency ratios.
The test based on eight values to extract a set of independent variables/factors with
high load. The results presented in table 4.2 show KMO score was 0.608 and the value
of Bartlett’s Test of Sphericity was 0.000 which indicates the extracted
factors/variables were significant. This means that they had a very high level of
reliability.

Table 4.2: KMO and Bartlett's Test for independent variables

Kaiser-Meyer-Olkin Measure of Sampling Adequacy. .608

Approx. Chi-Square 117.707
Bartlett's Test of Sphericity Df 28
Sig. .000

Source: Secondary data (2020)

Figure 4.1 indicates three factors of the financial ratio were extracted by the SPSS as
the best predictors of the banking investment, while the other five factors were
eliminated.Therefore, the three extracted factors/variables were used in the subsequent
analyses.

Figure 4.1: Scree plot for independent variables

45
Source: Secondary data (2020)

Table 4.3 depicts that the three extracted factors contributed 74.6% of the total variance
explained and the five dropped factors present 25.4%. Table 4.4 shows the first
extracted factor was var5 (return on equity) which contributed up to 37.9% of the total
variance with factor load of 0.926, the second factor was var1 (liquid assets to deposit-
borrowing ratio) which present 19.8% of the total variance with factor load of 0.871,
the third extracted factor was var3 (net Loans to deposit and borrowing) with
percentage representation of 16.9% and factor load of 16.9%. However, according to
Nunnally (1978) variables with factor load of 0.4 and above are considered reliable.

Table 4.3: Total Variance Explanation

46
 Component Initial Eigenvalues Extraction Sums of Squared Loadings
Total % of Cumulative Total % of Cumulative
Variance % Variance %
1 3.032 37.904 37.904 3.032 37.904 37.904
2 1.587 19.837 57.742 1.587 19.837 57.742
3 1.349 16.861 74.603 1.349 16.861 74.603
4 .945 11.817 86.419
5 .475 5.938 92.357
6 .286 3.573 95.931
7 .197 2.467 98.397
8 .128 1.603 100.000
Extraction Method: Principal Component Analysis.

Secondary data (2020)

Table 4.4: Rotated Component Matrix

Component
1 2 3
var5 .916 .187 -.026
var1 .900 .067 .182
var3 .859 -.093 .028
var6 -.661 -.239 .351
var4 .099 .903 -.169
var8 .088 .877 .316
var7 .120 .019 .785
var2 -.098 .054 .713
Extraction Method: Principal Component Analysis.
Rotation Method: Varimax with Kaiser Normalization.
a. Rotation converged in 4 iterations.

Source: Secondary data (2020)

4.3.2 Relationship between financial ratios and investment on bank branches

The study used weighted least squire regression analysis to establish the relationship
between extracted financial ratios (var1, var3 and var5) and banks’ decision to invest
in a number of branches. In order to have clear results, all data were changed to the

47
logarithm. The results have been presented in table4.5 where it can be observed that
the effects of these three extracted financial ratios on thedecision to invest on the
number of branches were significant (p-value < 0.0001).The correlation coefficient (R-
Squire) was 0.470which implies that there was a moderate relationship between the
selected proxies/variablesand investment on the number of branches. The coefficient
of the determinant (Adj R-Squire) was 0.431 and this indicated 43.1% of the decision
toinvestonthe number of branches could be influenced by selected financial ratios.

Table 4.5: Relationship between financial ratios and bank branches

R = 0.589 R-Square = 0.470Adj R-Square = 0.431 Sig < 0.0001

Model (1) Unstandardized Standardized T Sig. Collinearity Statistics
Coefficients Coefficients
B Std. Beta Tolerance VIF
Error
(Constant) 6.071 .662 9.165 .000
var1 -.004 .006 -.029 -.555 .593 .910 1.098
var3 -.133 .054 -.136 -2.473 .035 .829 1.206
var5 1.670 .088 1.029 19.039 .000 .853 1.173
a. Dependent Variable: Branches (var9)
b. Predictors: (Constant), var5, var3, var1

Source: Secondary data (2020)

Specific results showed liquid assets to deposit ratio (var1) had a negative insignificant
relationship with investment on branches (p-value = -0.029). Also net loan to deposit
ratio (var3) and return on equity (var5) had a negative significant relationship with
investment on the number of branches (var9). The level of

Significanceof var3 was less than 0.035 and that of var5 was below 0.0001. With these
statistics, it can be said that liquid assets to the deposit-borrowing ratio (V1) have no
significant power to predict investment on the number of branches in the banking
industry. But net loan to deposit ratio (var3) and return on equity (var5) have the power.
Nevertheless, the increase of the number of branches could depend highly on the

48
increase of return on equity but the decrease of branches could highly depend on the
increase of net loans to deposit ratio.

The regression equation to predict investment on the number of branches within the
banking industry using financial ratios can be given as the equation below (equation
1): -

𝑉𝑎𝑟9 = 6.071 − 0.004var1 − 0.133var3 + 1.67var5 … … … . equation 1

4.3.3 Relationship between financial ratios and investment on human resources

Similarly, weighted least square regression analysis was employed to establish a

relationship between the extracted financial ratio (var1, var3 and var5) with banks’
decision to investonthe number of human resources (var10). Data was also changed to
their logarithm values in order to have clear modelThe regression analysis revealed the
model was also significant with a probability value of less than 0.002. The coefficient
of the determinant was 0.792 that means the three extracted financial ratios could
contribute up to 79.2% of the decision on whether to invest in the number of human
resources. Meanwhile correlation coefficient was 0.680 which indicate a strong
correlation between investment decision on the number of human resources and the
three extracted financial ratios.

From table 4.6, it can be noted that net loan to deposit ratio (var3) and return on equity
(var5) had a strong significant relationship with investment on the number of human
resources (var10). All had a significant value of less than 0.05. However, net loan to
deposit ratio (var3) shown to have a negative relationship with investment on human
resources while return on equity (var5) shown to have a positive relationship with
investment on human resources. On the other hand, liquid assets to deposit ratio (var1)
had a negative insignificant relationship with the number of human resources (p-value
= 0.683). With these statistics, it can be accepted that number of human
resources/employees could increase when the return on equity increases and/or when a
net loan to deposit ratio decreases.

49
Table 4.6: Relationship between financial ratios and human resources

R = 0.890 R-Square = 0.792Adj R-Square = 0.723 Sig = 0.002

Model (2) Unstandardized Standardized T Sig. Collinearity Statistics
Coefficients Coefficients
B Std. Beta Tolerance VIF
Error
(Constant) 6.143 .629 9.761 .000
var1 .003 .006 .067 .421 .683 .910 1.098
var3 -.136 .051 -.447 -2.678 .025 .829 1.206
var5 .322 .083 .636 3.864 .004 .853 1.173
a. Dependent Variable: Employees (var10)
b. Predictors: (Constant), var5, var3, var1

The equation to predict investment on a number of human resources (var10) using

liquid assets to deposit ratio (var1), net loan to deposit ratio (var3) and return on equity
(var5) could be given as follow: -

Var10 = 6.143 − 0.003var1 − 0.136var2 + 0.322var5 … … . equation 2

4.4 Discussion of the study results

In this section, the researcher presents thediscussion of the findingsof the research as
per specific objectives. The study had three specific objectives which called for the
relationship between investment decision which determines the opening of new
branches and recruitment of new employees as dependent variable and proxies of
liquidity ratio, efficiency ratio as well as profitability ratio as independent variables.
The researcher performed principal component analysis (PCA) of the independent
variables in order to extract factors/variables which could highly explain the
relationship between independent and dependent variables. Three factors/variables
were extracted and these were liquid assets to deposit ratio (var1), net loan to deposit
ratio (var3) and return on equity (var5). This was followed by a linear regression
analysis between extracted factors and proxies of investment decisions. However, all
data were converted to logarithm values in order to have clear model.

50
4.4.1 The effect of liquidity ratios on investment decision making

The first objectives called for the determination of the effect of liquidity ratio analysis
on investment decision making. Among three proxies of liquidity ratio included in this
study; two of them were extracted after conducting PCA. These were var1 and var3.
The results obtained from WLSR showed that var1 had insignificant relation with
investment on banks’ branches while var3 had a significant relationship with
investment on banks’ branches. For that reason, the study accepted var3 (one of the
proxies of liquidity) could significantly predict investment on the number of banks’
branches.Therefore, the study rejected null hypothesis 1 which stated that liquidity
ratios do not significantly predict investment on the number of branches within the
bank industry.

Concerning investment on the number of human resources, the study found that net
loan to deposit ratio (var3) was significantly inverse propositional to the number of
human resources/employees in the banking industry. Hence, the study accepted that
liquidity ratios could significantly predict an increase and decrease of human resources
within this industry. The study rejected null hypothesis 2 which stated that liquidity
ratios do not significantly predict investment on the number of human resources within
the bank industry.

The study accepted that liquid asset to deposit ratio and net loan to total asset ratio do
not foster effective investment decision, therefore, do not enforce opening of a new
branch and enforce for additional human resource/ manpower. But net loan to deposit
ratio could do. The study also accepted that, in investment decision making, managers
of selected commercial banks were looking on the ability of their banks to manage short
term liabilities and generate income from assets. They were also looking on the market
price of their products to determine whether an increase in branches or human resources
could earn them more profits.

Kiwelo (2015) declaredthat, for the company to be sustainable, it should always

consider its liquidity values in any new operations or investment. Query (2014) argued

51
that the liquidity values are very important to be considered if an investment is to be
made to avoid the difficulties such as long time to be taken to convert back the asset
into cash. Therefore, the study wants commercial banks in Tanzania also to closely
consider their liquidity values in making investment decisions.

The assets to deposit liquidity ratio is regularly referred to as a key fundamental metric
for safekeeping of money by the organization. This ratio represents the degree to which
the company has liquidity close and, financed by moderately steady and unsurprising
(for the most part retail) on funds safekeeping, as opposed to by possibly more
unpredictable discount obligation to be subsidized. Obviously, a bank’s monetary
record may likewise incorporate deposits from huge non-bank organizations, which
frequently act like discount financing (Omare, 2016). Many banks hold billions of
dollars in assets and have several subsidiaries in different industries (Kisu, 2014).

4.4.2 The effect of profitability ratios on investment decision making

The next specific objective was to establish the effect of profitability ratios on
investment decision making in the banking industry. The proxies of profitability ratios
included were return on assets (var4), return on equity (var5) and cost to income ratio
(var6); while investment decision making was still presented as invest in the number
of branches (var9) and the number of human resources (var10). After conducting PCA
var4 and var6 were excluded following their low factor load and var5 was extracted
since it had high factor load. The results of WLSR revealed var5 had significant
positive power to predict both investmentsinthe number of branches and human
resources.

The study rejected null hypothesis 3 which states that profitability ratios do not
significantly predict investment on the number of branches within the bank industry.
Also, the study rejected null hypothesis 4 which states that profitability ratios do not
significantly predict investment on the number of human resources within the bank
industry.

52
This study showed evidence of a significant relationship between profitability ratios
and decision making in Tanzanian commercial banks. Similarly, other studies in other
countries have shown the existence of a significant relationship between profitability
and investment decisions in business organizations. A good example is the study by
Agala et al (2014) from Japan and the study by Baba (2013) from Malaysia which
found the existence of positive significant relationship between profitability and
decision making in the banking sector. However, there some authors like Amedu
(2012) from Ghana who did not find the relationship between profitability and
investment decisions in the local commercial banks. This being the fact, the study
argued that the relationship between profitability ratios and decision making depends
on the business model used by each bank and/or used by each banking industry.

Demirguc-Kunt et al., (2003) also found that return on equity could not directly relate
to business investments in small and medium service companies but not in large service
companies. The researcher argued that equity investors do consider the size of the
companies to which they can invest in terms of the amount of assets invested and
amount of operation capital of the company. Return on equity, according to Higgins
(2012), is thekey profitability ratios that investors use to measure the amount of a
company’s income that is returned as shareholder equity. Thisratio reveals how
effectively a corporation is generating profit from the money that equity investors have
put into the business.

Information presented in the literature review (chapter two) suggests that many banks,
especially the leading banks in a given financial market, hold some assets and have
improved their investment performance through return on assets. However, there is a
cutting point where the further holding of assetsresults in decrease in investment
performance.Cost to income ratio was omitted through PCA because it had low factor
load. But the study suggested that management of the commercial banks in Tanzania
consider costs before performing any investment decision. However, Ariffin (2012)
and Tyunin (2018) stated that the cost-to-income ratio gives the management of the
business organization a clear view of how efficiently their businesses are run.

53
Management can monitor the cost of opening new businessesusing a cost-to-income
ratio. The higher the cost suggests closure of the investment decision while the higher
the income suggests the expansion of the investment.

4.4.3 The effect of efficiency ratios on investment decision making

The third specific objective of this study was to determine the effect of efficiency ratios
on investment decision making. Two efficiency ratios were reviewed; these were
efficiency ratio (V7) and earnings ratio (V8). However, after PCA analysis, all these
two factors were dropped since they had low factor load. Hence, there were no proxies
of efficiency ratio to regress with proxies of investment decisions. This being the fact
the study concluded that efficiency ratio could not have the power to predict investment
on the number of branches or employees/human resources within Tanzania banking
industry.

The study accepted null hypothesis 5 which states that efficiency ratios do not
significantly predict investment on the number of branches within the bank industry.
Also, the study accepted null hypothesis 6 which states that efficiency ratios do not
significantly predict investment in the number of human resources within the bank
industry. The study argued that efficiency ratios were found to have no power to
directly predict investment decisions in the reviewed commercial banks because the
banks were not performing well in their operations. Improvement of management of
commercial banks in Tanzania would increase their operational performance.

A study by Kigadiye (2014) argued that earning was having apositive relationship
withthe increasing number of employees in Norwegian commercial banks. This means
the Norwegian banks could make the decision on the recruitment of new employees
based on the received earnings. This study accepted that earnings ratio is an important
efficiency ratio.Since it shows how much profit the bank is receiving from each shilling
it lends to the clients/borrowers. It also shows the amount a bank receives from each
shilling saved by depositors within the bank.

54
4.5 Conclusion

The study assessed the role of financial ratios in investment decision making within the
banking sector. The information reported in this study is meaning full since data were
collected from the annual reports of the selected banks, a reliable source. According to
Modern Portfolio Theory (MPT), the major custodian of financial information that is
important for investment decision making is the financial statement. The MPT
continued to narrate that financial ratios are the bedrock on which investment decision
making stood.

The study indicated that financial ratios were differently considered in decision toward
investment in number of human resources and branches. Different results have been
observed on liquidity ratios, profitability ratios and efficiency ratios. Efficiency ratios
were found not to have the ability to influence investment decisions in the commercial
banks in terms of the number of both human resources and branches. The study
discovered that investment on both human resources and branches could increase with
the decrease of liquid assets to deposit ratio (var1) and net loan to deposit ratio (var3)
but could increase with an increase of return on equity (var5).

55
 CHAPTER FIVE

STUDY SUMMARY, CONCLUSION AND RECOMMENDATION

5.1 Introduction

In this section, the researcher presents the summary of the entire study, conclusion
based on the study questions and recommendations that will bring effectiveness in the
investment decision making within commercial banks. However, the chapter gives
areasfor further studies.

5.2 Summary of the study

The aim of the study was to examine the effect of financial ratios on investment
decisions in the banking industry. In order to achieve this general objective, the study
posed three questions which were: What is the effect of liquidity ratios on investment
decision making? What is the effect of efficiency ratios on investment decision
making? And what is the effect of profitability ratios on investment decision making?
All these three questions constitute independent variables in the researchers’
conceptual framework. The dependent variables on investment decisions constitute two
variables namely investment in opening new branches and investment in the increasing
number of human resources.

The study collected data from commercial banks listed in Dar es Salaam Stock
Exchange. They were selected on the basis of their operating capital and coverage in
which the five leading banks were selected. Therefore, the study used a purposive
sampling technique and covered a period of seven years from 2010 to 2016. The
findings were analysed using SPSS where principal component analysis and weighted
least squire regression analyses were performed. PCA was conductedin order to make
data reduction (so that to remove the problem of multicollinearity) while WLSR-
analysis was done in order to establisha relationship between dependent and
independent variables.

56
5.2.1 The effect of liquidity ratios on investment decision

The liquidity ratios assessed by this study were a liquid asset to deposit ratio, net loan
to total asset ratio as well as net loan to deposit ratio. Through PCA net loans to total
asset ratio was omitted and the other two ratios were extracted. The results of WLSR-
analysis indicated that liquid asset to deposit ratio had a negative insignificant
relationship with both number of branches and human resources in the commercial
banks. Meanwhile, net loans to deposit ratio had negative significant power to predict
investment in the number of branches and human resources. Therefore, investment in
these parameters could increase with the decrease of net loan to deposit ratio.

5.2.2 The effect of profitability ratios on investment decision

The proxies of profitability ratios analysed were the return on assets, the return on
equity and the cost to income ratio. The results gave a clue that return on equity had a
positive significant effect on the decision to invest in the number of both branches and
human resources. The study concludes that an increase in return on equity was
influencing an increase in investment on both number of branches and employees in
the reviewed commercial banks. Return on assets and cost to income ratio were noted
to have no direct effect on the investment decision making in the reviewed commercial
banks. These two variables were discovered to have low reliability (factor load) in
predict investment therefore they were omitted during PCA.

5.2.3 The effect of efficiency ratios on investment decision making

The study analyzed efficiency ratio and earnings ratio as the proxies of efficiency
ratios. The finding of PCA indicated that both efficiency ratio and earnings ratio were
less reliable variables/factors for predicting investment decisions in the banking
industry. Hence, the study accepted that efficiency ratios did not have the direct ability
to predict investment decisions in the banking industry in terms of the number of human
resource and number of branches.

57
5.3 Conclusion of the study

The study concludes that financial ratios have different effects on investment decision
making in the banking industry. Some ratios could positively influence and others
could negatively influence the openness of investment in terms of human resources and
branches. For instance, among extracted variables liquid assets to deposit-borrowing
ratio were found to have a negative insignificant power to influence investment while
net loans to deposit and borrowing were found to have negative significant influence
in the investment decisions. Return on equity was found to have positive significant
power to predict investment in both numbers of branches and human resources. On the
other hand, proxies of efficiency ratios were found to be unreliable in determine
investment decisionsin commercial banks.Finally, these results give a chance to the
study to conclude that financial ratios have mixed effects on investment decision
making in the banking industry.

5.4 Implication of the study

The findings give us a clue that banks perform investment analysis in which at certain
extent financial ratios become a benchmarked for establishing investment decisions.
This is because the financial position or financial healthiness of the company (in terms
of asset and liability) can be identified from the financial ratios. The results also have
proved the validity of MPT theory which claimed that financial ratios can be used to
determine whether to pursue suggested investment or not. This is hand in hand with
making investment profitability projections. Accordingly, the study has accepted
financial ratios (particularly liquid assets to deposit-borrowing ratio, net loans to
deposit and borrowing as well as return on equity) have an important role in making
investment decisions within the banking industry.

5.5 Recommendation of the study

The following has been suggested in order to improve investment decision making
within the banking industry:

58
  Commercial banks should make regular use of their financial ratio analysis in
deciding whether to invest or not. They should consider ratios like liquid assets
to deposit-borrowing ratio, net loans to deposit and borrowing, return on equity
and other ratios.

 However, banks should demonstrate proper ways of keeping financial records,

in such a manner that they can be retrieved when needed and analyzed quickly.

 Commercial banks should employ skilled personnel (in accounting and related
subjects) who are competent and capable to collect and analyze financial
information.

 The Bank of Tanzania (BOT) should deliberately speed up the sensitization

campaign to Tanzanian commercial Banks to focus on ratios analysis as among
the best tool in effective decision making in the banking industry.

5.6 Area for further study

To get a comprehensive picture of this study,a similar study should be conducted but it
should expand the scope and cover financial data before the year 2010. Other future
studies should examine the role of other factors in investment decision making rather
than financial information. These factors may have a great impact on the process of
making banks’ investment decision.

59
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