Capital structure, ownership and crisis: how different are banks?

Author:Saibal Ghosh, Goutam Chatterjee
Position:Centre for Advanced Financial Research and Learning, Mumbai, India

Purpose The purpose of this study is to examine the issue of bank capital structure which has been widely debated in recent times, especially in view of the envisaged implementation of the revised Basel capital standards. An issue that has not been adequately addressed is the factors affecting capital structure of banks from a corporate finance perspective. To address this, the authors... (see full summary)

Capital structure, ownership and
crisis: how dierent are banks?
Saibal Ghosh
Centre for Advanced Financial Research and Learning, Mumbai, India, and
Goutam Chatterjee
Reserve Bank of India, Mumbai, India
Purpose The purpose of this study is to examine the issue of bank capital structure which has been
widely debated in recent times, especially in view of the envisaged implementation of the revised Basel
capital standards. An issue that has not been adequately addressed is the factors affecting capital
structure of banks from a corporate nance perspective. To address this, the authors assemble data on
publicly listed Indian banks for an extended time span and compare the ndings with a comparable
sample of largest non-nancial rms.
Design/methodology/approach In view of the longitudinalnature of the data, the authors use panel
data techniquesto examine the issue.
Findings The analysis indicates thatprotability, growth opportunities and risk are thefactors that are
most relevant in inuencing bankcapital. Second, the crisis appears to have exerted a perceptible impacton
bank capital.
Practical implications On balance, the ndings refute the conventional wisdom that bank capital
structure is purely a response to the regulatory requirements. Instead, the results would that bankscapital
decisions are inuenced by several non-regulatory considerations as well, including government policies
toward banks,which is particularly relevant in countries with predominantlystate-owned banking systems.
Originality/value First, the authorsexamine the relevance of bank ownership for leverage, an aspect not
adequately addressedin emerging economy banking systems. Second,they consider the impact of regulatory
pressure on bank leverage,which assumes relevance in the aftermath of the crisis,wherein banks have been
hard-pressed for capital.And nally, they contribute to the thin literature on the interlinkage between capital
structureand board structure for banks.
Keywords Bank regulation, Basel, Banking
Paper type Research paper
1. Introduction
Banks are special primarily because of the highly leveraged nature of their business.
Deposit, which is the mainstay of their leverage, is generally insured at least partially but
often without commensurate premia. To ameliorate possible moral hazard concerns,
regulators prescribe certainminimum capital-to-asset ratio to be maintained by banks at all
times. With the introduction of capital standards by the Basel Committee in the late 1980s,
such norms have, by and large, been adopted universally with suitable country-specic
renements to reect banksportfolio risk more accurately. Thus, according to one view,
regulatory standards determine the capital ratios of banks with some cushion above the
prescribed minimum to minimize the likelihood of regulatory intervention or the need to
raise capital at a short notice. However, empirical evidence since the 1990s bears out that
banks hold capital buffer much in excess of regulatory minimum (Van Roy, 2008). This
raises a questionas to what other factors may affect their capital structure.
Journalof Financial Regulation
Vol.26 No. 2, 2018
pp. 300-330
© Emerald Publishing Limited
DOI 10.1108/JFRC-09-2016-0085
The current issue and full text archive of this journal is available on Emerald Insight at:
Such higher capital requirements often come at a cost, though. It has been argued that
higher capital requirements for banks might affect their performance. This could occur if
bankscost of nancing were to increase signicantly because of more capital holding as
opposed to debt. The higher funding costs could result in lower return for banks or an
increase in their lending rates (Hellmann et al., 2000;Diamond and Rajan, 2000;Berger and
Bouwman, 2013).
Theoretically, several reasons have been put forth to justify why banks hold capital in
excess of regulatory minimum(Berlin, 2011). One strand of literature contends that the Basel
capital requirement is a key factor that drives bankscapital behavior. In the models
advanced by Allen et al. (2011) and Mehran and Thakor (2011), higher capital promotes
better monitoring of loans which,in turn, is manifest in higher prots and/or higher market
valuation. An alternate lineof thinking observes that lower levels of capital might engender
excessive risk taking. Anticipating this possibility, debt holders require a premium to
nance banks. Consequently, market discipline from debtors compels banks to hold
sufcient amount of capital(Calomiris and Kahn, 1991). It is also possible that higher capital
level serves as a buffer in the event of a decline in revenuesthat may prompt a run on banks
(Diamond and Rajan, 2000). Yet others state that, notwithstanding the manifold differences,
banks may have similar incentives as those of non-nancial rms, and as a consequence,
their capital structuremay be guided by the same set of factors.
Empirically therefore, it should be possible to test within an empirical set up which of
these factors are more relevant in inuencing leverage. We contribute to this literature by
analyzing the determinants of capital structure for Indian banks covering the period
1992-2012 that encompasses the nancial crisis. To explore whether similar results carry
over to non-nancial rms, we also report results with a comparable set of variables for
these entities.
Though we focus primarily on leverage, we address several related issues as well. First
and most importantly, we examine the relevanceof bank ownership for leverage, an aspect
that has not been addressed in prior research.On the one hand, following from the corporate
nance literature, given the implicit government guarantee, state-owned banks (SOBs)
might be more inclined to raise debt,implying higher leverage. From the buffer perspective
on the other hand, banks with higher buffers could be less likely to take higher debt,
suggesting lower leverage.
Extant evidence suggeststhat the capital buffers of private banks are on average, higher
as compared with SOBs. To illustrate, during 1992-2012, for instance, the equity-to-asset
ratio of private banks was 8.4 as comparedto 5.5 for SOBs. Post-crisis, private banks equity-
to-asset has improved to 16.9 as compared to 5.6 for SOBs. The equity-to-asset for foreign
banks (FBs) has traditionally been lower, averaging 12.4 during the 1992-2012 period. The
literature has focused on several facets of ownership, including its interlinkage with bank
performance (Micco et al.,2007), stability (Iannotta et al., 2007,2013;Beck et al., 2013),
efciency (Altunbas et al.,2001;Das and Ghosh, 2006;Casu et al., 2012), productivity
(Kumbhakar and Sarkar, 2003) and risk-taking (Barry et al., 2011). To what extent does
ownership matter for leveragehas not been adequately explored and this is one of the issues
addressed in the paper.
Second, we investigate the importance of the recent nancial crisis in impacting bank
capital. Several studies have examined the behavior of USA commercial banks during the
crisis (Huang, 2010;Ivashinaand Scharfstein, 2010;Cornett et al., 2011;Santos,2011). In the
case of India, Acharya and Kulkarni (2012) nd evidence to suggestthat SOBs fared better
during the crisis as compared to their private counterparts. Eichengreen and Gupta (2013)
provide evidence insupport of a deposit reallocation away from private banks.However, the
and crisis

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