Relationship between Capital Structure & Profitability: Evidence from UK Banking Industry Over the Period of 2007-2012

Abstract

In recent years, the capital structure and profitability was analyzed by too many researchers in academic level. However, most of them excluded banking industry due to different market structure and regulatory frameworks. The differential point of banking industry with other financial industries is minimum capital requirement that is 8% of equity capital. This requirement is for coverage of the bank's risk associated assets. These risk associated assets are subjected to other financial industries as well. But the banks are giant firms in the country economies. The bankruptcy of one can easily effect all the country economy. That’s why they described as 'too big to fail'. Therefore this capital hold is mandatory for them by law.This research is aiming to analyze the relationship between capital structure of the UK banks and its profitability. Before analyzing it, the research gives a brief information about literature view of this subject. In the chapter two, the theories of capital structure, as well as the Basel directives and camel ratios were covered. Afterwards, in the chapter three, UK banking industry and top six banks were overviewed. In chapter four, the difficulties, style and methodology of this research, as well as the conceptual frameworks beside the formulated hypotheses were covered. Hereafter, in chapter five, the top six banks of UK, and all related data of these banks over the period of 2007-2012 were gathered and sorted out. Afterwards, these data were penetrated through the correlation analysis to find out the relationship between input variables. At 1% significance level, it was observed that the gearing has a strong and negative impact on profitability, so on market value of equity.Finally, the findings of the analysis were discussed in the chapter six, and all relating calculations and data tables attached in the appendix of this research.