Determinants of bank capital structure, the case of vietnamese commercial bank system

ACKNOWLEDGEMENT I am grateful to all those who help me to complete the thesis I would like to thank the Vietnam-the Netherlands Programme for giving me permission to carry out the thesis after Thesis Research Design (TRD) defense and providing many precious researches through an account of EUR library website and others Especially, I am deeply thankful to my supervisor Dr Cao Hao Thi from Industrial Management Department of Ho Chi Minh City University of Technology for his instructions, suggestions and encouragements during the implementation of the thesis Moreover, I would like to express my deep gratitude to my family, friends and colleagues for all their support and valuable hints in order to help me to complete the thesis i ABSTRACT The study aims to identify determinants of Vietnamese banking capital structure Using panel data analysis like Fixed Effects Method (FEM) and Random Effects Method (REM), the study investigates the effect of size, growth, collateral value, profitability, dividend policy and business risk determinants to capital structure of commercial banks in Vietnam from 2007 to 2011 The main findings of the study are that Fixed Effects Model (FEM) is the most appropriate model in explaining the banking capital structure; furthermore, size, growth, collateral and profitability variables are statistically significant and have the expected sign with the book leverage variable However, risk and dividend variables are not statistically significant Based on reality situations, it is widely believed that the capital structure of Vietnamese banking system is not really good and does not meet the international standard at present The system does not have enough equity so as to prevent risks from the negative externalities and unexpected change of business environment Therefore, the study is going to recommend some policy implications to improve the capital structure situation by adjusting the determinants Moreover, the study also makes valuable instructions to banking managers of each commercial bank According to specific reality situation of each commercial bank, they will have right decisions to increase or decrease book leverage so as to not only maximize the own commercial bank’s value but also avoid facing up bankruptcy events Keywords: capital structure, book leverage, commercial bank, Fixed Effects Method (FEM), Random Effects Method (REM) ii TABLE OF CONTENTS Acknowledgement i Abstract ii Table of Contents iii Abbreviation vi List of Table vii List of Figure viii CHAPTER INTRODUCTION 1.1 Problem Statement 1.2 Research Objectives 1.3 Research Questions 1.3.1 Main question 1.3.2 Sub questions 1.4 Justifications of the study 1.5 Scope of the study 1.6 Organization of the study CHAPTER LITERATURE REVIEW 2.1 Theoretical literature 2.1.1 Modigliani and Miller (M&M theory, 1958) 2.1.2 Agency theory 10 2.1.3 The pecking – order theory 11 2.1.4 The static trade-off theory 12 iii 2.2 Empirical literature 12 2.2.1 Foreign empirical literature 12 2.2.2 Vietnamese empirical literature 22 2.3 Research Hypothesis 27 2.4 Conceptual Framework 27 2.5 Chapter Summary 28 CHAPTER DATA AND RESEARCH METHODOLOGY 29 3.1 Research Methodology 29 3.2 Data 35 3.3 Chapter Summary 37 CHAPTER 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 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 iv 5.3 Limitations and Further Studies 57 5.3.1 Limitations 57 5.3.2 Further Studies 58 References 59 Appendices 63 v ABBREVIATION BCBS: Basel Committee on Banking Supervision BL: Book Leverage CAR: Capital Adequacy Ratio FEM: Fixed Effects Method GDP: Gross Domestic Product GMM: Generalized Method of Moments REM: Random Effects Method vi LIST OF TABLE Table 1.1 Quantity of commercial banks in Vietnam Table 2.1 Definition of Variables 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 of Variables 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 vii 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 viii CHAPTER INTRODUCTION 1.1 Problem Statement Based on Ross, Westerfield and Jaffe (2010), capital structure is the combination of debt and equity Each company should choose the suitable debt-equity ratio (capital structure) in order to maximize the value of its company When the capital structure problems are mentioned in any researches, it is certainly that the famous theory Modigliani and Miller (M&M theory, 1958) are applied in these researches According to M&M theory, in the perfect capital markets (case of M&M proposition 1), choosing any capital structure not affect the value of specific company However, if all assumptions in M&M proposition are held except taxes and costs of financial distress, the value of the specific company will be affected by choosing the capital structure because of the tax shield benefits and costs of financial distress After the capital structure theory of Modigliani and Miller, many theories about capital structure are in turn released; in particular, agency theory was created by Jensen and Meckling (1976); pecking – order theory and static trade-off theory was developed by Myers (1984) These theories have indicated that capital structure affects not only the value of each enterprise but also the stability in business Therefore, there have many authors who research about the capital structure They also try to find out the independent variables that affect the enterprises capital structure; from that point, each enterprise have ability to choose the appropriate capital structure in order to maximize the value of the firm and stabilize the business operations Capital structure of each company is usually measured by the book leverage It is the basic formulation It is calculated by debt-to-equity or debt-to-asset, with asset is equity plus debt Commercial banks access the primary debts by attracting the money from depositors The specific characteristic of commercial bank business is to trade in money; thus, equity of commercial banks always accounts for small proportion of total asset Moreover, in the banking industry, they also use Capital Adequacy Ratio (CAR), which is the other proxy to measure the capital structure of each commercial bank (Basel Committee on Banking Supervision, 2006) CAR has been mentioned in Basel Accords, which are issued by Basel Committee on Banking Supervision (BCBS) Basel Accords have been built and developed in order to control the risk from the banking system and prevent the collapse of commercial banks in reality CAR is calculated by equity over asset; however, unlike book leverage, CAR emphasizes the different risk level of each asset In general, if commercial banks have low book leverage or high CAR, then they have not ability to take full advantage of tax shield benefit Conversely, if commercial banks have high book leverage or low CAR, then they have to face up the high financial 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-oriented market economy The financial sector, especially commercial bank system still have a rapid development both quality and quantity The quantity of Vietnamese commercial bank system increases from in 1991 to 94 in 2009 This leads to the increase in competitive level of Vietnamese banking system With the high competitive 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 carry out the purpose Table 1.1 presents quantity of commercial banks in Vietnam from 1991 to 2009 profits of banking system will be improved Moreover, the banking system has occasions to revaluate business efficiency of each branch; from that point, each commercial bank will have appropriate banking network Accordingly, banking system will have appropriate size level for the development of the economy In summary, the policy will make the Vietnamese banking system increase profits and have the appropriate size level; therefore, the leverage of banking system will be decreased Third, State Bank of Vietnam should tighten inspective mechanism to banking system This policy will make sure that commercial bank system attach special importance to both quality and quantity development, avoid the bubble development of banking system like in the case of several past years; therefore, Vietnamese banking system will no longer maintain the high asset growth, but more sustainable growth Moreover, State Bank of Vietnam should require commercial banks have to reserve more cash or more tangible assets that are transferred into cash easily such as certificate deposits, government bonds and so on; thus, commercial banks have enough funds to ensure liquidity problem In sum, the policy will make the Vietnamese commercial bank system lower growth and increase tangible assets; accordingly, the leverage of commercial bank system will be reduced Fourth, based on the explanations about the statistically insignificant of business risk and dividend variables to book leverage variable, State Bank of Vietnam should request commercial banks to raise the awareness of risk management and encourage domestic commercial banks to acquire knowledge and reality experiences in risk management from foreign financial institutions by permitting foreign financial institutions participating in the process of restructuring domestic banking system Furthermore, State Bank of Vietnam has to issue strict rules on dividend policy of Vietnamese commercial bank system Commercial banks should only pay dividends based on the reality situation, but not from shareholders’ pressure In reality, State Bank of Vietnam has just stipulated the 06/CT-NHNN directive on November 09, 2012 The directive has regulated that commercial banks only have ability to pay 54 dividends in 2012, 2013 when they make enough provisions for loan losses It is realized that authorities are taking drastic measures in order to improve the capital structure of commercial bank system In general, the policies that are mentioned as above have ability to control the determinants of Vietnamese banking system; as a result, it has the lower book leverage so as to reduce the probability that commercial banks face up insolvency situations and bankruptcy events 5.2.2 Policy implications for specific Vietnamese commercial banks cases The study also makes valuable instructions to improve the capital structure of each Vietnamese commercial bank by controlling the determinants According to specific reality situation of each commercial bank, banking managers will have right decisions to increase or decrease book leverage so as to not only maximize the own commercial bank’s value but also avoid facing up bankruptcy events The study makes policy implications for cases In particular, case is group of high leverage commercial banks and case is group of low leverage commercial banks 5.2.2.1 Policy implications for high leverage commercial banks High leverage commercial banks should consider to reduce own leverage in order to avoid facing up insolvency situations and bankruptcy events According to the results of panel regressions as above, it is realized that commercial banks need to choose at least of things in order to lower the book leverage: increasing tangible assets, profitability factors and decreasing size, growth factors The study aims to analyze some policies to control the determinants in order to gain the purpose First, these commercial banks should have drastic policies to reduce bad debt ratio In particular, they may reschedule loans for customers that have good projects but to be in repayment difficulty; moreover, they have to reclaim low credibility customer’s money urgently by dealing with collaterals of these customers When they have ability to lower the bad debt ratio, they will decrease to make provisions 55 for loan losses or reverse provision for bad debts; thus, their profits will be improved Therefore, their leverage will be decreased Second, these commercial banks need to attach special importance to both quantity and quality development, review credit and securities portfolios seriously, avoid bubble development like in several past years Accordingly, they will no longer maintain the high asset growth, but more sustainable growth In addition, they have to assess business efficiency of each branch; thus, they have ability to rebuild own banking network in order to have the appropriate size level In summary, the policies will make high leverage commercial banks lower growth and have the appropriate asset level; as a result, they will lower own leverage Third, these commercial banks should reserve more cash or more tangible asset that are converted into cash easily; thus, commercial banks have enough money to solve liquidity problem and avoid facing up insolvency situation The policy will make them increase tangible assets; accordingly, their leverage will be decreased Fourth, according to the explanations about the statistically insignificant of business risk and dividend variables to book leverage variable, each high leverage commercial banks should rebuild the process of risk management, improve the quality of human resources in risk management or acquire knowledge and reality experiences from foreign shareholders Moreover, these commercial banks should have appropriate dividend policies according to reality situation, but not from shareholders’ pressure In sum, these commercial banks need to have fully awareness about risk management and dividend policy so as to improve their capital structure 5.2.2.2 Policy implications for low leverage commercial banks According to reality situations, low leverage commercial banks should consider to increase own leverage in order to take advantage of tax shield Therefore, their profits are absolutely improved Based on the results of panel regressions as above, it is widely accepted that commercial banks need to choose at least of things in 56 order to raise the book leverage: increasing size, growth factors and decreasing profitability, collateral factors Among them, decreasing profitability is absolutely not applied to increase leverage because their mission is to improve profits Some policies are analyzed to adjust the determinants so as to achieve the purpose First, low leverage commercial banks should consider opening more branches and transaction points; thus, they have ability to access more customers By the way, they will attract more money from potential depositors and then use additional money to make loans The policy will make lower leverage commercial banks increase their size and achieve their own higher growth; therefore, their leverage will be increased Second, based on reality situation, if these commercial banks have a lot of spare cash and other high liquidity tangible assets, then they should convert a portion of them into low liquidity assets like loans in order to decrease tangible asset item Accordingly, their leverage will be increased Moreover, low liquidity assets like loans usually have higher expected return than high liquidity tangible assets like cash, government bond and so on; as a result, they should apply the policy to improve profits 5.3 Limitations and Further Studies 5.3.1 Limitations Although the study has identified determinants of Vietnamese commercial bank system and recommended some policy implications to the system clearly, but there exists some limitations in the study First, the study has recommended policy implications for each commercial bank by controlling the determinants Banking managers have ability to adjust the determinants so as to gain the own appropriate leverage However, the study has not researched on the optimal capital structure of Vietnamese commercial bank system If banking managers of each commercial bank have known about the optimal 57 capital structure, then they have ability to adjust own capital structure to approach to optimal level Second, based on the previous studies about banking capital structure in the case of developed and other developing countries such as Octavia, M & Brown, R (2008), Gropp, R & Heider, F (2009), it is realized that market leverage is also used as proxy for bank capital structure, together with book leverage; moreover, market-tobook ratio and asset risk are used as the proxies for in turn growth and risk variables However, according to available data at present, it is difficult to identify market value of assets, debts, equity and to collect the daily stock price of majority of Vietnamese commercial banks Therefore, market leverage is not applied in the model; in addition, asset growth and business risk are chosen as the proxies for in turn growth and risk variables in the study, instead of market-to-book ratio and asset risk like the previous studies 5.3.2 Further Studies The study aims to recommend some further studies about the capital structure of Vietnamese commercial bank system according to the limitations as above First, further studies should be investigated the optimal capital structure level of Vietnamese banking system Consequently, banking managers of each commercial bank have the good indicator to adjust own capital structure in order to harmonize the goal of preventing insolvency situations and bankruptcy events with the ability of maximizing the own commercial bank’s value Second, if there have enough data about market value of assets, debts, equity and daily stock price of each Vietnamese commercial bank, further studies may focus on relationships of determinants to market leverage of Vietnamese banking system; 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New York, NY: McGraw-Hill and Irwin 61 State Bank of Vietnam (2011) Orientations and Policies to Restructure Vietnamese Banking System in 2011-2015 Retrieved September 1, 2012 from http://www.fetp.edu.vn/ attachment.aspx?ID=3461 State Bank of Vietnam (2012) State Bank of Vietnam reveals money market data on 30/04/2012 Retrieved October 1, 2012 from http://vneconomy.vn/ 20120621012428822 P0C6 62 APPENDICES List of Vietnamese commercial banks in the sample No Name Website Bank for Foreign Trade of Vietnam (Vietcombank) www.vietcombank.com.vn Vietnam Bank for Industry and Trade (Vietinbank) www.vietinbank.vn Bank for Investment and Development of Vietnam (BIDV) www.bidv.com.vn Housing Bank of Mekong Delta (MHB) www.mhb.com.vn Asia Commercial Bank (ACB) www.acb.com.vn Sai Gon Thuong Tin Commercial Bank (Sacombank) www.sacombank.com.vn Vietnam Export Import Commercial Bank (Eximbank) www.eximbank.com.vn Vietnam Technological and Commercial Joint Stock Bank (Techcombank) www.techcombank.com.vn Military Commercial Bank (MB) www.mbbank.com.vn 10 Saigon Hanoi Commercial Bank (SHB) www.shb.com.vn 11 Dong A Commercial Bank www.dongabank.com.vn 12 Vietnam International Commercial Bank (VIB) www.vib.com.vn 63 No Name Website 13 VietnamProsperityCommercialBank (VPBank) www.vpb.com.vn 14 Vietnam Maritime Commercial Bank (MSB) www.msb.com.vn 15 Southeast Asia Commercial Bank (SeaBank) www.seabank.com.vn 16 Nam Viet Commercial Bank (Navibank) www.navibank.com.vn 17 Hanoi Building Commercial Bank (Habubank) www.habubank.com.vn 18 An Binh Commercial Bank (ABBank) www.abbank.vn 19 Southern Commercial Bank (Southern Bank) www.southernbank.com.vn 20 Orient Commercial Bank (OCB) www.ocb.com.vn 21 Nam A Commercial Bank (Nam A Bank) www.namabank.com.vn 22 Ho Chi Minh City Development Commercial Bank (HD Bank) www.hdbank.com.vn 23 Saigon Bank for Industry and Trade (Saigonbank) www.saigonbank.com.vn 24 Kien Long Commercial Bank (Kienlongbank) www.kienlongbank.com.vn 25 Western Commercial Bank (Westernbank) www.westernbank.vn 64 Fixed Effects Method (FEM) results Dependent Variable: BL Method: Panel Least Squares Date: 11/27/12 Time: 09:52 Sample: 150 Periods included: Cross-sections included: 25 Total panel (balanced) observations: 125 Variable Coefficient Std Error t-Statistic Prob C LOG(SIZE(-1)) COLL(-1) PROF GROW RISK DIV 0.869196 0.027848 -0.131156 -2.423503 0.016937 0.015341 -0.004980 0.039164 0.007200 0.051944 0.867427 0.004613 0.020308 0.011919 22.19390 3.867518 -2.524934 -2.793897 3.671505 0.755404 -0.417781 0.0000 0.0002 0.0132 0.0063 0.0004 0.4519 0.6771 Effects Specification Cross-section fixed (dummy variables) R-squared Adjusted R-squared S.E of regression Sum squared resid Log likelihood F-statistic Prob(F-statistic) 0.744784 0.663332 0.037624 0.133062 250.4610 9.143863 0.000000 65 Mean dependent var S.D dependent var Akaike info criterion Schwarz criterion Hannan-Quinn criter Durbin-Watson stat 0.886340 0.064843 -3.511376 -2.809955 -3.226426 2.494612 Random Effects Method (REM) results Dependent Variable: BL Method: Panel EGLS (Cross-section random effects) Date: 11/27/12 Time: 10:00 Sample: 150 Periods included: Cross-sections included: 25 Total panel (balanced) observations: 125 Swamy and Arora estimator of component variances Variable Coefficient Std Error t-Statistic Prob C LOG(SIZE(-1)) COLL(-1) PROF GROW RISK DIV 0.824093 0.032729 -0.057366 -2.746020 0.018954 0.002820 -0.002207 0.029006 0.005178 0.038835 0.735521 0.004137 0.018470 0.009983 28.41148 6.320451 -1.477152 -3.733433 4.582064 0.152693 -0.221110 0.0000 0.0000 0.1423 0.0003 0.0000 0.8789 0.8254 Effects Specification S.D Cross-section random Idiosyncratic random 0.023138 0.037624 Rho 0.2744 0.7256 Weighted Statistics R-squared Adjusted R-squared S.E of regression F-statistic Prob(F-statistic) 0.420618 0.391158 0.038670 14.27753 0.000000 Mean dependent var S.D dependent var Sum squared resid Durbin-Watson stat 0.521281 0.049559 0.176456 2.017077 Unweighted Statistics R-squared Sum squared resid 0.523801 Mean dependent var 0.248276 Durbin-Watson stat 66 0.886340 1.433588 Hausman Test Correlated Random Effects - Hausman Test Equation: EQ03RANDOM Test cross-section random effects Test Summary Cross-section random Chi-Sq Statistic Chi-Sq d.f 12.655281 Prob 0.0488 Cross-section random effects test comparisons: Variable Fixed Random Var(Diff.) Prob LOG(SIZE(-1)) 0.027848 0.032729 0.000025 0.3293 COLL(-1) PROF GROW RISK DIV -0.131156 -2.423503 0.016937 0.015341 -0.004980 -0.057366 -2.746020 0.018954 0.002820 -0.002207 0.001190 0.211439 0.000004 0.000071 0.000042 0.0324 0.4831 0.3234 0.1380 0.6703 67 Likelihood Ratio (LR) Test Redundant Fixed Effects Tests Equation: EQ02FIXED Test cross-section fixed effects Effects Test Statistic Cross-section F Cross-section Chi-square d.f Prob 3.181679 74.327594 (24,94) 24 0.0000 0.0000 Cross-section fixed effects test equation: Dependent Variable: BL Method: Panel Least Squares Date: 12/24/12 Time: 10:44 Sample: 150 Periods included: Cross-sections included: 25 Total panel (balanced) observations: 125 Variable Coefficient Std Error t-Statistic Prob C LOG(SIZE(-1)) COLL(-1) PROF GROW RISK DIV 0.803846 0.035887 -0.020819 -3.146932 0.019539 -0.012826 -8.67E-05 0.025803 0.004863 0.034938 0.722237 0.004515 0.019627 0.009997 31.15329 7.379996 -0.595896 -4.357200 4.328117 -0.653462 -0.008673 0.0000 0.0000 0.5524 0.0000 0.0000 0.5147 0.9931 R-squared Adjusted R-squared S.E of regression Sum squared resid Log likelihood F-statistic Prob(F-statistic) 0.537461 0.513943 0.045207 0.241154 213.2972 22.85232 0.000000 68 Mean dependent var S.D dependent var Akaike info criterion Schwarz criterion Hannan-Quinn criter Durbin-Watson stat 0.886340 0.064843 -3.300756 -3.142370 -3.236412 1.599729 ... structure of Vietnamese commercial bank system The study analyzes capital structure problem in the background of restructuring banking system process of Vietnamese Government and State Bank of Vietnam... believed that 1 is the intercept of commercial bank and the other  show the difference between the intercept of own bank and the one of bank Second, the specific function of REM is: REM : BLit... for 62% the one of total Vietnamese banking system; moreover, total shareholder’s equity of the sample accounts for 59% the one of Vietnamese commercial bank system Therefore, it is the good