Determinants of bank capital structure , the case of vietnamnese commercial bank system , luận văn thạc sĩ

2010 and Chau, N.H 2012, it is widelybelieved that the capital structure of commercial banks are affected by size,profitability, business risk, growth, collateral value and dividend poli

UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES

VIETNAM- NETHERLANDSPROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

DETERMINANTS OF BANK CAPITAL

STRUCTURE: THE CASE OF VIETNAMESE

COMMERCIAL BANK SYSTEM

BY

PHAM TUAN ANH

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES

VIETNAM- NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

DETERMINANTS OF BANK CAPITAL

STRUCTURE: THE CASE OF VIETNAMESE

COMMERCIAL BANK SYSTEM

A thesis submitted in partial fulfilment of the requirements for the degree of

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

I am grateful to all those who help me to complete the thesis I would like to thankthe Vietnam-the Netherlands Programme for giving me permission to carry out thethesis after Thesis Research Design (TRD) defense and providing many preciousresearches through an account ofEUR library website and others

Especially, I am deeply thankful to my supervisor Dr Cao Hao Thi from IndustrialManagement Department of Ho Chi Minh City University of Technology for hisinstructions, suggestions and encouragements during the implementation of thethesis

Moreover, I would like to express my deep gratitude to my family, friends andcolleagues for all their support and valuable hints in order to help me to completethe thesis

Based on reality situations, it is widely believed that the capital structure ofVietnamese banking system is not really good and does not meet the internationalstandard at present The system does not have enough equity so as to prevent risksfrom the negative externalities and unexpected change of business environment.Therefore, the study is going to recommend some policy implications to improvethe capital structure situation by adjusting the determinants Moreover, the studyalso makes valuable instructions to banking managers of each commercial bank.According to specific reality situation of each commercial bank, they will have rightdecisions to increase or decrease book leverage so as to not only maximize the owncommercial bank's value but also avoid facing up bankruptcy events.

Method (FEM), Random Effects Method (REM)

TABLE OF CONTENTS

Acknowledgement i

Abstract ii

Table of Contents iii

Abbreviation vi

List of Table vii

fF'

L 1St 0 Igure •••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••• VIII CHAPTER 1 INTRODUCTION 1

1.1 Problem Statement 1

1.2 Research Objectives 6

1.3 Research Questions 6

1.3.1 Main question 6

1.3 2 Sub questions 7

1.4 Justifications ofthe study 7

1.5 Scope of the study 7

1.6 Organization ofthe study 8

CHAPTER 2 LITERATURE REVIEW 9

2.1 Theoretical literature 9

2.1.1 Modigliani and Miller (M&M theory, 1958) 9

2.1.2 Agency theory 10

2.1.3 The pecking- order theory 11

2.1.4 The static trade-offtheory 12

2.2 Empirical literature 12

2.2.1 Foreign empirical literature 12

2.2.2 Vietnamese empirica1literature 22

2.3 Research Hypothesis 27

2.4 Conceptual Framework 27

2.5 Chapter Summary 28

CHAPTER 3 DATA AND RESEARCH METHODOLOGY 29

3 .1. Research Methodology 29

3.2 Data 35

3.3 Chapter Summary 37

CHAPTER 4 FINDINGS AND DISCUSSION 38

4.1 Descriptive Statistics 38

4.2 Panel regressions results 41

4.3 Comparison with previous studies 48

4.4 Chapter Summary 50

CHAPTER 5 CONCLUSIONS AND POLICY IMPLICATIONS 51

5 1 Conclusions 51

5.2 Policy Implications 52

5.2.1 Policy implications for total Vietnamese banking system 52

5.2.2 Policy implications for specific Vietnamese commercial banks cases 55

5.2.2.1 Policy implications for high leverage commercial banks 55

5.2.2.2 Policy implications for low leverage commercial banks 56

5.3 Limitations and Further Studies 57

5.3.1 Limitations 57

5.3.2 Further Studies 58

References 59

Appendices 63

BCBS: Basel Committee on Banking SupervisionBL: Book Leverage

CAR: Capital Adequacy Ratio

FEM: Fixed Effects Method

GDP: Gross Domestic Product

GMM: Generalized Method of Moments

REM: Random Effects Method

LIST OF TABLE

Table 2.1 Definition ofVariables 15

• Table 2.2 Foreign empirical studies in researching the bank capital structure 20

Table 2.3 Empirical studies in researching the Vietnamese capital structure 25

Table 3.1 Definition ofVariables 31

Table 3.2 Classifying banks in the sample by certain asset level on December 31, 2011 36

Table 3.3 Financial items of the sample and total Vietnamese banking system on December 31, 2011 36

Table 4.1 Summary statistics of each variable 38

• Table 4.2 Correlation matrix 40

Table 4.3 FEM and REM regression results 42

Table 4.4 Hausman test 43

Table 4.5 Likelihood ratio test 44

Table 4.6 Summary of research results 50

LIST OF FIGURE

Figure 1.1 Capital Adequacy Ratio (CAR) of developing countries 5

Figure 2.1 The determinants of bank capital structure 28

Figure 3.1 Research process of the study 29

Figure 4.1 Total asset in the sample from 2006 to 2011. 39

Figure 4.2 Total charter capital in the sample from 2006 to 2011 47

CHAPTER 1. INTRODUCTION

1.1 Problem Statement

Based on Ross, Westerfield and Jaffe (2010), capital structure is the combination ofdebt and equity Each company should choose the suitable debt-equity ratio (capitalstructure) in order to maximize the value of its company When the capital structureproblems are mentioned in any researches, it is certainly that the famous theoryModigliani and Miller (M&M theory, 1958) are applied in these researches.According to M&M theory, in the perfect capital markets (case 1 of M&Mproposition 1), choosing any capital structure do not affect the value of specificcompany However, if all assumptions in M&M proposition 1 are held except taxesand costs of financial distress, the value of the specific company will be affected bychoosing the capital structure because of the tax shield benefits and costs offinancial distress After the capital structure theory of Modigliani and Miller, manytheories about capital structure are in tum released; in particular, agency theory wascreated by Jensen and Meckling (1976); pecking - order theory and static trade-offtheory was developed by Myers (1984) These theories have indicated that capitalstructure affects not only the value of each enterprise but also the stability inbusiness Therefore, there have many authors who research about the capitalstructure They also try to find out the independent variables that affect theenterprises capital structure; from that point, each enterprise have ability to choosethe appropriate capital structure in order to maximize the value of the firm andstabilize the business operations

Capital structure of each company is usually measured by the book leverage It isthe basic formulation It is calculated by debt-to-equity or debt-to-asset, with asset isequity plus debt Commercial banks access the primary debts by attracting themoney from depositors The specific characteristic of commercial bank business is

to trade in money; thus, equity of commercial banks always accounts for smallproportion of total asset Moreover, in the banking industry, they also use CapitalAdequacy Ratio (CAR), which is the other proxy to measure the capital structure of

each commercial bank (Basel Committee on Banking Supervision, 2006) CAR hasbeen mentioned in Basel Accords, which are issued by Basel Committee onBanking Supervision (BCBS) Basel Accords have been built and developed inorder to control the risk from the banking system and prevent the collapse ofcommercial banks in reality CAR is calculated by equity over asset; however,unlike book leverage, CAR emphasizes the different risk level of each asset Ingeneral, if commercial banks have low book leverage or high CAR, then they havenot ability to take full advantage of tax shield benefit Conversely, if commercialbanks have high book leverage or low CAR, then they have to face up the highfinancial distress cost such as the bankruptcy cost.

Vietnam is still a developing country Since Doi Moi (economic reforms in 1986),Vietnamese economy has changed from planned-economy into socialism-orientedmarket economy The financial sector, especially commercial bank system still have

a rapid development both quality and quantity The quantity of Vietnamesecommercial bank system increases from 9 in 1991 to 94 in 2009 This leads to theincrease in competitive level of Vietnamese banking system With the highcompetitive level in Vietnamese commercial bank system at present, each bank has

to perform the right policy to maximize the value and reduce the business risk.Among them, they need to choose the appropriate capital structure in order to carryout the purpose Table 1.1 presents quantity of commercial banks in Vietnam from

1991 to 2009

Source: State Bank of Vietnam- SBV

Banks; JVCBs: Joint - Venture Commercial Banks; FCBs: 100% Foreign-Owned Commercial Banks and Branch ofForeign Commercial Banks)

The Vietnamese banking system has a rapid development; in addition, it contributes

to economic growth and living standard improvement However, it has beenexposed many weaknesses and shortcomings; from that point, they have caused theunsafe banking operations and unstable macroeconomic situation Therefore, theGovernment and State Bank of Vietnam have advocated restructuring theVietnamese commercial bank system by approving the project, which is namely

"Orientations and Policies to Restructure Vietnamese Banking System in 2011-2015" Based on the project, the State Bank of Vietnam has recognized weaknessesand shortcomings of Vietnamese banking system Among them, the financialcapacity of Vietnamese banking system is still limited According to the14112006/ND-CP decree that was signed by Vietnamese Prime Minister onNovember 22, 2006, each commercial bank has to meet the legal capitalrequirement, minimum 3.000 billion VND in the end of 2010 However, based onthe information from the project, there have 3 commercial banks that do not meet

the requirement to 2011 yet; moreover, there are 30 commercial banks whose chartercapital are smaller than 5.000 billion VND (equivalent 240 million USD) in the end of

20 11

•

Moreover, Vietnamese commercial bank system is collapsed easily from the negativeexternalities and unexpected change of business environment such as global financialcrisis in 2009 and unstable macroeconomic situation of Vietnam in 2011 because thecapital structure of Vietnamese banking system does not meet the internationalstandard Based on the information from the project, the average CAR of Vietnamesecommercial bank system was 11.85% at September 30, 2011, especially the averageCAR of State-Owned Commercial Banks was only 8.49% Meanwhile, the averageCAR of Foreign-Owned Commercial Banks is very high (28.58%) If the Foreign-Owned Commercial Banks was excluded from the Vietnamese commercial banksystem, then the real average CAR of domestic commercial banks was only 11.13%.The Financial Management and Analysis of Projects, issued by Asian DevelopmentBank (ADB) in 2005, has recommended that the minimum CAR of Asian DevelopmentBank's Developing Member Countries (ADB DMCs) should be 12% because of loosebanking regulations and supervisions, the expansion of directed lending It is realizedthat the CAR of many commercial banks does not meet the ADB standard, especiallyState-Owned Commercial Banks Besides, in reality, CAR of Vietnamese bankingsystem is much lower than many other developing countries Other countries which are

in the Southeast Asia with Vietnam such as Indonesia, Philippines, Malaysia andThailand have the safe commercial bank system, with the CAR are very high and meetthe international standard well Figure 1.1 compares the CAR of Vietnam in 2011 withthe one of other developing countries

10.0%

5.0%

0.0%

Figure 1.1: Capital Adequacy Ratio (CAR) of developing countries

Source: State Bank ofVietnam-SBV

In short, the capital structure of Vietnamese banking system is not really good atpresent The system does not have enough equity in order to prevent risks from thenegative externalities and unexpected change of business environment Therefore,the capital structure problem needs to be solved seriously The study desires to finddeterminants of bank capital structure in Vietnam; thus, they will be controlledlogically in order to improve the Vietnamese banking capital structure

Moreover, according to the static trade-off (Myers, 1984 ), each Vietnamesecommercial bank need to choose the own appropriate capital structure byconsidering the trade-off between the benefit of debts and cost of debts The benefit

of debts is the tax deductibility of interest payments and the cost of debts is the cost

of financial distress such as bankruptcy cost and the losses that the firm has to incurfrom the bankruptcy events In reality, it is difficult to choose the optimal capitalstructure because Vietnamese commercial banks almost have not ability to identifythe cost of financial distress Therefore, managers of each Vietnamese commercialbank only have ability to identify the range of own appropriate leverage in order to

not only maximize the own commercial bank's value but also avoid facing up thebankruptcy events The study has no ambition to find the optimal capital structure ofVietnamese commercial bank system, but merely to identify its determinants; thus,banking managers have ability to control these determinants in order to gain the ownleverage that is suitable for the business of each commercial bank.

According to the previous research such as Octavia, M & Brown, R (2008), Gropp, R

& Heider, F (2009), Caglayan, E & Sak, N (2010) and Chau, N.H (2012), it is widelybelieved that the capital structure of commercial banks are affected by size,profitability, business risk, growth, collateral value and dividend policy Therefore, thestudy tests whether these factors as above are really impacting on capital structure inVietnamese commercial bank system

1.2 Research Objectives

The objectives of this study are to:

i) Determine the elements which have impacted on capital structure of Vietnamesecommercial bank system and test whether each element causes capital structure ofVietnamese commercial bank system

ii) Recommend some policy implications m order to not only develop the commercialbank system but also control the risk from their business; in addition, the study desires

to make valuable instructions to improve the capital structure of each Vietnamesecommercial bank by controlling the determinants

1.3 Research Questions

1.3.1 Main question

The main question of the study is "What are the determinants of capital structure in Vietnamese commercial bank system?"

1.3.2 Sub questions

i) Do factors like size, growth, collateral value, profitability, business risk anddividend policy have statistically significant in explaining the model that relatedwith capital structure of commercial banks in Vietnam?

ii) Do these factors as above have the expected sign in accordance with capital structure theories and previous studies?

1.4 Justifications of the study

There have many empirical studies that related to the capital structure problem;however, there have few empirical studies which research the determinants of bankcapital structure Moreover, most of the studies focus on the situation of Europe andUSA Therefore, this paper contributes to the academic study as one ofcomprehensive studies about the capital structure of commercial banks in Vietnam

In addition, this study aims to update the hottest issues of the capital structure ofVietnamese commercial bank system The study analyzes capital structure problem

in the background of restructuring banking system process of VietnameseGovernment and State Bank of Vietnam According to the useful and informativeresults, authorities have ability to propose the right policies to develop thecommercial bank system and control the risk from their business; besides, managers

of each Vietnamese commercial bank have ability to choose the own appropriatecapital structure

1.5 Scope of the study

The study determines the elements which have impacted on bank capital structure

in Vietnam from 2007 to 20 11

1.6 Organization of the study

The remaining study includes 4 chapters: Chapter 2 gives a review of theoreticaland empirical studies which are related to capital structure topic Chapter 3mentions the research methodology and data collection; thus, findings anddiscussion are presented in Chapter 4 Finally, Chapter 5 draws conclusions,recommends some policy implications and mentions limitation; thus, somedirections for further studies are also presented in the chapter

CHAPTER 2 LITERATURE REVIEW

Chapter 2 gives a review of theoretical and empirical studies which are related tocapital structure topic The chapter presents 4 main parts which contain theoreticalliterature, empirical literature, research hypothesis and conceptual framework First,theoretical literature part introduces 4 famous theories which include Modiglianiand Miller (M&M theory, 1958), agency theory (Jensen and Meckling, 1976),pecking - order theory and static trade-off theory (Myers, 1984 ) Second, empiricalliterature part presents cases of developed and developing countries which arerelated to both non-bank and bank capital structure Thus, research hypothesis andconceptual framework will be mentioned in the study based on the results ofprevious empirical studies

2.1 Theoretical literature

When mentioning the capital structure, there are several theories that are related to

• this issue Among them, the first cornerstone of capital structure theories has been

carried out by Modigliani and Miller (M&M theory, 1958) After the capitalstructure theory of Modigliani and Miller, many theories about capital structure are

in tum released The study expresses 3 famous other capital structure theories,which include agency theory was created by Jensen and Meckling (1976); pecking-order and static trade-off theory was developed by Myers (1984)

2.1.1 Modigliani and Miller (M&M theory, 1958)

According to the M&M theory, there are 2 basic propositions: proportion 1examines the relationship between the firm value (V) and capital structure andproportion 2 investigates the relationship between cost of capital (r5 ) and capitalstructure In each proportion, authors considered 3 specific cases In my topic, theproportion 1 ofM&M theory is researched deeply

In case 1 of the proportion 1, all assumptions hold in this model: homogeneous expectations, homogeneous business risk classes, perpetual cash flows, and

especially, capital market is perfectly; it means that there exists perfect competition,firms and investors have ability to borrow or lend at the same interest rate and theyequally access to all relevant information Moreover, there have no financial distresscosts and taxes Besides, Modigliani and Miller also mentioned other cases, inparticular, all assumptions as above hold except the corporate income taxassumption (case 2) and all assumptions as above hold except the corporate incometax and financial distress costs assumptions (case 3).

Based on the M&M theory, the value of unlevered firm and levered firm are thesame in case 1, it means that choosing any capital structure do not affect the value

of the firm However, in case 2 and 3, the value of the firm is affected by the capitalstructure, in particular, the functions as below show the relationship between thevalue of the firm and capital structure:

Case 1: VL = Vu

Case 2: V L = Vu + T c * B

Case 3 : V L = V u + T c * B - PV (costs of financial distress)

With V L: value of the levered firm; V u: value of the unlevered firm; B: debt value;Tc: rate of corporate tax, Tc * B: present value of tax shield and PV(costs offinancial distress) is the present value of financial distress cost

Especially, in case 3, the value of the firm rises with leverage and falls with costs offinancial distress Therefore, each firm should choose the appropriate capitalstructure in order to take advantages of tax shield benefits; however, if the leverage

of the firms is too high, then they will face up the high costs of financial distresssuch as bankruptcy cost The possibility of bankruptcy has a negative impact on thevalue of the firm

2.1.2 Agency theory

Jensen and Meckling (1976) proposed that the firm may choose capital structure

according to the existence of agency cost There are 2 main conflicts in choosing the

capital structure First, the conflicts between managers and shareholders willhappen since managers desire to receive more benefits but doing less effort inmaximizing the value of the company Therefore, managers decide to increase thelevel of the debts so as to carry out the high risky projects The purpose of decisions

is to complete the tasks and business plan from the requirements of stockholders;however, if these projects face up losses, then stockholders will bear theconsequences of losses Second, rising level of debts may arise the conflictsbetween shareholders and debt-holders Debt-holders always receive the fixedreturn The conflicts arise when the shareholders decide to perform the high riskyprojects If the investments earn the return that higher than the value of debts, thenshareholders will receive most of the gain; otherwise, the debt-holders have to incurthe losses because the maximum losses of stockholders are only the amount of theirinitial stockholders' investment (limited liabilities)

2.1.3 The pecking-order theory

The pecking-order theory was developed by Myers (1984) He argued that thecapital structure choice of the firm can be explained from the perspective ofasymmetric information and the existence of transaction costs The more level ofasymmetric information, the more risk that outsider investors facing; thus, theoutsider investors require more discount rate from issuing stocks Therefore, thepreference of the firm is that they would like finance by internal funds first such asretained earnings, instead of with external funds If the firm must to attract theexternal funds, then debt is preferred to equity

The theory has explained that companies usually use less debt when they haveability to earn the high return because they prioritized to finance their projects byinternal funds Besides, the theory has also appreciated the importance of financialslack When enterprises have the financial slack, they have spare cash or transferthe asset such as government bond, stock into cash easily From that point, theyhave ability to take advantage of investment opportunities as they appear On the

contrary, if enterprises have no financial slack, then they have to choose the externalfunds by borrowing debts with high interest rate or issuing the common stock thatprice of each stock is under the face value.

2.1.4 The static trade-off theory

The static trade-off theory was also developed by Myers (1984 ) This theorysuggests that each firm need to choose the appropriate capital structure byconsidering the trade-off between the benefit of debts and cost of debts carefully.The benefit of debts is the tax deductibility of interest payments and the cost ofdebts is the cost of financial distress such as bankruptcy cost and the losses that thefirm has to incur from the bankruptcy events However, in reality, it is difficult tochoose the optimal capital structure because the firms almost have not ability todetermine the cost of financial distress

In general, commercial bank is the special kind of enterprises so M&M, agency,pecking-order and static trade-off theories are absolutely applied for choosing theappropriate bank capital structure

2.2 Empirical literature

2.2.1 Foreign empirical literature

There have many empirical studies which research about the capital structure.However, almost empirical studies specialize in researching non-banks capitalstructure Booth et al (200 1), Frank and Goyal (2005) argue that severalindependent variables which may affect the leverage of each non- financialinstitution are size, profitability, business risk, growth, collateral value and dividendpolicy

First, size has the positive relationship with the leverage Large firms normallyfinance their projects by using more debts They are difficult to cope with thebankruptcy because of higher diversification The positive relationship between size

and leverage has been in accordance with the argument of asymmetric information(Myers and Majluf, 1984) Small enterprises usually do not announce enoughinformation about their financial situation or extraordinary events; accordingly,potential lenders are afraid of providing credit fund to small-size enterprises On thecontrary, large firms, especially listed firms, are easy to access loans from financialinstitutions because there have a little asymmetric information between the ownersand creditors The firms have ability to make the best of economies of scale inaccessing long-term loans or issuing long-term debts such as corporate bonds;moreover, they may have bargaining power to lenders.

Second, firms with higher profit tend to have lower debt-equity ratio It has beensuitable for the viewpoint of the pecking-order theory (Myers, 1984) High-profitcompanies usually finance its project by retained earning first, instead of withexternal fund because of the perspective of asymmetric information and theexistence of transaction costs

Third, there is negative relationship between the business risk and leverage Frankand Goyal (2005) argued that firms face up high business risk when they have morevolatile cash flow; thus, they cope with the higher cost of financial distress Theyhave considered the trade-off between tax-shield benefits and bankruptcy cost.More financial distress cost decreases the probability that tax-shield benefits will beused up; as a result, they should use less debt in order to reduce the volatile cashflow

Fourth, firm's growth has the negative relationship with the leverage Booth et al.(200 1), Frank and Goyal (2005) both use market-to-book ratio as a proxy forgrowth A high market-to-book ratio means that firms have ability to carry out thehigh growth opportunities; however, these firms also face up the higher cost ofbankruptcy Therefore, companies which have high market-to-book ratio tend to useless leverage Besides, Frank and Goyal (2005) also have recommended that thegrowth of assets and ratio between capital expenditures and assets are the other

proxies to measure the firm's growth They have argued that these variables should bepositively with the book leverage according to the viewpoint of the pecking - ordertheory When profits do not increase correlatively with the increase in investmentactivities of firms, then they should use more debt in order to keep the high growth.

Fifth, if companies have many tangible assets, then they will use more debts becausethese assets can be used as collateral The agency theory has explained the relationshipclearly Jensen and Meckling (1976) have emphasized that there always exist agencycost of debts The conflicts arise when the shareholders decide to carry out the highrisky projects If the investments earn the return that lower than the value of the debts,the debt-holders have to incur the losses Therefore, debt-holders are willing to lendmore money and reduce the credit risk when firms have many tangible assets that can

be used as collateral Furthermore, based on the static trade-off theory (Myers, 1984),tangible assets such as land, equipments, factories have lower expected financialdistress cost; on the contrary, intangible assets will lose most their value if bankruptcyevent occurs

Finally, when firms have ability to pay dividend, then they will use less debts Based onthe pecking-order theory (Myers and Majluf, 1984 ), dividend is considered as goodsignal about future prospect of firms; accordingly, they will issue more equity and lessleverage

According to Mishkin (2000), capital structure of commercial banks may be affectedonly by the regulations of capital requirement, especially each commercial bank mustreserve amount of capital to reduce the probability of failure according to the standard

of Basel Accords However, several empirical studies like Octavia, M and Brown, R.(2008), Gropp, R and Heider, F (2009), Caglayan, E & Sak, N (2010) found thatstandard determinants of non-firm capital structure which include size, profitability,business risk, growth, collateral value and dividend policy are also significant inexplaining the capital structure of banks The dependent variables

of the 3 empirical studies, which was considered as the proxy of commercial bankcapital structure, was the book leverage or market leverage It is measured by debt-to-equity or debt-to-asset, with asset is equity plus debt In banking industry, commercialbanks access primary debts by attracting the money from depositors These studies usedfixed effect of panel data method to identify determinants of bank capital structure.Octavia, M and Brown, R (2008), Gropp, R and Heider, F (2009) have shown thatbook leverage has been affected by 6 main determinants, which include size,profitability, growth, collateral value, dividend policy and asset risk Table 2.1 presentsways to measure each variable in Octavia, M and Brown, R (2008), Gropp, R andHeider, F (2009) and Caglayan, E & Sak, N (20 10).

Table 2.1: Definition of Variables

A DEPENDENT VARIABLES

1 Book Leverage (BL) 1-(book value of equity I book value of assets)

2 Market Leverage (ML) 1-(market value of equity I market value of assets)

B INDEPENDENT VARIABLES

2 Profitability (Prof) Profit after tax I book value of assets

3 Market-to-book ratio (MTB) Market value of assets I Book value of assets

4 Collateral (Coli) Tangible assets I book value of assets

5 Dividend (Div) Equal1 when bank pays dividend in a given year

6 Asset risk (Risk) Yearly standard deviation of daily stock price

returns * (market value of equity I market value of bank)

The general function has been expressed as follow:

BLi,t =~ỡt Ln(Sizei,t-t)+~zProfi,t-1 +~3MTBi,t-I +~4Colli,t-I +~sDivi,t +

~6ln(Riski,t-I) +uitMLi,t =~ỡtLn(Sizei,t-I)+~zProfi,t-I+~3MTBi,t-I+~4Colli,t-I +~sDivi,t +

~6ln(Riski,t-I) +uitAccording to the results of Gropp, R & Heider, F (2009), all coefficients arestatistically significant and have the expected sign in case of developed countries.First, size has the positive relationship with the leveragẹ Large commercial banks areeasier to attract deposits than small ones because there have a little asymmetricinformation between depositors and large ones Depositors normally have confidence

in the brand name of large commercial banks Besides, the large commercial bankshave many branches than small ones; thus, depositors are easy to access bankingservices from large commercial banks

Second, commercial banks with higher profit tend to have lower debt-equity ratiọ It

is suitable for the viewpoint of pecking-order theory (Myers, 1984) High-profitcommercial banks usually give the loans and develop banking services by retainedearning first, instead of depending too much on the money from depositors because ofthe perspective of asymmetric information and the existence of transaction cost On thecontrary, low-profit commercial banks have to choose the external funds by borrowingthe debts with high deposit rates The more level of asymmetric information, the morerisk that depositors facing; thus, depositors require high deposit rate from thecommercial banks

Third, market-to-book ratio has the negative relationship with the leveragẹ A highmarket-to-book ratio means that commercial banks have ability to carry out the highgrowth opportunities; however, these banks also face up the higher cost of bankruptcỵTherefore, commercial banks which have high market-to-book ratio tend to use lessleveragẹ

Fourth, if commercial banks have many tangible assets, then they will use moredebts because these assets can be used as collateral Depositors normally haveconfidence in commercial banks that have many tangible assets because theycertainly will receive more money when high tangibility commercial banks gobankruptcy Furthermore, based on the static trade-off theory (Myers, 1984),tangible assets such as money, government bond, land have lower expectedfinancial distress cost; on the contrary, intangible assets will lose most their value ifbankruptcy event occurs.

Fifth, when commercial banks have ability to pay dividend, then they will use lessdebts Based on the pecking-order theory (Myers and Majluf, 1984 ), dividend isconsidered as good signal about future prospect of commercial banks; accordingly,they will issue more equity and less leverage

Finally, there is negative relationship between the asset risk and leverage.Commercial banks have to face up high financial distress cost when they have highasset risk They have considered the trade-off between tax-shield benefits andbankruptcy cost according to static trade-off theory (Myers, 1984) More financialdistress cost decreases the probability that tax-shield benefits will be used up; as aresult, they should use less debt in order to decrease the probability of happeningbankruptcy events

About the case of developing countries, Octavia, M and Brown, R (2008) realizedthat there have 4 independent variables which include size, profitability, asset riskand dividend policy have the expected sign; on the contrary, 2 other variables havenot the expected sign They have suggested that there exists overpricing situation inthe capital market when commercial banks have high market-to-book ratio Thisleads the high level of asymmetric information between the bank owners andexternal investors; thus, commercial banks will issue more debts In addition,collateral value variable has not the expected sign according to the reality situation.Based on Octavia, M and Brown, R (2008), there have average 43.5% assets of

developing countries banks are used as collateral, that are much higher than 26.6% ofdeveloped countries banks Accordingly, one extra dollar of tangible asset may havelower marginal benefit in ensuring debts than the case of developed countries.

Moreover, Caglayan, E & Sak, N (2010) has researched the bank capital structure inthe specific case of Turkey Dividend and asset risk variables were not applied in theirmodel because of unmeaning results They only used 4 independent variables, whichinclude size, profitability, growth and tangibility in the model These variables arestatistically significant and have the expected sign

Besides, some empirical studies such as Asarkaya, Y.& Ozcan, S.(2008) andRomdhane, M (2010) have used Capital Adequacy Ratio (CAR) as the proxy of bankcapital structure According to Asarkaya, Y & Ozcan, S (2008), 7 independentvariables which are risk level (risk), CAR of previous period (CAR0 ), asset size (asset),return on equity (ROE), share of deposit in non-equity liabilities (deposit), averageCAR of the sector (AVCAP) and economic growth (GDP) have affected the CAR ofTurkish banking sector They have used Generalized Method of Moments (GMM) torun the regression The desired level of CAR can be written as follows:

CARi,t = (1-a.) CARi,t-1 +a CAR\t + ei,t (a.: speed of adjustment)

The proxy variables which include risk level (risk), asset size (size), return on equity(ROE), share of deposit in non-equity liabilities (deposit), average CAR of the sector(AVCAP) and economic growth (GDP) have been used to estimate the unobservedCAR* because the target level of CAR has been not observed

CAR\t=~0+ ~1Sizei,t+ ~2Riski,t+ ~3ROEi,t+ ~4depositi,t+ ~sAVCAPi,t+

~6GDPi,t + Ui,t·

The parameter estimate of GMM is expressed by the coefficient of lagged CAR (A.1).The target level of CAR can be rewritten as following:

Based on Asarkaya, Y & Ozcan, S (2008), it is widely accepted that the results are

in accordance with the theory CAR of previous period, portfolio risk, economicgrowth, average CAR of the sector, return on equity have the positive relationshipwith CAR; moreover, share of deposits and asset size have the negative relationshipwith CAR

Besides, Romdhane, M (20 10) used fixed effect and random effect of panel datamethod to identify the determinants of bank's capital ratio in Tunisia He has provedthat 8 independent variables which contain asset size, risk, net margin interest,equity cost, ratio of deposits, deposit variability, intermediation rate, ratio of thesector have affected the bank's capital ratio in Tunisia According to the results ofRomdhane, M (20 10), all coefficients are statistically significant and have theexpected sign In detail, the deposit ratio, the equity cost and asset size havenegative relationship with CAR All the other variables have positive relationshipwith CAR

In general, foreign empirical studies in researching the capital structure of banks arepresented briefly in Table 2.2

Table 2.2: Foreign empirical studies in researching the bank capital structure

1 Octavia, Fixed effect of panel data From the financial All coefficients are

Brown, R 6 main determinants: commercial banks significant

(2008) size, profitability, in 10 developing Only size,

countries (Brazil, growth, collateral value, profitability,

India, Jordan, dividend policy and asset dividend policy and

Korea, Malaysia,

Mexico, Pakistan,

Thailand, Turkey signbook leverage and and Zimbabwe)

market leverage. from 1996-2005. Market-to-book

ratio and collateral variables have not the expected sign.

2 Gropp, R Fixed effect of panel data 200 biggest listed All coefficients are

F (2009) 6 main determinants: of 16 countries significant and have

(US and 15 EU the expected sign size, profitability,

members) from growth, collateral value,

1991 to 2004 dividend policy and asset

risk.

Dependent variable:

book leverage and market leverage

3 Caglayan, Fixed effect of panel data 25 deposit banks All coefficients are

N (2010) 4 independent variables: period 1992-2007 significant and have

the expected sign size, profitability, growth

and tangibility.

Dependent variable:

book leverage.

Methodology Data Results

No Authors

January 2002

December 2008.

variables have positive relationship with capital adequacy ratio.

;;:

2.2.2 Vietnamese empirical literature

In the specific case of Vietnam, there are several empirical studies which researchVietnamese non-financial capital structure such as Nguyen,T.D.K & Ramachandran, N.(2006), Biger, N & Nam, N.V & Quyen, H.X (2007) and Dzung, N & Rainey, I.D &Gregoriou, A (2012) Similar to the empirical studies about the capital structure ofdeveloped and other developing countries cases, they have also used the basicdeterminants such as size, growth, profitability, business risk and tangibility in theirmodel Among them, size, growth and profitability have really affected the capitalstructure of Vietnamese companies In particular, profitability has the negativerelationship with the book leverage, size and growth have the positive relationship withone The determinants have supported theories strongly Conversely, the impactoftangibility and business risk on leverage are not in accordance with theories.According to 3 empirical studies as above, the negative relationship between tangibilityand leverage is in accordance with the context of Vietnam Vietnamese firms with fewtangible assets are difficult to access the credit funds from commercial bank system;thus, they tend to depend on short-term liabilities like trade credit Moreover, based onthe results of Nguyen,T.D.K & Ramachandran, N.(2006), business risk has the positiverelationship with leverage in Vietnamese case because the State Bank of Vietnamsupervised the banking system during 1998-2001 The interest rate was controlledwithin a band; as a result, high risk companies had ability to access loans with interestrates that were lower than the ones when credit market was set by the market forces

Besides, the 3 empirical studies have also used the ownership variable to measure theimpact on the leverage It is widely accepted that state-owned firms are easier to accessthe bank loans than private ones When state-owned firms have new investmentprojects, they have ability to access the loans from state-owned commercial banksbecause the Government is the same owner of theirs

When researching the Vietnamese small-medium size enterprises, Nguyen, T.D.K

& Ramachandran, N (2006) suggested that banking relationship and networkingvariables have positive relationship with the leverage If firms focus on establishingand maintaining the good relationship with banks, then they will receive more trustfrom commercial banks It is widely believed that the level of asymmetric informationbetween the firms and banks is decreased when the firms have good bankingrelationship Moreover, firms with wide networking always get reliability fromcommercial banks Therefore, they have ability to receive trade credit or loans fromcommercial banks

About the banking industry, Chau, N.H (2012) researched the capital structure ofVietnamese banking system He only used 4 determinants which include size, growth(Grow), profitability (Prot) and collateral value (Coli) to determine the impact on bookleverage Pooled and fixed effect panel least square methods were used in his studies.The regression function is expressed as follow:

BLi,t =Po+P 1 *Ln(Sizei,t-t)+P2 *Profi,t-t+P3 *Growi,t+P4 *Colli,t-t+uit·

Based on the results of his paper, coefficients of size and profitability are statisticallysignificant and have the expected sign In detail, size has the positive relationship andprofitability has the negative relationship with the book leverage

Moreover, there is negative relationship between collateral value and book leverage Itmeans that if commercial banks have more assets as collateral, then they will use lessdebt It is not in accordance with the agency theory but suitable for the situation ofdeveloping countries, similar to Octavia, M and Brown, R (2008) and Caglayan, E &Sak, N (2010) There have average 40% assets of Vietnamese banking system are used

as collateral, similar to average 43.5% assets in developing countries and much higherthan average 26.5% assets in developed countries based on the results of Octavia, M.and Brown, R (2008) Consequently, one additional currency unit of tangible asset inVietnamese banking system have lower marginal benefit in ensuring debts than the case

of developed countries

In addition, commercial banks with higher growth tend to have higher debt-equityratio in Vietnamese case It is not in accordance with static trade-off theoryaccording to the viewpoint of the author However, he has argued that the variableshould be positively with the book leverage according to the real situation ofVietnam When profits of commercial banks do not increase correlatively with theincrease in their investment activities, then they should use more debt in order tokeep the high growth.

In sum, empirical studies m researching the Vietnamese capital structure are

presented briefly in Table 2.3

Table 2.3: Empirical studies in researching the Vietnamese capital structure

1 Nguyen, Multiple regressions Financial Size, ownership, banking T.D.K& 8 determinants: statements of relationship and networking Ramacha- growth, tangibility, 176 state- variables have positive ndran, N business risk, owned and relationship with dependent (2006) profitability, size, firm 382 private variables They have

ownership, banking SMEs in supported theories strongly relationship, Vietnam Growth and profitability networking from 1998 to variables are significant but Dependent variables: 2001 not the important factors to debt ratio, short-term explain the leverage and other short-term decisions Tangibility and liabilities ratio business risk variables are

not in accordance with theories.

2 Biger, N Ordinary Least Square 3,778 Profitability, size, growth

&Nam, (OLS) observations and industry classification N.V.& 8 determinants: from are statistically significant Quyen, collateralized assets, Vietnamese and have the expected sign H.X profitability, tax rate, enterprises Collateralized assets and (2007) non-debt tax shield, census 2002 - effective tax rate are not in

size, growth, industry 2003,which accordance with theories and firm ownership is carried out Non-debt tax shied is not

by General Dependent variables: statistically significant.

Statistics liabilities ratio and

Office (GSO) debt ratio.

No Authors Methodology Data Results

3 Dzung,N Generalized Method of 116 non- Profitability, growth,

& Rainey, Moments (GMM) financial liquidity and state

I.D.& 6 determinants: size, listed firms ownership variables are Gregoriou, profitability, growth, on HOSE and statistically significant and

and firm ownership 2007 to 2010 Tangibility and size Dependent variables: variables have partly total leverage, short- support hypothesis They term leverage and have negative relationship long-term leverage with the short-term

leverage and positive relationship with the long- term leverage.

4 Chau, N.H Pooled and fixed effect 29 Size and profitability (2012) panel least square Vietnamese variables are statistically

4 main determinants: commercial significant and have the size, growth, banks from expected sign.

profitability and 2006 to 2010 Collateral variable is

Dependent variable: important factors to explain

Growth variable is not in accordance with static trade-off theory.

2.3 Research Hypothesis

According to previous research such as Octavia, M & Brown, R (2008), Gropp, R

& Heider, F (2009), Caglayan, E & Sak, N (2010) and Chau, N.H (2012), it is widelybelieved that the expected sign of each determinant is that size, growth are positivelyand collateral, profitability, business risk, dividend policy are negatively with leverage.Therefore, the study has 6 null hypotheses as follows:

H 1 : Size has positive relationship with book leverage.

H 3 : Collateral has negative relationship with book leverage.

H 4 :Profitability has negative relationship with book leverage

H 5 : Business risk has negative relationship with book leverage.

2.4 Conceptual Framework

Based on the previous research such as Nguyen, T.D.K & Ramachandran, N (2006),Octavia, M & Brown, R (2008), Gropp, R & Heider, F (2009), Caglayan, E & Sak, N.(2010) and Chau, N.H (2012), it is widely accepted that the capital structure is affected

by main factors which include size, growth, collateral, profitability, business risk anddividend policy In particular, the expected sign of each determinant is that size, growthare positively and collateral, profitability, business risk, dividend policy are negativelywith leverage Figure 2.1 shows the determinants of bank capital structure

al (2001), Frank and Goyal (2005) argue that size, profitability, business risk,growth, collateral value and dividend policy may affect the leverage of each non-financial institution Similarly, Octavia, M & Brown, R (2008), Gropp, R &

Heider, F (2009), Caglayan, E & Sak, N (2010) and Chau, N.H (2012) found thatstandard determinants of non-firm capital structure as above are also significant inexplaining the capital structure of banks In particular, the expected sign of eachdeterminant is that size, growth have positive and collateral, profitability, businessrisk, dividend policy have negative with leverage