The relationship between capital structure and performance of Islamic banks

Purpose – This paper aims to examine the effect of capital structure on Islamic banks’ (IBs) performance to provide guidance to finance managers for raising capital funds. As newcomers to the markets, IBs are facing a trade-off. They can either use high capital ratios which increase the soundness...

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Main Authors:	Tarek Al-Kayed, Lama, Syed Mohd Zain, Sharifah Raihan, Duasa, Jarita
Format:	Article
Language:	English English
Published:	Emerald Group Publishing Limited 2014
Subjects:	HG4001 Financial management. Business finance. Corporation finance.
Online Access:	http://irep.iium.edu.my/41324/ http://irep.iium.edu.my/41324/ http://irep.iium.edu.my/41324/ http://irep.iium.edu.my/41324/1/JIABR-04-2012-0024.pdf http://irep.iium.edu.my/41324/4/41324-The%20relationship%20between%20capital_SCOPUS.pdf

id	iium-41324
recordtype	eprints
spelling	iium-413242017-09-21T07:44:27Z http://irep.iium.edu.my/41324/ The relationship between capital structure and performance of Islamic banks Tarek Al-Kayed, Lama Syed Mohd Zain, Sharifah Raihan Duasa, Jarita HG4001 Financial management. Business finance. Corporation finance. Purpose – This paper aims to examine the effect of capital structure on Islamic banks’ (IBs) performance to provide guidance to finance managers for raising capital funds. As newcomers to the markets, IBs are facing a trade-off. They can either use high capital ratios which increase the soundness and safety of the bank and lower the required return by investors, or depend on deposits and Islamic bonds which are considered cheaper sources of funds due to their tax rebate. An IB’s management must carefully decide the appropriate mix of debt and equity, i.e. capital structure, to maximize the value of the bank. Design/methodology/approach – Using a sample of 85 IBs covering banking systems in 19 countries, the study uses a two-stage least squares method to examine the performance determinants of IBs to control the reverse causality from performance to capital structure. Findings – After control of the macroeconomic environment, financial market structure and taxation, results indicate that IBs’ performance (profitability) responds positively to an increase in equity (capital ratio). The result is consistent with the signaling theory which predicts that banks expected to have better performance credibly transmit this information through higher capital. Optimal capital structure results of the IBs found a non-monotonic U-shaped relationship between the capital-asset ratio and profitability, supporting the efficiency risk and franchise value hypotheses. Research limitations/implications – Due to limitations for market data, the study uses book accounting ratios. Future research where market data are available could use performance measures, such as Tobin’s Q in performance determinants models. Practical implications – The non-monotonic relationship found between IBs’ return on equity and capital ratios suggests that equity issuances for IBs’ with low capital ratios (lower than the turning point of 37.41 per cent) are expensive and have a negative effect on their profitability. On the other hand, managers of well-capitalized IBs (banks with capital ratios beyond 37.41 per cent) are advised to rely on equity when faced by a decision to raise capital, as the capital ratio starts to affect their profitability positively. Originality/value – Islamic banking literature has been silent on IBs’ capital structure and its relevance; this study will try to fill in the existent gap. Keywords Performance, Capital structure, Islamic banks, Optimal capital structure Emerald Group Publishing Limited 2014 Article PeerReviewed application/pdf en http://irep.iium.edu.my/41324/1/JIABR-04-2012-0024.pdf application/pdf en http://irep.iium.edu.my/41324/4/41324-The%20relationship%20between%20capital_SCOPUS.pdf Tarek Al-Kayed, Lama and Syed Mohd Zain, Sharifah Raihan and Duasa, Jarita (2014) The relationship between capital structure and performance of Islamic banks. Journal of Islamic Accounting and Business Research, 5 (2). pp. 158-181. ISSN 1759-0817 http://www.emeraldinsight.com/doi/full/10.1108/JIABR-04-2012-0024 10.1108/JIABR-04-2012-0024
repository_type	Digital Repository
institution_category	Local University
institution	International Islamic University Malaysia
building	IIUM Repository
collection	Online Access
language	English English
topic	HG4001 Financial management. Business finance. Corporation finance.
spellingShingle	HG4001 Financial management. Business finance. Corporation finance. Tarek Al-Kayed, Lama Syed Mohd Zain, Sharifah Raihan Duasa, Jarita The relationship between capital structure and performance of Islamic banks
description	Purpose – This paper aims to examine the effect of capital structure on Islamic banks’ (IBs) performance to provide guidance to finance managers for raising capital funds. As newcomers to the markets, IBs are facing a trade-off. They can either use high capital ratios which increase the soundness and safety of the bank and lower the required return by investors, or depend on deposits and Islamic bonds which are considered cheaper sources of funds due to their tax rebate. An IB’s management must carefully decide the appropriate mix of debt and equity, i.e. capital structure, to maximize the value of the bank. Design/methodology/approach – Using a sample of 85 IBs covering banking systems in 19 countries, the study uses a two-stage least squares method to examine the performance determinants of IBs to control the reverse causality from performance to capital structure. Findings – After control of the macroeconomic environment, financial market structure and taxation, results indicate that IBs’ performance (profitability) responds positively to an increase in equity (capital ratio). The result is consistent with the signaling theory which predicts that banks expected to have better performance credibly transmit this information through higher capital. Optimal capital structure results of the IBs found a non-monotonic U-shaped relationship between the capital-asset ratio and profitability, supporting the efficiency risk and franchise value hypotheses. Research limitations/implications – Due to limitations for market data, the study uses book accounting ratios. Future research where market data are available could use performance measures, such as Tobin’s Q in performance determinants models. Practical implications – The non-monotonic relationship found between IBs’ return on equity and capital ratios suggests that equity issuances for IBs’ with low capital ratios (lower than the turning point of 37.41 per cent) are expensive and have a negative effect on their profitability. On the other hand, managers of well-capitalized IBs (banks with capital ratios beyond 37.41 per cent) are advised to rely on equity when faced by a decision to raise capital, as the capital ratio starts to affect their profitability positively. Originality/value – Islamic banking literature has been silent on IBs’ capital structure and its relevance; this study will try to fill in the existent gap. Keywords Performance, Capital structure, Islamic banks, Optimal capital structure
format	Article
author	Tarek Al-Kayed, Lama Syed Mohd Zain, Sharifah Raihan Duasa, Jarita
author_facet	Tarek Al-Kayed, Lama Syed Mohd Zain, Sharifah Raihan Duasa, Jarita
author_sort	Tarek Al-Kayed, Lama
title	The relationship between capital structure and performance of Islamic banks
title_short	The relationship between capital structure and performance of Islamic banks
title_full	The relationship between capital structure and performance of Islamic banks
title_fullStr	The relationship between capital structure and performance of Islamic banks
title_full_unstemmed	The relationship between capital structure and performance of Islamic banks
title_sort	relationship between capital structure and performance of islamic banks
publisher	Emerald Group Publishing Limited
publishDate	2014
url	http://irep.iium.edu.my/41324/ http://irep.iium.edu.my/41324/ http://irep.iium.edu.my/41324/ http://irep.iium.edu.my/41324/1/JIABR-04-2012-0024.pdf http://irep.iium.edu.my/41324/4/41324-The%20relationship%20between%20capital_SCOPUS.pdf
first_indexed	2023-09-18T20:59:12Z
last_indexed	2023-09-18T20:59:12Z
_version_	1777410509044187136

The relationship between capital structure and performance of Islamic banks

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