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Capital structure

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Capital structure

Abstract

The paper is prepared based on the motivation of considerable cross sectional variation with respect to the leverage of the banks standing in distinction to the predictable wisdom of capital guideline being considered as the banks’ main drivers of the capital structures. The banks’ corporate structure has been from the outlook of the literature related to the capital structure of the non-financial firms. The sample of this paper includes 150 banks from just two countries: United States and United Kingdom between 2009 and 2014. Great care has been taken in this paper in reducing the survivorship bias in the database of Bankscope.   

Introduction

There are a large number of experiential and theoretical writing related to the capital structure of non-financial firms has been developing since the Modigliani and Miller’s (1958) influential paper. Nonetheless, the inconclusive nature of capital structure’s determinants and the theoretical contributions has narrowed down the empirical work with respect to the set of potential candidates. Over and above, the large numbers consisting of the major part of the empirical and theoretical literature related to the banking has been treating the bank’s uniqueness. However, the studies related to the capital structure have largely being absent. The peculiarity of the same has been on the grounds of recognition that apart from the heavy regulation of the banks, the difference with the non-financial firms has been minimum. In accordance with that, the need that is apparent with respect to the broader understanding of the capital structure of the bank, there should be three views that must be under the consideration. 

The capital structure of the bank’s overriding determinant has been the regulatory framework with the operation of the banks take place. These notions are used by the banks in optimizing their capital structure with a sole requirements and regulatory rules into account. This would be implying that they will be holding the capital amount that the regulators will be requiring and thus the increase in the leverage up to that particular point. The strong view of the regulation can be relaxed that becomes the main driving force of the capital structure of the bank.  It can happen that the banks would be holding the discretionary capital in avoiding the outlay of issuing equity at a short notice and avoiding the regulatory requirements as a consequence of falling below it. This has been referred as the buffer view, where the capital buffers are held by the banks individually.  Lastly, the potential regulation effect can be completely disregarded with the assumption that the determinants that are non-financial have been explaining the banks’ capital structure as well.   

The attention has also been needed to be paid to the developments that are recent in terms of the regulatory environment.  From the period of mid 2000s the characterization of the growth that was soaring and the well beings that were fundamental to the economy, the new regulatory frameworks are being in the proposed and implemented. The banking sector has been put under pressure because of these frameworks as they would need to be complying with, inter alia, and requirements of the capital and the practices of disclosures.  As a consequence, there has been need to broaden the knowledge related to the compliance of the dogmatic capital. There have been a large figure of researchers that have been addressing this topic; there are times when the characterization has been the lacking of the generalizability of cross country or analysis that is narrowly focused.  Thus, the analysis should be done with respect to the effects of the regulatory accords that are highly debated and the directives. This can be done with both capital ratio levels variation and the components hereof being addressed.  This can be proving to be valuable to understand the way the banks have been differing from each other to comply with the requirements of regulatory capital, while it may also be adding knowledge to the capital strategies fields within banking.  

Literature Review

The first decade of the 21st century should be characterized by these aspects. There is particular interest regarding this decade in relation to the freshness in the memory and the uniqueness of it and may be adding the insights that are groundbreaking to understand the capital structure of banks, capital compliance that is regulatory and the behavior of the bank.  

There is importance in noting that the literature determining target leverage ratios of the banks has been relatively small. The specification regarding the model and the samples has been different with inconsistencies in the findings.  The focus has been primarily on the results with consistencies across the studies and that has been related to the capital ratios or the leverage ratios measurable at the market prices.  

The departures from the irrelevant proposition from Modigliani and Miller (1958) have been evident with corporate finance’s long tradition in investing the decisions associated to the capital constitution of firms. However, the question remains the elements that determine the capital structure of the banks. The standards answers found in the text books are that there is no need in investigating the financial positions of the banks as because the capital regulations have constituted the departures that are the overriding ones from the proposition of the Modigliani and Miller.

The banks have been holding capital as the regulatory authorities have required them to do so. The capital that has high costs required the bank managers to often wanting in holding fewer bank fiscal than what the dogmatic authorities requires. Therefore, the bank capital requirements determine the bank capital amounts (Mishkin 2000, p.227). 

Literally taken, this has been suggestive of the bank leverage ratio being constant.  In the cross section, there is observation regarding the little variation in the structures of the bank’s capital. The distribution related to the book equity to asset ratio for a sample of 150 widely traded banks positioned in United Kingdom and the United States between 2009 and 2014. The banks’ capital ratios are widely varied and indicative of requirement of further investigation in the capital structure of the bank.

This paper’s strategy is looking for the guidance in the literature of the pragmatic corporate finance that examined at extent the non-financial firms’ corporate structures (Frank and Goyal 2007). With regards to the specifics, this paper will examining the leverages of the banks as the variables’ function that has been exhibiting a stable and consistent relationship of cross-sectional in nature with the leveraging of non-fiscal firms in UK and US (Rajan and Zingales 1995). The question remains regarding the uncovering of the same patterns related to the banks being identified for the firms. There is also a question mark regarding evidence with respect to the resources regulation binding or the monetary firms looking like the non-fiscal firms.

A key motivational aspect of this paper is that in the corporate structure that is related to the investigation of the same, the banks are usually excluded. Nonetheless, large banks that are publicly listed forms the group of firms that are homogeneous in nature operates internationally with production technology that are comparable. Therefore, they have constituted a normal hold-out sample, in particular for the reason of being synchronized and are viewed recurrently as special.  The writing in relation to the leverage of the firms have been converging on a variety of standard variables are in relation to the corporate structure of the non-fiscal firms. The factors’ heftiness is checked in this paper that is outside the environment compared to the environment that uncovered them originally.  

Lemmon et al. (2007) advocates that stability exists in the relationship of the normal variables to the capital structure, although their power in explaining the capital structure of the firms’ overall variation has been low. The driver of the capital structure of the firms by time invariant and unobserved with regards to the firm has a fixed effect. The question remains whether the financial firms’ capital structure has been driven by such fixed effects. If the answer is yes, it would be suggestive that looking into factors that explain capital structure is preferable and not having limitation to the firms but extending to the economic sector. 

This paper has been finding the determinants of the capital structure of the firms that are standard cross sectional and also applying to the publicly traded and large US and UK banks. The significance and the sign have been identical and the magnitude of the economy in relation to the effect of the most variables on control of the banks tending to be bigger in comparison to the results obtained from the Frank and Goyal (2005) with respect to the US firms and Rajan and Zingales (1995) for the firms located in the G-7 countries. This paper has been unsuccessful in detecting the capital regulation’s first order effect of the banks included in the sample. This has been consistent with regards to both book along with market leverage in the time when peril and the macro factors are controlled. This is done at the time when the effect of the capital buffers are considered for UK and US banks that are under examining unconnectedly as well as the series of cross sectional regression is examined over time. The results have not changed when used by the regulatory Tier 1 capital ratios as an alternative of the book leverage is considered as the reliant variable.  The strength regarding the determinants of the standard corporate finance has been weakening for the banks that have close to the requirement of least amount capital.   

Moreover, this paper has been documenting the variables of the standard corporate finance, fixed effects of the time invariant that are unobserved and of the bank with the explanation of the capital structure bank’s variation. The banks having the high (low) leverage levels at the commencement of the sample are also tending to be having high (low) leverage levels at the end. Hence, there are conformations with regards to the evidence that are recent and with respect to the capital structures’ determinants for separate set of firms and in an environment that has different institutional and legal aspects.  Much like the non-fiscal firms, the corporate structure has been stable for the financial firms at the level that have been specific to the each of the banks individually.  There is contrast with regards to the bank level stability to the requirements that are uniform and have the imposition on the banks by regulators on the basis of Basel I and its consequent modifications. 

There is a question with regards to whether requirement of the capital has been constraining the banks. Barth et al. (2005), Flannery and Rangan (2007) and Berger et al. (2007) reveals that the banks’ capital level in the US and across the world has been at a considerably higher level than the suggestions made by the regulations. The argument of the Flannery and Rangan (2007) has been on the ratios of the bank leverage that are market discipline outcomes. This paper has been supportive of the view of the market discipline from the perspective of compliment.

This paper is made in relation to the theories developed by the optimally constructed capital structure of the bank, where there is no binding of the capital structure. The debt has been countering the incentive of the risk shifting to the financial firms’ management. Myers and Rajan (1998) argues that depending upon the assets liquidation, the financial firms will be having the optimal leverage with respect to the interior level depending on the assets’ liquidity.  Diamond and Rajan (2000) suggests that the capital structure of the bank that is optimal has the outcome of the trade-off flanked by the ability regarding the forcing of the borrower to repay, costs related to the distress of the bank, and creation of liquidity. The banks may also be holding equity to be monitoring and committing their loans in an environment of competition (Allen et al. 2007)

This paper argues that collateral is the determining factor of the capital structure and has been developing a model that is dynamic agency based with admiration to the financing of the firm on the basis of the promises to collateralize in paying the tangible assets. It has been maintained in this paper that enforcing the payment is a determinant that is critical with regards to both residing of the ownership of the assets with the financier or the user financing of the firm. The study of the firm’s dynamic neoclassical model where, the subject of the constraints related to the collateral has been the financing that has been the derivation of the limited enforcement and firms choosing between renting assets and the purchasing. The theory of risk management, leasing, capital structure, and optimal investment has been enabling the analysis of the first dynamic in relation to the financing versus the trade-off of the risk management and financing of the firm when renting of the capital can be done by the firms.    

In a neoclassical model that is frictionless, there have been indeterminate asset ownership and there has been assumption that the firms are renting all capital. The firm’s dynamic and the recent agency model have been ignoring the possibility that the firms will be renting capital. However, the frictionless capital’s rental market will be obviating financial constraints. This paper has been explicitly considering buying decision versus dynamic leasing. The leasing of the modeling has been highly collateralized although it is costly to finance. Under the lease of the capital, the retaining of the ownership by the financier has been facilitating repossession that has 

 

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