The Determinants of Capital Structure: Some Evidence from Banks

Motivated by substantial cross-sectional variation in banks’ leverage, which stands in contrast to the conventional wisdom that capital regulation is the main driver of banks’ capital structures, this paper examines the capital structure of banks from the perspective of the empirical capital structure literature for non-financial firms. Moreover, banks are generally excluded from studies of capital structure and therefore constitute a natural hold-out sample that may be of particular interest given its relatively homogenous composition and particular institutional context. Our sample includes banks from 16 different countries (US and 15 EU members) from 1991 to 2004. We focus on the 200 largest listed banks (100 from the US and 100 from the EU – sampled anew each year based on their size) and have taken great care to reduce the survivorship bias in the Bankscope database. The paper finds that the standard cross-sectional determinants of firms’ capital structures also apply to large, publicly traded banks in the US and Europe. The sign and significance are identical and the economic magnitude of the effect of most variables on bank leverage tends to be larger compared to the results found in the literature for non-financial firms. We are unable to detect a first order effect of capital regulation on the capital structure of banks in our sample. This true for both book and market leverage, when controlling for risk and macro factors, when considering the effect of capital buffers, for US and EU banks examined separately, as well as when examining a series of cross-sectional regressions over time. Our results are unchanged when using regulatory Tier 1 capital ratios instead of book leverage as the dependent variable. The strength of the standard corporate finance determinants of leverage, however, weakens for those banks that are close to the minimum capital requirement. Further, we document that beyond the standard corporate finance variables, unobserved time-invariant bank fixed-effects are important in explaining the variation of banks’ capital structures. Banks with high (low) levels of leverage at the beginning of our sample also tend to have high (low) levels of leverage at the end. Hence, we confirm the recent evidence on the determinants of capital structure for non-financial firms in a sample of banks that operate in a different legal and institutional environment. Like non-financial firms, financial firms appear to have stable capital structures at levels that are specific to each individual bank. Such stability at the bank level stands in contrast to the uniform requirements imposed on banks by regulators based on Basel I and its subsequent modifications. Furthermore, our paper is complementary to the market discipline view of banking regulation that examines why the level of capital of banks in the US and around the world is much higher than regulation would suggest. The paper is also related to recent theories of optimal bank capital structure, in which capital requirements are not necessarily binding.

Gropp, Reint and Florian Heider (2008), The Determinants of Capital Structure: Some Evidence from Banks, ZEW Discussion Paper No. 08-015, Mannheim.