Capital Structure of Commercial Bank in Bangladesh

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2.Problem Statement

Does Financial Leverage affect the financial performance of Bangladeshi commercial banks?

Financial leverage is an influential factor on the company’s returns & risk, forming a critical part of the capital structure (combination of debt & equity). It can significantly affect the value of the firm in a negative or positive way, as it magnifies the return & risk. Thus, concluding the impact of financial leverage on the performance & profitability of Bangladeshi banks listed, would be beneficial for the financial managers of companies that operate, as it will provide an insight on the impact of financial leverage in a no interest based financial system & how it may affect the financial performance.

The financial sector’s contribution in Bangladesh to GDP has remained static at 1.5 percent during 1999-2000 periods. Commercial banks are at the heart of this financial sector by contributing 80% of the total. Relative stability achieved by the support extended by both the central bank and the Government of Bangladesh in the past has restored public confidence in the country’s banking sector. Moreover, Nationalized Commercial Banks (NCBs) and old generation Private Commercial Banks (PCBs) would have to lower the rate of NPAs in their portfolios. Failure to do so would mean re-capitalization, at least for the NCBs. This may in turn lead to a further drain on the limited resources of the Government of Bangladesh. At this time or in the immediate future this re-capitalization would not be feasible. With these conditions in place, the World Bank anticipates the likelihood of a situation where the ever-increasing burden of non-performing loans and growing rate of debt servicing would place the economy under enormous strain and result in a crisis in the banking sector in the long term. (Alrafa Akter, Afroza Parvin and Sanzida Easmin, 2015)

Moreover, based on a sample of the 569 largest, publicly traded commercial banks in 26 developed and emerging countries during the period 2004-2013, it was observed that there are large variations in bank’ capital. A cross-country comparison in reached the same conclusion despite the fact that these large financial institutions operate in the same or similar markets, and thus are subject to quasi-similar forces. (Viet-Dung Tran* Isabelle Girerd-Potin Pascal Louvet, 2015)

So ultimately, the problem statement is “investigate the relationship between ROE, ROA, and NIM with LTD, STD, Size, Growth, and GDP and linking them altogether to find the impact on the capital structure.

3.Purpose

The purpose of conducting this research, as follow:

- To identify the impact of financial leverage on the financial performance of the firm.

- To identify the nature of the relationship between the financial leverage used by Bangladeshi banks and their profitability.

- To conduct statistical applications while discovering the nature of the relationship between the dependent & independent variable.

- To create an opportunity for future research to be conducted on the subject.

4.Literature Review

Financial leverage can be described as the extent to which a business or investor is using the borrowed money. Financial leverage is a measure of how much firm uses equity and debt to finance its assets. As debt increases, financial leverage increases. It has been seen in different studies that financial leverage has the relationship with financial performance. In financial management, capital structure theory refers to a systematic approach to financing business activities through a combination of equities and liabilities. Competing capital structure theories explore the relationship between debt financing, equity financing and the market value of the firm. The traditional theory of capital structure strongly believes that the optimal mix of capital ensures a low weighted average cost of capital that maximizes the market value per share. But the leverage and equity ratios are not sufficient in determining performance, because there are multiple factors interfering in these relationships. We are measuring the financial performance of our firms by taking ROA, ROE and Net Income Margin. The several factors that we choose that affect the financial performances are debt, growth, size of the firm, inflation and GDP.

4.1: ROE (Dependable Variable):

According to the study of Yoon and Jang (2005) an empirical insight was found into the relationship between return on equity (ROE), financial leverage and size of firms in the restaurant industry for the period 1998 to 2003 using OLS regressions and for this purpose they take 62 Restaurant firms in US. Research results showed that high leveraged firms were less risky in both market-based and accounting-based measures. There is positive relationship between financial leverage and both profit measures and positively correlated. Also, suggest that at least during the test period firm size had a more dominant effect on ROE of restaurant firms than debt use, larger firms earning meaningfully higher equity returns. Results also suggest that regardless of having lower financial leverage, smaller restaurant firms were significantly more risky than larger firms.

Abdul (2012) conducted study to determine the relationship between capital structure decisions and the performance of firms in Pakistan. The study concluded that financial leverage has a significant negative relationship with firm performance as measured by ROA, GM, and Tobin’s Q. The relationship between financial leverage and firm performance as measured by the return on equity (ROE) was negative but not statistically significant. In another study, Javed and Akhtar (2012) explored the relationship between capital structure and financial performance. They concluded that there is a positive relationship between financial leverage, financial performance, and growth and size of the companies. The study, which focused on the Karachi Stock Exchange in Pakistan, used correlation and regression tests on financial data. The findings of the study are consistent with the agency theory. This study however isolated the other financing decisions and focused only on financial leverage.

Kaumbuthu (2011) carried out a study to determine the relationship between capital structure and return on equity for industrial and allied sectors in the Nairobi Securities Exchange during the period 2004 to 2008. Capital