Issues on Bank’s Capital Structure and Profitability: A Developing Country Context

Abstract

Purpose: The study aims to show the effect of capital structure on banks' profitability in developing countries. Design/Methodology/Approach: The study is conducted on 28 commercial banks from 2009 to 2016 of panel data to infer the concurrent relationship between capital structure and profitability. The preliminary diagnoses picked up the Generalized Methods of Moments (GMM) method to address the endogeneity issue in dynamic panel data. Findings: The study found that the bank's capital structure is negatively associated with profitability and vice versa. Moreover, asset tangibility and regulatory capital harm banks' current capital structure, whereas tax shield and 1-year lagged capital structure have a positive influence. On the contrary, a bank's profitability is positively associated with bank growth, and 1-year lagged profit, while credit risk and liquidity are negatively affected. The study implies that banks should use an appropriate mixture of debt and equity; otherwise, immature decisions in capital structure may demise banks' profitability, which will ultimately turn into bank failure. Practical Implications: Adherence to the adoption of stringent capital structure allures banks in maximizing profit to cope with market competition. Beyond the theoretical aspects, the study extends its scope in the practical implications of adopting a profit-maximizing capital structure in a developing country context. However, capital structure choice differs from bank to bank based on their performance and position in the market. The study clearly addressed some of the relevant issues which affect banks' performance adversely in practice. Originality/Value: The study contributes to the existing literature and tries to explain the role of capital structure in banks' performance, mostly in submerge economies.