Determinants of capital structure of Islamic and conventional commercial banks

Abstract

Purpose The purpose of this paper is to investigate how conventional and Islamic commercial banks in Pakistan choose their capital structure and what are the most significant factors that affect their choice of capital structure. Design/methodology/approach The authors collected the data from the annual reports of commercial banks listed on Karachi Stock Exchange Pakistan during 2004-2014. Panel data techniques, namely, pooled ordinary least squares, fixed effects and random effects, were used to estimate the relationship between book leverage and bank-specific variables such as profitability, size, growth, tangibility and earnings volatility. Findings Descriptive statistics indicate that conventional commercial banks are more levered than Islamic commercial banks. Moreover, conventional commercial banks are larger, profitable and have relatively safe earnings than Islamic commercial banks. In contrast, Islamic commercial banks have relatively more fixed operating assets and growth in total assets compared to the conventional commercial banks. Regression results indicate that profitability, growth and tangibility are negatively, whereas bank size and earnings volatility are positively, related to book leverage of conventional commercial banks. On the other hand, only three variables, namely, profitability, bank size and tangibility, have material effects on capital structure choice of Islamic commercial banks. Profitability and tangibility are negatively while bank size is positively related to book leverage of the Islamic banks. In sum, results of the study indicate that Islamic and conventional commercial banks have their own way to choose the capital structure than the non-financial firms; however, their choice is affected by the similar variables as identified for non-financial firms in Pakistan. Practical implications Results of this study provide support to bank managers to understand the effects of bank-specific variables on capital structure and make them able to determine a balanced capital structure considering the regulations framed by the central bank of the country. Originality/value This is the first study that investigates the factors that affect the capital structure of conventional and Islamic commercial banks in Pakistan. Moreover, findings of this study lay some foundation upon which a more detail analysis of capital structure of banks could be based.