Bank‐level and country‐level determinants of bank capital structure and funding sources

Date01 October 2018
Published date01 October 2018
AuthorHafiz Hoque,Eilnaz Kashefi Pour
DOIhttp://doi.org/10.1002/ijfe.1635
RESEARCH ARTICLE
Banklevel and countrylevel determinants of bank capital
structure and funding sources
Hafiz Hoque
1
| Eilnaz Kashefi Pour
2
1
The York Management School,
University of York, York, UK
2
Department of Accounting and Finance,
Birmingham Business School, University
of Birmingham University House,
Birmingham, UK
Correspondence
Hafiz Hoque, The York Management
School, University of York, Freboys Lane,
York YO10 5GD, UK.
Email: hafiz.hoque@york.ac.uk
JEL Classification: G21; G32
Abstract
We examine the determinants of capital structure and funding sources of 347
large global banks between 1998 and 2016 from 57 countries around the world.
We find that the capital structure of banks does not evolve only as a result of
capital regulations, it is also affected by market forces. We find that bank cap-
ital structure corresponds to corporate finance theory and buffer view and, in
particular, that markettobook ratio, size, and risk are positively related and
that profitability is negatively related to bank leverage. Banks in countries with
higher tax advantages, creditor rights, deposit insurance, and bankruptcy codes
have more leverage, and those bound by common law have less leverage. Size
and countrylevel factors are important determinants of sources of financing.
KEYWORDS
capital structure, crisis, deposit/nondeposit financing, global banks, speed of adjustment
1|INTRODUCTION
Almost all of the studies on capital structure exclude the
banking industry (e.g., Bessler, Drobetz, Haller, & Meier,
2013; Fan, Titman, & Twite, 2012) because capital ade-
quacy regulation dictates their capital structure. Another
important reason to exclude banks is that their balance
sheets are very different from the other firms because of
their typically very high leveraging and deposit taking.
Although this may justify excluding banks from a study
of nonbank industrial firms, it is reasonable to ask
whether the theories relating to capital structure that
hold for industrial firms also hold for banks. This paper
thus asks: what are the determinants of bank capital
structure? We examine the banklevel, regulatory, and
countrylevel determinants of bank capital structure.
Because banks are deposittaking institutions, we also
examine the determinants of deposit and nondeposit
financing. We use large banks, which are a particular
focus of the current regulatory environment because of
their importance domestically and internationally as sys-
temically important financial institutions.
For banks higher leverage ratios arise as they deal
with money, and leverage are much more important. A
bank lends out money that is essentially borrowed from
the customers. In some sense, these deposits are loans
granted to the bank that could be withdrawn by the
depositors at any time. In sum, banking is all about
leverage. Put simply, banks are highly leveraged institu-
tions that are in the business of facilitating leverage for
others. The leverage ratio is used to capture how much
debt the bank has relative to its capital, such as Tier 1
capital, including common stock, retained earnings, and
other selected assets. Although it is considered safer
for a bank to have higher leverage (DeAngelo & Stulz,
2013), but we expect that there are variations in capital
structure across banks and that is determined by their asset
structure, tax rates, and regulations, which we analyse in
this paper.
The amount of bank capital is determined by bank
capital requirements (Mishkin, 2000, p. 227). This means
that bank leverage should be determined by regulations
and that there should be less variation in leverage across
banks.
1
Putting it differently, standard corporate finance
Received: 31 January 2017 Revised: 22 April 2018 Accepted: 20 June 2018
DOI: 10.1002/ijfe.1635
504 © 2018 John Wiley & Sons, Ltd. Int J Fin Econ. 2018;23:504532.wileyonlinelibrary.com/journal/ijfe
theories should have little power in explaining the cross
sectional variation in leverage for banks. Figure 1 plots
Tier 1 capital as a percentage of riskweighted assets.
Interestingly, the Tier 1 capital ratio shows considerable
variation. This implies that bank leverage needs more
investigation, as it seems that capital structure decisions
are not only a result of capital regulation.
Barth, Caprio, and Levine (2005), Berger, Herring,
and Szegö (1995), and Brewer III, Kaufman, and Wall
(2008) find that historically banks hold higher levels of
capital than the regulatory minimum. This finding
implies that banks hold capital buffers in excess of the
regulatory minimum, asserting the role of market forces
in determining the cushions banks tend to maintain over
the minimum capital requirements. Figure 1 also shows
that banks hold a higher level of Tier 1 capital as than
that prescribed by the Basel regulations.
There is a large body of literature that investigates the
determinants of capital structure within individual coun-
tries.
2
Some papers examine capital structure choices
across countries to link the crosssectional variation in
the institutional environment.
3
Recently, Gropp and
Heider (2010) have examined the determinants of bank
capital structure using a sample of US and EU15 banks,
and they confirm that the market/corporate finance view
of capital structure applies to banks. Our study is related
to Gropp and Heider (2010), but our approach is different
in three respects: First, we investigate the impact of tax;
second, in addition to banklevel variables, we also exam-
ine institutional and countrylevel variables; and third,
we test whether financial crisis shows any significant
effect on the leverage of banks.
In particular, the paper contributes to the literature in
several ways. First, we examine whether bank capital
structure evolves as a result of capital regulations or cor-
porate finance and buffer views explain the capital struc-
ture of banks. We use an international sample of large
banks from 57 countries to examine whether the bank
level characteristics such as profitability, markettobook,
and size explain some of variations of the capital struc-
ture of banks. Our findings imply that capital structure
of banks is not solely determined by the capital regula-
tions, rather, corporate finance theory/buffer view
explains a significant portion of capital structure of banks
across the globe.
Second, what is the role of countrylevel governance
and institutional factors in determining the capital struc-
ture of banks? There are a few studies that have looked
at the importance of countrylevel governance and insti-
tutional factors in the capital structure of nonfinancial
firms across the globe (e.g., Bessler et al., 2013; Fan
et al., 2012). We extend their evidence in the case of
banks. Our findings are consistent with Bessler et al.
(2013) and Fan et al. (2012) using a nonfinancial sample
from a number of countries, and in that countrylevel
governance variables is a very important determinant of
capital structure. Consistent with the previous literature
(Bessler et al., 2013; Claessens, Djankov, & Mody, 2001;
Djankov, McLiesh, & Shleifer, 2007; Fan et al., 2012
and La Porta, LopezdeSilanes, Shleifer, & Vishny,
1997, 1998), we find that, in contrast to countries with
a common law origin, those with bankruptcy and deposit
insurance have higher book leverage. These findings
relate to the importance of the legal system, the imple-
mentation of investor rights, and the resolution of finan-
cial distress.
We also examine the countrylevel governance and
institutional determinants of nondeposit and deposit
financing. We find that these variables are even more
important compared with banklevel variables for the
sources of financing. The standard corporate finance
determinants have little or no explanatory power in deter-
mining the sources of banks'capital structure when we
control for countrylevel characteristics, whereas the
magnitude and significance of countrylevel variables
suggest that country effects are more important for the
sources of financing of banks.
4
Third, the tax treatment of interest and dividend pay-
ments is found to be an important factor that affects the
leverage of firms after the seminal work of Modigliani
and Miller (1958) and Miller (1977). However, no studies
try to understand whether bank leverage responds to the
Miller tax ratio in a similar way to nonfinancial firms. In
this paper, we hand collect the data on tax rates for differ-
ent countries and relate it to the leverage of banks. We
compute the Miller (1977) tax ratio and show that it is
positively related to the leverage. This is in line with
FIGURE 1 This figure plots the Tier 1 capital ratio as risk
weighted assets across 57 countries over 19982012 period [Colour
figure can be viewed at wileyonlinelibrary.com]
HOQUE AND POUR 505

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