INTRODUCTION
Problem Statement
The theory developed by Myers (1984) highlights the significant impact of capital structure on both the value of enterprises and their operational stability Numerous researchers have explored the factors influencing capital structure, aiming to identify independent variables that affect it This understanding enables businesses to select an optimal capital structure, ultimately maximizing firm value and ensuring stable operations.
The capital structure of companies is primarily assessed through book leverage, calculated using debt-to-equity or debt-to-asset ratios, where assets equal equity plus debt Commercial banks, which primarily deal in money, obtain their main debts by attracting deposits, resulting in a smaller proportion of equity in their total assets Additionally, the Capital Adequacy Ratio (CAR) serves as another important measure of a commercial bank's capital structure, as outlined by the Basel Committee on Banking Supervision in the Basel Accords.
To manage risks within the banking system and avert the potential collapse of commercial banks, the Capital Adequacy Ratio (CAR) is utilized, calculated by dividing equity by assets Unlike traditional book leverage, CAR highlights the varying risk levels associated with different assets Generally, commercial banks with low book leverage or high CAR may miss out on maximizing tax shield benefits In contrast, those with high book leverage or low CAR face increased financial distress costs, including the risk of bankruptcy.
Vietnam, a developing country, has undergone significant economic transformation since the Doi Moi reforms in 1986, shifting from a planned economy to a socialism-oriented market economy This transition has spurred rapid growth in the financial sector, particularly within the commercial banking system, which expanded from just 9 banks in 1991 to 94 by 2009, reflecting both qualitative and quantitative advancements in the industry.
The competitive landscape of the Vietnamese banking system has intensified, compelling each commercial bank to adopt effective strategies that enhance value while minimizing business risks A critical aspect of this approach is the selection of an appropriate capital structure, which is essential for achieving their objectives As illustrated in Table 1.1, the number of commercial banks in Vietnam reflects this dynamic environment.
Table 1.1: Quantity of commercial banks in Vietnam
Source State Bank of Vietnam — SBV
(Note.- SOCBs State — Owned Commercial Banks, JSCBs Joint — Stock Commercial Banks, JVCBs Joint — Venture Commercial Banks,’ FCBs 100ºXằ Foreign-Owned Commercial Banks and Branch ofForeign Commercial Banks)
The Vietnamese banking system has experienced rapid growth, significantly contributing to economic development and improved living standards However, it faces several weaknesses and shortcomings that have led to unsafe banking practices and an unstable macroeconomic environment In response, the Government and the State Bank of Vietnam are committed to restructuring the commercial banking system through the approval of a comprehensive project aimed at addressing these issues.
Between 2011 and 2015, the State Bank of Vietnam identified significant weaknesses in the Vietnamese banking system, particularly regarding its financial capacity According to the decree 141/2006/ND-CP, each commercial bank was required to have a minimum legal capital of 3,000 billion VND by the end of 2010 However, by 2011, three commercial banks had failed to meet this requirement, and an additional 30 banks had charter capital below 5,000 billion VND (approximately 240 million USD).
The Vietnamese commercial banking system is vulnerable to external shocks and sudden changes in the business environment, as evidenced by the global financial crisis of 2009 and the ongoing instability in Vietnam's macroeconomic conditions.
As of September 30, 2011, the capital structure of the Vietnamese banking system fell short of international standards, with an average Capital Adequacy Ratio (CAR) of 11.85% Notably, State-Owned Commercial Banks reported a significantly lower average CAR of just 8.49%, while Foreign-Owned Commercial Banks boasted a much higher average CAR of 28.58% Excluding Foreign-Owned Commercial Banks, the actual average CAR for domestic commercial banks dropped to 11.13% These findings highlight the need for improvements in the capital adequacy of Vietnamese banks, as recommended by the Asian Development Bank (ADB) in its 2005 Financial Management and Analysis of Projects report.
• that the minimum CAR of Asian Development Bank’s Developing Member
The Capital Adequacy Ratio (CAR) of countries classified as ADB Developing Member Countries (DMCs) should be at least 12%, yet many commercial banks, particularly State-Owned Commercial Banks, fail to meet this standard due to lax banking regulations and directed lending practices In fact, Vietnam's banking system exhibits a CAR significantly lower than that of several other developing nations In contrast, Southeast Asian countries like Indonesia, the Philippines, Malaysia, and Thailand boast robust commercial banking systems, with CARs that not only meet but exceed international standards Figure 1.1 illustrates the CAR of Vietnam in 2011 compared to other developing countries.
Figure 1.1: Capital Adequacy Ratio (CAR) of developing countries
Source State Bank of Vietnam-SBV
The current capital structure of the Vietnamese banking system is inadequate, lacking sufficient equity to mitigate risks from negative external factors and unexpected changes in the business environment Consequently, it is essential to address the capital structure issues seriously This study aims to identify the determinants of bank capital structure in Vietnam, with the goal of logically managing these factors to enhance the overall capital structure of the Vietnamese banking sector.
According to the static trade-off theory (Myers, 1984), Vietnamese commercial banks must select an appropriate capital structure by balancing the benefits of debt, such as tax-deductible interest payments, against the costs, including financial distress and bankruptcy expenses However, determining the optimal capital structure is challenging for these banks, as they often lack the means to accurately assess financial distress costs Consequently, bank managers can only identify a suitable range of leverage that maximizes their bank's value while minimizing bankruptcy risks This study aims not to pinpoint the optimal capital structure for the Vietnamese banking system, but to identify its determinants, enabling banking managers to effectively control these factors and establish leverage that aligns with their individual business needs.
According to the previous research such as Octavia, M & Brown, R (2008), Gropp,
Research by R & Heider (2009), Caglayan & Sak (2010), and Chau (2012) indicates that various factors such as size, profitability, business risk, growth, collateral value, and dividend policy significantly influence the capital structure of commercial banks This study aims to examine the impact of these factors on the capital structure within the Vietnamese commercial banking system.
Research Objectives
This study aims to identify the key factors influencing the capital structure of the Vietnamese commercial banking system and assess their impact Additionally, it seeks to provide policy recommendations that will enhance the development of the commercial banking sector while managing associated risks The research will also offer practical guidance for improving the capital structure of individual Vietnamese commercial banks by effectively controlling these determinants.
Research Questions
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 and dividend policy have statistically significant in explaining the model that related with 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?
Justifications of the study
Numerous empirical studies have explored the capital structure problem, yet there is a scarcity of research specifically examining the determinants of bank capital structure Furthermore, most existing studies predominantly concentrate on the contexts of Europe and the USA This paper aims to fill this gap by providing a comprehensive analysis of the capital structure of commercial banks in Vietnam, thereby contributing to the academic discourse on this important topic.
This study seeks to address current issues regarding the capital structure of the Vietnamese commercial banking system amidst the ongoing restructuring efforts by the Vietnamese Government and the State Bank of Vietnam The findings provide valuable insights that enable authorities to formulate effective policies for the development of the commercial banking sector while managing associated business risks Additionally, the results empower managers of Vietnamese commercial banks to select suitable capital structures tailored to their specific needs.
Scope of the study
The study determines the elements which have impacted on bank capital structure in
Organization of the study
The study is structured into five chapters: Chapter 2 reviews relevant theoretical and empirical literature on capital structure, while Chapter 3 outlines the research methodology and data collection process Findings and discussions are detailed in Chapter 4, and Chapter 5 concludes the study by offering policy recommendations, addressing limitations, and suggesting directions for future research.
LITERATURE REVIEW
Theoretical literature
The capital structure is a critical aspect of finance, with several theories explaining its dynamics The foundational theory, known as Modigliani and Miller (M&M theory), was introduced in 1958, setting the stage for further research Following M&M, other significant theories emerged, including agency theory developed by Jensen and Meckling in 1976, and the pecking order theory These theories collectively contribute to our understanding of how firms structure their capital.
— order and static trade-off theory was developed by Myers (1984).
The M&M theory presents two fundamental propositions: the first explores the connection between a firm's value (V) and its capital structure, while the second analyzes how capital structure affects the cost of capital (rd) Each proposition is examined through three specific cases, with a focus on the first proposition in this discussion.
In case 1 of the proportion 1, all assumptions hold in this model: homogeneous expectations, homogeneous business risk classes, perpetual cash flows, and
In a perfectly competitive capital market, firms and investors can borrow or lend at the same interest rate, have equal access to relevant information, and face no financial distress costs or taxes Modigliani and Miller identified variations of this ideal scenario, specifically noting that in case 2, all assumptions hold except for the presence of corporate income tax, while in case 3, both corporate income tax and financial distress costs are excluded.
According to the M&M theory, the value of both unlevered and levered firms remains identical in case 1, indicating that capital structure choices do not influence a firm's value However, in cases 2 and 3, the firm's value is impacted by its capital structure, as demonstrated by the functions that illustrate the relationship between firm value and capital structure.
Case 3 : +L - VU + T, * B — PV(costs of financial distress)
The value of a levered firm (VL) is influenced by the value of an unlevered firm (Vp) and the firm's debt value (B) The corporate tax rate (T) plays a crucial role, as it contributes to the present value of the tax shield (T * B) Additionally, the present value of financial distress costs must be considered when evaluating a firm's overall financial health.
In case 3, a firm's value increases with leverage but decreases due to the costs associated with financial distress To maximize tax shield benefits, each firm must select an appropriate capital structure; however, excessive leverage can lead to significant financial distress costs, including bankruptcy The risk of bankruptcy adversely affects the overall value of the firm.
Jensen and Meckling (1976) suggested that a firm's capital structure is influenced by agency costs, leading to two primary conflicts The first conflict arises between managers and shareholders, as managers may seek to enhance their own benefits while exerting minimal effort to maximize company value This often results in managers opting for higher debt levels to fund risky projects, which, while intended to meet shareholders' expectations, can lead to significant losses borne solely by shareholders if those projects fail The second conflict occurs between shareholders and debt-holders, as debt-holders receive fixed returns, creating tension when shareholders pursue high-risk investments If these investments yield returns exceeding the debt's value, shareholders benefit disproportionately, while debt-holders face losses, given that shareholders' maximum loss is limited to their initial investment.
The pecking-order theory, introduced by Myers in 1984, posits that a firm's capital structure is influenced by asymmetric information and transaction costs Asymmetric information increases the risks for outside investors, leading them to demand higher discount rates for equity Consequently, firms prefer to finance their operations using internal funds, such as retained earnings, before seeking external financing When external funding is necessary, firms typically opt for debt over equity.
Companies tend to utilize less debt when they can generate high returns, opting to fund projects through internal resources Additionally, the theory highlights the significance of financial slack, which allows businesses to maintain spare cash or easily convert assets like government bonds and stocks into cash This financial flexibility enables them to seize investment opportunities as they arise.
When enterprises lack financial slack, they are compelled to seek external funding options, which often involves borrowing at high-interest rates or issuing common stock at prices below their face value.
2.1.4 The static trade-off theory
The static trade-off theory, introduced by Myers in 1984, posits that firms must carefully evaluate the trade-off between the benefits and costs of debt when selecting their capital structure The primary benefit of debt lies in the tax deductibility of interest payments, while the costs include financial distress, such as bankruptcy expenses and associated losses However, determining the optimal capital structure proves challenging for firms, as they often lack the ability to accurately assess the costs 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 the appropriate bank capital structure.
Empirical literature
Numerous empirical studies have focused on capital structure, primarily examining non-bank institutions According to Booth et al (2001) and Frank and Goyal (2005), key independent variables influencing the leverage of non-financial institutions include size, profitability, business risk, growth, collateral value, and dividend policy.
Larger firms tend to utilize more debt to finance their projects, establishing a positive correlation between size and leverage Their greater diversification makes it more challenging for them to face bankruptcy, further reinforcing this relationship.
According to Myers and Majluf (1984), asymmetric information significantly impacts the ability of small enterprises to secure funding, as they often fail to disclose sufficient financial information, leading potential lenders to hesitate in providing credit In contrast, larger firms, particularly publicly listed companies, experience less asymmetric information between owners and creditors, making it easier for them to obtain loans These larger firms can capitalize on economies of scale when accessing long-term financing options, such as issuing corporate bonds, and they often possess greater bargaining power with lenders.
Companies with higher profits typically exhibit a lower debt-equity ratio, aligning with the pecking-order theory proposed by Myers in 1984 These high-profit firms prefer to finance their projects using retained earnings rather than relying on external funding, primarily due to concerns related to asymmetric information and transaction costs.
A negative relationship exists between business risk and leverage, as highlighted by Frank and Goyal (2005) They suggest that firms with more volatile cash flows experience heightened business risk, leading to increased financial distress costs This situation necessitates a careful evaluation of the trade-off between the benefits of tax shields and the potential costs of bankruptcy Consequently, to mitigate cash flow volatility and reduce the likelihood of financial distress, firms are advised to utilize less debt.
Fourth, firm’s growth has the negative relationship with the leverage Booth et al.
Frank and Goyal (2001, 2005) utilize the market-to-book ratio as an indicator of growth potential A high market-to-book ratio signifies that firms possess the capability to pursue significant growth opportunities, but it also indicates that these firms are exposed to increased bankruptcy risks Consequently, companies with elevated market-to-book ratios often adopt specific strategies to navigate these challenges.
According to Frank and Goyal (2005), firms should consider asset growth and the ratio of capital expenditures to assets as key indicators of their growth They suggest that these variables should have a positive correlation with book leverage, in line with pecking-order theory When a firm's profits do not rise in proportion to its investment activities, it is advisable for the firm to utilize more debt to maintain high growth levels.
Companies with significant tangible assets tend to utilize more debt, as these assets serve as collateral, reducing credit risk for lenders According to agency theory, particularly as outlined by Jensen and Meckling (1976), agency costs associated with debt arise when shareholders pursue high-risk projects that may yield returns lower than the debt's value, placing debt-holders at risk of loss Consequently, lenders are more inclined to provide financing when firms possess ample tangible assets Additionally, the static trade-off theory proposed by Myers (1984) indicates that tangible assets, such as land and equipment, incur lower expected financial distress costs compared to intangible assets, which can substantially lose value in the event of bankruptcy.
When companies are capable of paying dividends, they tend to rely less on debt financing According to the pecking-order theory proposed by Myers and Majluf (1984), the payment of dividends serves as a positive signal regarding a firm's future prospects Consequently, firms are likely to issue more equity and maintain lower levels of leverage.
Mishkin (2000) asserts that the capital structure of commercial banks is primarily influenced by capital requirement regulations, which mandate that each bank maintain a certain level of capital to minimize the risk of failure, in line with the Basel Accords standards Additionally, various empirical studies, such as those conducted by Octavia, support this assertion.
M and Brown, R (2008), Gropp, R and Heider, F (2009), Caglayan, E & Sak,
In 2010, N discovered that the typical factors influencing non-firm capital structure—such as size, profitability, business risk, growth, collateral value, and dividend policy—are also crucial in understanding the capital structure of banks.
In a study of 14 empirical analyses examining commercial bank capital structure, leverage was assessed using book leverage or market leverage, calculated through debt-to-equity or debt-to-asset ratios, where assets equal equity plus debt Commercial banks primarily obtain funds through deposits from customers.
These studies used fixed effect of panel data method to identify determinants of bank capital structure Octavia, M and Brown, R (2008), Gropp, R and Heider, F.
Research conducted in 2009 identified six key determinants that influence book leverage: size, profitability, growth, collateral value, dividend policy, and asset risk These factors are crucial for understanding how leverage is measured, as detailed in Table 2.1 from the study by Octavia, M and Brown.
R (2008), Gropp, R and Heider, F (2009) and Caglayan, E & Sak, N (2010). Table 2.1: Definition of Variables
1 Book Leverage (BL) 1-(book value of equity / book value of assets)
2 Market Leverage (ML) 1-(market value of equity / market value of assets)
1 Size book value of assets
2 Profitability (Prof) Profit after tax / book value of assets
3 Market-to-book ratio (MTB) Market value of assets / Book value of assets
4 Collateral (Coll) Tangible assets / book value of assets
5 Dividend (Div) Equal 1 when bank pays dividend in a given year
6 Asset risk (Risk) Yearly standard deviation of daily stock price returns * (market value of equity / market value of bank)
The general function has been expressed as follow:
1'ff i,‹ -fio+fi;Ln(Size;,t.i +02 roº.,t-i +0)MTB[,t-i+fi4Coll„ t-i +fi5DiVi,t
According to the results of Gropp, R & Heider, F (2009), all coefficients are statistically significant and have the expected sign in case of developed countries.
Larger commercial banks tend to have a positive correlation with leverage, as they can attract deposits more easily than smaller banks This is largely due to reduced asymmetric information, with depositors placing greater trust in the established brand names of larger institutions Additionally, the extensive branch networks of large banks facilitate easier access to banking services for depositors, enhancing their appeal.
Second, commercial banks with higher profit tend to have lower debt-equity ratio.
According to pecking-order theory (Myers, 1984), high-profit commercial banks prioritize using retained earnings to extend loans and enhance banking services, minimizing reliance on depositor funds due to asymmetric information and transaction costs In contrast, low-profit commercial banks often resort to external financing, offering higher deposit rates to attract funds Asymmetric information increases the risks for depositors, leading them to demand higher returns from commercial banks.
Research Hypothesis
- According to previous research such as Octavia, M & Brown, R (2008), Gropp, R.
According to Heider et al (2009), Caglayan and Sak (2010), and Chau (2012), it is generally accepted that the determinants of leverage exhibit specific relationships: size and growth are positively associated with leverage, while collateral, profitability, business risk, and dividend policy are negatively correlated Consequently, the study formulates six null hypotheses to explore these dynamics.
H;: Size has positive relationship with book leverage.
H2 : Growth has positive relationship with book leverage
Hi: Collateral has negative relationship with book leverage.
Hi: Profitability has negative relationship with book leverage
H$: Business risk has negative relationship with book leverage. ×6: Dividend policy has negative relationship with book leverage.
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,
Research by E & Sak (2010) and Chau (2012) indicates that key factors influencing capital structure include size, growth, collateral, profitability, business risk, and dividend policy Notably, size and growth are positively correlated with leverage, while collateral, profitability, business risk, and dividend policy exhibit a negative relationship with leverage Figure 2.1 illustrates these determinants of bank capital structure.
Figure 2.1: The determinants of bank capital structure
Chapter Summary
This chapter reviews key theoretical and empirical studies on capital structure, highlighting four fundamental theories: the Modigliani and Miller (M&M) theory from 1958, agency theory from 1976, and the pecking order theory.
(1984) and static trade-off theory (1984) Several empirical studies like Booth et 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.
Research by Caglayan and Sak (2010) and Chau (2012) indicates that the determinants of non-firm capital structure are also relevant for banks' capital structure Specifically, factors such as size and growth positively influence leverage, while collateral, profitability, business risk, and dividend policy have a negative impact on it.
DATA AND RESEARCH METHODOLOGY
Research Methodology
The research process about the capital structure of Vietnamese banking system which includes 6 steps as presented in Figure 3 1.
Recommend policy implications Figure 3.1: Research process of the study
STEP 1 Identify determinants of bank capital structure
Research by Octavia and Brown (2008), Gropp and Heider (2009), and Caglayan and Sak (2010) indicates that the capital structure of banks is represented by the book leverage variable Factors influencing the capital structure of commercial banks include size, profitability, growth, collateral value, dividend policy, and risk In the context of Vietnamese commercial banks, asset growth is utilized as a proxy for growth due to challenges in determining the market value of assets, while business risk serves as the proxy for risk, as only eight Vietnamese banks are listed on the stock exchange, making it difficult to obtain daily stock prices for others.
The model identifies six key determinants as independent variables: size, profitability, collateral value, growth, business risk, and dividend policy These variables and their measurement methods are detailed in Table 3.1.
1-(book value of equity / book value of assets)
1 Size book value of assets (Unit: 1000 billion VND)
Percentage change in total assets Nguyen, T.D.K &
Tangible assets / book value of assets
Profit after tax / book value of assets
Standard deviation of profit after tax (Unit: 1000 billion VND)
Equal 1 when commercial bank pays dividend in a given year
The study gathers the financial reports of 25 Vietnamese commercial banks from
2007 to 2011 The variables in the model will be calculated from the financial reports.
STEP 3 Carry out descriptive statistics
The study conducts a comprehensive analysis of each variable through descriptive statistics, utilizing key summary indicators such as Mean, Median, Maximum, Minimum, Standard Deviation, Skewness, Kurtosis, and Jarque-Bera Additionally, a correlation matrix is employed to assess the correlation levels between independent and dependent variables, as well as to identify multicollinearity among the independent variables.
The general function in the model: BL„,-f(Size;,t-i , Prof.,t COlli,t-i , GrOWi,t› Skj (j
DiVi,t with i shows the i‘ commercial bank unit and t for the t‘ time period (i=1-
Based on Gujarati, N.D and Porter, C.D (2009), the study tends to apply 2 panel data regressions in the model: Fixed Effects Model (FEM) and Random Effects Model (REM).
First, the specific function of FEM is:
Each commercial bank's intercept may differ, though it remains constant over time, while the slope coefficients for all banks are assumed to be stable To account for the varying intercepts among commercial banks, the fixed effect least-squares dummy variable (LSDV) method can be utilized The regression model is presented as follows:
COlli,t-i + #5 Grow„ ‘ 06 Ski,t+ 67 Div„ t + u;t whelk D i 1 for second bank and =0
In the analysis of commercial banks, the intercept ci; is recognized as the baseline for bank 1, while the variables for other banks illustrate the differences in their respective intercepts compared to bank 1 Additionally, the specific function of REM plays a crucial role in this evaluation.
In this analysis, rather than addressing the fixed effect model (FEM), we will treat the variable as a random variable with a mean value of §i The intercept for each commercial bank can be represented as li ' 1 +