Advertisement

Determinants of Financial Leverage in Islamic Banks

  • M. A. Rehman ShahEmail author
  • A. Rashid
  • M. Khaleequzzaman
Chapter

Abstract

This study aims to explore the determinants of financial leverage in the Islamic banking industry of Pakistan. It also aims at exploring the effects of macroeconomic conditions and policy variables on the financing decisions of Islamic banking industry. The study uses unbalanced panel data covering the period from 2006 to 2012. The results from fixed effect model indicate that bank-specific variables, namely bank size, tangibility, and growth are positively related to banks’ financial leverage, whereas profitability, liquidity, and capital adequacy ratio are negatively related to the financial leverage of banks. On the other hand, real interest rate and inflation are negatively related to the financial leverage of Islamic banking industry, while industrial production index has a positive impact upon the financial leverage of the Islamic banking industry of Pakistan.

Keywords

Financial leverage Capital structure Islamic banking 

JEL Classification

G32 G34 

References

  1. Afza, T., & Hussain, A. (2011). Determinants of Capital Structure Across Selected Manufacturing Sectors of Pakistan. International Journal of Humanities and Social Science, 1(12), 254–262.Google Scholar
  2. Ahmed, H. (2007). Issues in Islamic Corporate Finance: Capital Structure in Firms. IRTI Occasional Papers No. 226. Jeddah: Islamic Research and Teaching Institute.Google Scholar
  3. Akhavein, J. D., Berger, A. N., & Humphrey, D. B. (1997). The Effect of Bank Megamergers on Efficiency and Prices: Evidence From the Profit Function. Review of Industrial Organization, 11, 95–139.Google Scholar
  4. Al-Deehani, T., Karim, R., & Murinde, V. (1999). The Capital Structure of Islamic Banks Under the Contractual Obligation of Profit Sharing. International Journal of Theoretical and Applied Finance, 2(3), 243–283.Google Scholar
  5. Ali, I. (2011). Determinants of Capital Structure: Empirical Evidence from Pakistan. Master thesis, Enschede: University of Twente Enschede.Google Scholar
  6. Ali, K., Akhtar, M. F., & Sadaqat, S. (2011). Practical Implication of Capital Structure Theories: Empirical Evidence from the Commercial Banks of Pakistan. European Journal of Social Sciences, 23, 165–173.Google Scholar
  7. Alper, D., & Anbar, A. (2011). Bank Specific and Macroeconomic Determinants of Commercial Bank Profitability: Empirical Evidence from Turkey. Business and Economics Research Journal, 2(2), 139–152.Google Scholar
  8. Amidu, M. (2007). Determinants of Capital Structure of Banks in Ghana: An Empirical Approach. Baltic Journal of Management, 2(1), 67–79.Google Scholar
  9. Antoniou, A. Guney Y., & Paudyal, K. (2008). The Determinants of Capital Structure: Capital Market-Oriented Versus Bank-Oriented Institutions. Journal of Financial and Quantitative Analysis, 43(1), 59–92.Google Scholar
  10. Ariccia, G. D., Laevena, Luc, & Marquez, R. (2013). Real Interest Rates, Leverage, and Bank Risk-Taking. Journal of Economic Theory, 41, 1–35.Google Scholar
  11. Baker, M. & Wurgler, J. (2007). Investor Sentiment in the Stock Market. Journal of Economic Perspectives, 21(2), 129–151.Google Scholar
  12. Barth, J., Caprio, G. & Levine, R. (2005). Rethinking Bank Regulation: Till Angels Govern. Cambridge: Cambridge University Press.Google Scholar
  13. Baum, C. F., Caglayan, M. & Rashid, A. (2013). Capital Structure Adjustments: do Macroeconomic and Business Risks Matter? Boston College Working Papers in Economics 822. Boston: Boston College Department of Economics.Google Scholar
  14. Baxter, N. D. (1967). Leverage, the Risk of Ruin and the Cost of Capital. Journal of Finance, 22(3), 395–403.Google Scholar
  15. Beattie, V., Goodacre, A., & Thomson, S. (2000). Operating Leases and the Assessment of Lease-Debt Substitutability. Journal of Banking and Finance, 24, 427–470.Google Scholar
  16. Bellinetti, J. V. (2009). Capital Structure Pattern and Macroeconomics Conditions; A Study on the Nordic Banking Sector 2003–2008. Umeå: Umeå School of Business.Google Scholar
  17. Berger, A., DeYoung, R., Flannery, M., Lee, D. & Özde O. (2008). How Do Large Banking Organizations Manage Their Capital Ratios? Journal of Financial Services Research, 34(2), 123–149.Google Scholar
  18. Booth, L., Aivazian, V., Demirguc-Kunt, A., & Maksimovic, V. (2001). Capital Structures in Developing Countries. Journal of Finance, 56(1), 87–130.Google Scholar
  19. Bradley, M., Jarrell, G. A., & Kim, E. H. (1984). On the Existence of An Optimal Capital Structure: Theory and Evidence. Journal of Finance, 39(3), 857–878.Google Scholar
  20. Brewer, E., Kaufman, G., &, Wall, L. (2008) Bank Capital Ratios Across Countries: Why Do They Vary? Journal of Financial Services Research, 34(2), 177–201.Google Scholar
  21. Chittenden, F., Hall, G., & Hutchinson, P. (1996). Small Firm Growth, Access to Interest on Corporate Capital Structure. Journal of Finance, 43(2), 271–281.Google Scholar
  22. Cook, D. O. & Tang, T. (2010). Macroeconomic Conditions and Capital Structure Adjustment Speed. Journal of Corporate Finance, 16(1), 73–87.Google Scholar
  23. Diamond, D. W. & Raghuram G. R. (2000). A Theory of Bank Capital. Journal of Finance, 55(6), 2431–2465.Google Scholar
  24. Fauzi, F., & Locke, S. (2012). Board Structure, Ownership Structure and Firm Performance: A Study of New Zealand Listed-Firms. Asian Academy of Management Journal of Accounting of Finance, 8(2), 43–67.Google Scholar
  25. Frank, M. Z., & Goyal, V. K. (2004). Capital Structure Decisions: Which Factors Are Reliably Important? Financial Management, 38(1), 1–37.Google Scholar
  26. Gajurel, D. P. (2006). Macroeconomic Influences on Corporate Capital Structure. Master degree thesis, Kathmandu: Tribhuvan University.Google Scholar
  27. Graham, J. R., Lemmon, M. L., & Schallheim, J. S. (1998). Debt, Leases, Taxes, and the Endogeneity of Corporate Tax Status. Journal of Finance, 53(1), 131–162.Google Scholar
  28. Grais, W., & Kulathunga, A. (2008). Capital Structure and Risk in Islamic Financial Services. Islamic Finance: The Regulatory Challenge. Singapore: John Wiley and Sons, 418 pp.Google Scholar
  29. Greene, W. H. (2008). Econometric Analysis (6th ed.). Upper Saddle River, NJ: New York University, Prentice Hall.Google Scholar
  30. Gropp, R., & Heider, F. (2010). The Determinants of Bank Capital Structure. Review of Finance, 14(4), 587–622.Google Scholar
  31. Gul, S., Khan, M. B., Razzaq, N., & Saif, N. (2012). How Firm Characteristics Affect Capital Structure in Banking and Insurance Sectors (The Case of Pakistan). European Journal of Business and Management, 4(12), 6–16.Google Scholar
  32. Hackbarth, D., Miao, J., & Morellec, E. (2006). Capital Structure, Credit Risk and Macroeconomic Conditions. Journal of Financial Economics, 82(3), 519–550.Google Scholar
  33. Hall, M. J., Dar, H. A., & Muljawan, D. (2004). A Capital Adequacy Framework for Islamic Banks. Applied Financial Economics, 14(6), 429–441.Google Scholar
  34. Harzi, A. (2012). The Impact of Basel III on Islamic banks: A Theoretical Study and Comparison with Conventional Banks. Paper Presented at the Research Chair Ethics and Financial Norms of University Paris, September 12, Paris.Google Scholar
  35. Hausman, J. A. (1978). Specification Tests in Econometrics. Econometrica, 46(6), 1251–1271.Google Scholar
  36. Houston, J., James, C., & Marcus, D. (1997). Capital Market Frictions and the Role of Internal Capital Markets in Banking. Journal of Monetary Economics, 35(3), 389–411.Google Scholar
  37. Jayaratne, J. & Morgan, D. P. (1999). Capital Market Frictions and Deposit Constraints on Banks. Journal of Money, Credit and Banking, 32(1), 74–92.Google Scholar
  38. Jordan, J., Lowe, J., & Taylor, P. (1998). Strategy and Financial Policy in UK Small Firms. Journal of Business Finance and Accounting, 25(1), 1–27.Google Scholar
  39. Kayhan, A., & Titman, S. (2007). Firms’ Histories and Their Capital Structures. Journal of Financial Economics, 83(1), 1–32.Google Scholar
  40. Korajczyk, R., & Levy, A. (2003). Capital Structure Choice: Macroeconomic Conditions and Financial Constraints. Journal of Financial Economics, 68(1), 75–109.Google Scholar
  41. Korner, P. (2007). The Determinants of Corporate Debt Maturity Structure: Evidence from Czech firms. Journal of Economics and Finance, 57(3–4), 142–158.Google Scholar
  42. Koziol, C., & Lawrenz, J. (2009). What Makes a Bank Risky? Insights From the Optimal Capital Structure of Banks. Journal of Banking and Finance, 33(5), 861–873.Google Scholar
  43. Levy, A., & Hennessy, C. (2007). Why does Capital Structure Choice Vary with Macroeconomic Conditions? Journal of Monetary Economics, 54(6), 1545–1564.Google Scholar
  44. Michaelas, N., Chittenden, F., & Poutziousris, P. (1999). Financial Policy and Capital Structure Choice in UK SMEs: Empirical Evidence from Company Panel Data. Small Business Economics, 12(2), 113–130.Google Scholar
  45. Mishkin, F. (2000). The Economics of Money, Banking and Financial Markets (6th ed.). New York: Addison Wesley.Google Scholar
  46. Misman, F., & Ahmad, W. (2011). Loan Loss Provisions: Evidence from Malaysian Islamic and Conventional Banks. International Review of Business Research Papers, 7(4), 94–103.Google Scholar
  47. Modigliani, F., & Miller, M. (1958). The Cost of Capital, Corporation Finance and the Theory of Investment. American Economic Review, 48(3/4), 261–297.Google Scholar
  48. Modigliani, F., & Miller, M. H. (1963). Corporate Income Taxes and the Cost of Capital: A Correction. American Economic Review, 53, 433–443.Google Scholar
  49. Myers, S. C. (1977). Determinants of Corporate Borrowing. Journal of Financial Economics, 5(2), 147–175.Google Scholar
  50. Myers, S. C. (1984). The Capital Structure Puzzle. Journal of Finance, 39(3), 575–592.Google Scholar
  51. Myers, S. C., & Majluf, N. (1984). Corporate Financing and Investment Decisions When Firms have Information Investors Do Not Have. Journal of Financial Economics, 13(2), 187–221.Google Scholar
  52. Nagano, M. (2009). Islamic Finance and the Theory of Capital Structure. Discussion Papers in Economics No. 501. Nagoya: Society of Economics Nagoya City University.Google Scholar
  53. Opler, T. C., & Titman, S. (1994). Financial Distress and Corporate Performance. Journal of Finance, 49, 1015–1040.Google Scholar
  54. Parashar, S. P., & Venkatesh, J. (2010). How Did Islamic Banks Do During Global Financial Crisis? Banks and Bank Systems, 5(4), 54–62.Google Scholar
  55. Rajan, R. G., & Zingales, L. (1995). What Do We Know About Capital Structure? Some Evidence from International Data. Journal of Finance, 50(5), 1421–1460.Google Scholar
  56. Rajhi, W., & Hassairi, S. A. (2012). Capital Structure and Financial Risks in Non-conventional Banking System. International Journal of Economics and Finance, 4(4), 252–265.Google Scholar
  57. Rashid, A. (2013). Risks and Financing Decisions in The Energy Sector: An Empirical Investigation Using Firm-Level Data. Energy Policy, 59(8), 792–799.Google Scholar
  58. Sayilgan, G., Karabacak, H., & Küçükkocaoglu, G. (2006). The Firm-Specific Determinants of Corporate Capital Structure: Evidence From Turkish Panel Data. Investment Management and Financial Innovations, 3(3), 125–139.Google Scholar
  59. Scholes, M., Wilson, P., Wolfson, M. (1990). Tax Planning, Regulatory Capital Planning, and Financial Reporting Strategy for Commercial Banks. Review of Financial Studies, 3(4), 625–650.Google Scholar
  60. Shah, A. & Hijazi, T. (2004). The Determinants of Capital Structure of Stock Exchange-Listed Non-Financial Firms in Pakistan. Pakistan Development Review, 43(4), 605–618.Google Scholar
  61. Shah, A., & Khan, S. (2007). Determinants of Capital Structure: Evidence from Pakistani Panel Data. International Review of Business Research Papers, 3(4), 265–282.Google Scholar
  62. Shyam-Sunder, L., & Myers, S. C. (1999). Testing Static Tradeoff Against Pecking Order Models of Capital Structure. Journal of Financial Economics, 51(2), 219–244.Google Scholar
  63. Smith, C., & Watts, R. (1992). The Investment Opportunity Set and Corporate Financing, Dividend and Compensation Policies. Journal of Financial Economics, 32, 263–292.Google Scholar
  64. Staking, K. B., & Babbel, D. F. (1995). The Relation Between Capital Structure, Interest Rate Sensitivity, and Market Value in the Property-Liability Insurance Industry. Journal of Risk and Insurance, 62(4), 690–718.Google Scholar
  65. Taleb, G. A., & Shubiri, F. N. (2007). Capital Structure Decisions and Debt Maturity Structure: An Empirical Evidence from Jordan. Journal of Commerce, 3(4), 49–60.Google Scholar
  66. Titman, S., & Wessels, R. (1988). The Determinants of Capital Structure Choice. Journal of Finance, 43(1), 1–19.Google Scholar
  67. Vitor, D. A., & Badu, J. (2012). Capital Structure and Performance of Listed Banks in Ghana. Global Journal of Human Social Science 12(5), 56–62.Google Scholar
  68. Yan, A. (2006). Leasing and Debt Financing: Substitutes or Complements? Journal of Financial and Quantitative Analysis, 41(3), 709–731.Google Scholar

Copyright information

© The Author(s) 2019

Authors and Affiliations

  • M. A. Rehman Shah
    • 1
    Email author
  • A. Rashid
    • 2
  • M. Khaleequzzaman
    • 3
  1. 1.Basic Sciences and Humanities DepartmentUniversity of Engineering and TechnologyTaxilaPakistan
  2. 2.International Institute of Islamic EconomicsInternational Islamic UniversityIslamabadPakistan
  3. 3.School of Islamic Banking & FinanceInternational Islamic UniversityIslamabadPakistan

Personalised recommendations