Determinants of capital adequacy ratio in Turkish Banks: A panel data analysis...
African Journal of Business Management Vol.5 (27), pp. 11199-11209, 9 November, 2011 Available online at http://www.academicjournals.org/AJBM DOI: 10.5897/AJBM11.1957 ISSN 1993-8233 ©2011 Academic Journals
Full Length Research Paper
Determinants of capital adequacy ratio in Turkish Banks: A panel data analysis Ahmet Büyükşalvarcı1* and Hasan Abdioğlu2 1
Faculty of Health Sciences, Selcuk University, 42030 Konya, Turkey. Faculty of Economics and Administrative Sciences, Balikesir University, 10200, Bandirma, Balikesir, Turkey.
2
Accepted 26 September, 2011
The purpose of this study is to investigate the determinants of Turkish banks' capital adequacy ratio and its effects on financial positions of banks covered by the study. Data are obtained from banks' annual reports for the period 2006 - 2010. Panel data methodology is used in this study and analyzes relationships between independent variables; bank size (SIZE), deposits (DEP), loans (LOA), loan loss reserve (LLR), liquidity (LIQ), profitability (ROA and ROE), net interest margin (NIM) and leverage (LEV) and a dependent variable which is capital adequacy ratio (CAR). The results of the paper indicate that LOA, return on equity and LEV have a negative effect on CAR, while LLR and return on assets positively influence CAR. On the other hand, SIZE, DEP, LIQ and NIM do not appear to have any significant effect on CAR. Key words: Capital adequacy ratio, Turkish banks, panel data analysis.
INTRODUCTION Financial markets have changed shape as the providers of financial services have extended their scope of activities. However, in recent decades financial entities commonly go bankrupt with disastrous consequences for individuals and society since a bankrupt limited liability company is not responsible for losses exceeding its financial resources (Jong and Madan, 2011). In recent years, banking crises have become increasingly common and increasingly expensive to deal with. Prudential regulation of banks is supposed to prevent or at least to reduce the frequency of such crises. The group of issues
*Corresponding author. E mail:
[email protected]. Tel: +90 507 379 29 49. Fax: +90 332 241 62 11. Abbreviations: BRSA, Banking Regulation and Supervision Agency; BAT, Banks Association of Turkey; SIZE, bank size; DEP, deposits; LOA, loans; LLR, loan loss reserve; LIQ, liquidity; ROA and ROE, profitability; NIM, net interest margin; LEV, leverage; CAR, capital adequacy ratio; LSDV, leastsquare-dummy-variables; EGLS, estimates generalized least squares; DW, Durbin-Watson.
that fails under the heading of bank capital adequacy has received a great deal of attention from regulators, bankers and academics in recent years and is likely to continue as a subject for debate for many years to come (Morgan, 1984). The Basle Accord was partly in response to a series of international bank failures and concern over unequal national capital standards. Commercial banks are legally required to maintain adequate capital funds. The primary function of bank capital is to provide resources to absorb possible future losses on assets. How much capital should a commercial bank have? The standard capital adequacy arguments sound like a broken record. Regulators always seem to want more capital and bankers always want less. Both sides need well-defined goals for establishing a capital adequacy strategy and both sides should be taking a broader view of the costs that are relevant in setting that strategy. From the bank stockholders’ viewpoint, the function of capital is to earn a satisfactory rate of return. Commercial banks are legally required to maintain adequate capital funds. Any workable standard for measuring capital adequacy should be expressed in terms of the function of bank capital (Stegall, 1966). The rules on
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minimum capital requirements have followed an international harmonization guided by the Basel Committee, starting from 1988, date in which the first agreement was issued (Brogi, 2010).In order to prevent bank failures and protect the interest of the depositors, it is necessary to require banks to maintain a significant level of capital adequacy. Because of its importance, the western banking system has established internationallyrecognized capital regulations, which are formulated by the Basel Committee on Banking Supervision. The Basel Committee on Banking Supervision is a committee of banking supervisory authorities that was established by the central bank governors of the Group of Ten countries in 1975. It sets out the details of the agreed framework for measuring capital adequacy and the minimum standard. The basic idea of the 1988 Basel Capital Accord has two parts. First, it established the definition of capital and distinguished between its core elements (Tier 1) and supplementary elements (Tier 2). The 1988 Basle Accord explicitly considered only credit risk. It required internationally active banks to hold a minimum capital equal to 8% of risk adjusted assets, with capital consisting of Tier I capital (equity capital and disclosed reserves) and Tier II capital (long term debt, undisclosed reserves and hybrid instruments). In 1988, the Basel Committee introduced capital adequacy regulation that has been adopted by more than 100 countries (Jacobson at al., 2002 and Chami and Cosimano, 2003). In Basel II to revise the 1988 Accord has been to develop a framework that would further strengthen the soundness and stability. Insufficient risk dependence and the possibilities of arbitrage in the present regulations are important reasons behind the Basel Committee’s revision of the capital adequacy rules. Its revision can also be seen as a natural consequence of the rapid developments in recent years in credit risk management and credit risk measurement and the banks’ greater readiness and ability to quantify credit risk (Jacobson at al., 2002). The Committee is also retaining key elements of the 1988 capital adequacy framework, including the general requirement for banks to hold total capital equivalent to at least 8% of their risk-weighted assets; the basic structure of the 1996 Market Risk Amendment regarding the treatment of market risk and the definition of eligible capital. Basel II is more risk sensitive than the 1988 Accord higher than allowed for in this framework (Çelik and Kızıl, 2008; Thampy, 2004). Basel Capital Accord covers not only the calculation of capital adequacy ratio but also other supporting issues like sound supervisory processes and market discipline. The aim of this paper is to investigate empirically determinants of capital adequacy ratio in Turkish banks. Capital adequacy ratio is analyzed based on annually data from 2006 to 2010 by nine bank specific variables. The bank specific variables used in this study are bank size, deposits, loans, loan loss reserve, liquidity, profitability, net interest margin and leverage. In the
analyses panel data method was used. A BRIEF OVERVIEW OF TURKISH BANKING SYSTEM The banking sector forms a great part of the Turkish financial system in its dynamic economy. Most of the transactions and activities of money and capital markets are carried out by banks. Most State banks were established to finance a particular industry such as agriculture, but private banks generally have close connections to large industrial groups and holdings. In Turkey, first banking activities started in early 1800s with the so-called money-changers and the Galata bankers. During this period, all quasi-banking activities were carried out by money-changers, and The Galata bankers consisted mostly of the ethnic-minorities in Istanbul. With the deterioration of the Ottoman Empires’ financial situation after the Crimean war, the Empire needed external financial support. It was during this period when representatives of several foreign banks came to Istanbul with the purpose of extending credits to the Empire at high interest rates. The Ottoman Bank (Osmanlı Bankası) was established in 1856 with its head office in London and served as the Central Bank until the 1930s.The Central Bank, founded in the early 1930s, has the usual central bank responsibilities, such as issuing banknotes, protecting the currency, and regulating the banking system and credit. The Central Bank also finances the government’s budget deficits and makes loans to public and private banks. But after 1983 the Central Bank began to reduce lending and stepped up its supervisory functions. Before 1980 there were only 4 foreign banks in Turkey, but their number grew rapidly during the 1980s as liberalized conditions and today there are almost 50 of them. During these years a series of reforms were adopted to promote financial market development; interest and foreign exchange rates were liberalized, new entrants to the banking system were permitted and foreign banks were encouraged to operate in Turkey. All banks in Turkey are subject to the Banks Act and to the provisions of other laws regarding to banks. The new Law brought the Banking Regulation and Supervision Agency (BRSA) into life to safeguard the rights and benefits of depositors. The Banks Association of Turkey (BAT) is the representative body of the banking sector in Turkey established for protecting and promoting the professional interests of its members.Table 1 shows the summary of the number of banks, branches and personnel in Turkish banking sector. As of 2010, there are a total of 49 banks operating with 9935 branches and 189.783 personnels in Turkey. LITERATURE REVIEW Many researchers have worked on capital adequacy. A
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Table 1. Number of banks, branches and personnel in Turkish banking sector.
Number of banks State Deposit Banks Private Deposit Banks Banks within the structure of SDIF Global Capital Deposit Banks Development and Investment Banks Participation Banks Number of Branches Deposit Banks Development and Investment Banks Participation Banks Number of Personnel Deposit Banks Development and Investment Banks Participation Banks
2006 50 3 14 1 15 13 4 7.302 6.904 42 356 150.966 138.599 5.255 7.112
2007 50 3 12 1 17 13 4 8.122 7.658 42 422 167.760 153.212 5.361 9.187
2008 49 3 11 1 17 13 4 9.304 8.724 44 536 182.665 166.326 5.307 11.032
2009 49 3 11 1 17 13 4 9.581 8.968 44 569 184.205 167.063 5.340 11.802
2010 49 3 11 1 17 13 4 9.935 9.296 42 597 189.783 171.974 5.395 12.414
Source: BRSA, BAT.
number of researchers have provided insights, theoretical as well as empirical, into the capital adequacy. A brief overview of the studies focusing on developed and emerging capital markets is presented in this paper. Modigliani and Miller (1958) state that in a world with perfect financial markets, capital structure and hence, capital regulation is irrelevant. Hahn (1966) analyzes factors determining adequacy of capital in commercial banks. Analysis of the real factors influencing the quantity and quality of capital is similar to a study in econometrics with size, growth, and profitability as the independent variables and capitalization as the dependent variable on the first level. Independent variables on the first level become dependent variables on the second level with other independent variables influencing them. Quantitative and qualitative influences exist on both levels of analysis. Capitalization is a function of size and growth factors which vary in their influence according to growth conditions and policies affecting structure. Profitability is also a function of size and growth. Although, profitability fluctuates in the short run with given levels of capitalization, in the long run levels of capitalization adjust to achieve competitive rates of return regardless of differences in size and growth. The principle that secular changes in capitalization occur through changes in capital rather than through changes in deposits and assets is established by multiple correlation analysis for banks in the United States for the period 1953-1962. On the second level of analysis, two sets of independent variables influence size, growth, and profitability. One set includes local influences. The most pervasive set of independent variables on the second level of analysis includes the nature of the economy, the environment provided by government, and the nature of the banking system.
Santomero and Watson (1977) show that too tight a capital regulation lead banks to reduce their credit offer and, as a result, give rise to a fall in productive investment (Barrios and Blanco, 2003). They argue that, from society’s viewpoint, the optimal level of capital for the banking system should be determined by the point at which the marginal public returns to bank capital (decreased chances of failure and decreased chances of disruption of the payments system) exactly equal the marginal public costs of bank capital (the opportunity cost of diverting capital from other productive uses). Under some legal and political structures, however, regulators may not consider the social costs and, therefore, will require more capital in the system than society may desire. Short provides an excellent graphical presentation. They address the question of capital adequacy macro/banking system level (Morgan, 1984). Marcus (1983) explained the dramatic decline in capital to asset ratio in U.S commercial banks during the last two decades. He hypothesized that the rise in nominal interest rates might have contributed to the fail in capital ratios, time series-cross section estimation supports the hypothesis regarding the interest rate. Jeff (1990) gave an overview of capital requirements for banks and financial institutions showing that there was no difference in capital standards for these two types of financial institutions. He said that capital adequacy was reflected in asset size as a proxy of a well-managed bank. This gave benefits for strongly capitalized banks according to poorly capitalized banks which will sell assets to raise capital. In I990's capital adequacy has become the major benchmark for financial institutions. And it was considered as a primary measure for safety and soundness. Jeff was also regards the return on assets ratio as a primary measure of a well-managed
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bank. Bensaid et al. (1995) consider the capital requirement in the context of both adverse selection and moral hazard. Adverse selection arises as the quality of the bank’s assets is private information to the bank’s owners, and moral hazard arises as the bank’s profit depend on the unobservable effort chosen by the banker. Song (1998) examined Korean banks’ responses to the Basel risk weighted capital adequacy requirements implemented in 1993. The author concluded that the higher capital requirements were generally effective because Korean banks generally did not much utilize “cosmetic” adjustments to increase their capital ratios. Reynolds et al. (2000) studied financial structure and bank performance from 1987 to 1997. Financial performance ratios which were used as dependent variables (capital adequacy, liquidity, profitability, and loan preference) were regressed to structural variables (bank assets, net income, administrative expenses and time). They have examined the financial structure and performance of banks in eight East and Southeast Asian Countries. They found that profitability and loan preferences increases with size, but capital adequacy decreases with size, so large banks have smaller capital adequacy ratios, and profit is directly related to capital adequacy. And as management (given by administrative expenses) increased from a small size, the capital adequacy ratio fill to a minimum, then increased as management became larger and larger. Yu (2000) documented bank size, liquidity and profitability are the main determinants of bank capital ratio in Taiwan. The author summarized that large banks in Taiwan have much lower capital ratios than the small banks which is consistent with the previous study where the large banks feel that they are “too big to fail”. The author also suggested that the banks mainly use internal source of capital, this contributes that more profitable banks tend to have higher capital ratios. The remarkable finding of this paper is the relationship between the equity-to-asset ratio and the liquidity ratio is significantly positive for small banks, but significantly negative for medium size banks. Aggarwal and Jacques (2001) reported that US banks increased their capital ratio without increases in credit risk. They concluded that the prompt corrective action positively and significantly affected capital ratio in both high capital and low capital banks with a faster speed of adjustment in undercapitalized banks. Rime (2001) examined the Swiss banks’ capital and risk behavior. The author adopts a simultaneous equations approach to examine whether Swiss banks which close to the minimum regulatory standards tend to increase their capital ratio. He suggests regulatory pressure has a positive and significant impact on capital ratio. However, there is no evidence of capital requirement has significant impact on the banks’ risk taking behavior. Saunders and Wilson (2001) suggested that the relationship between charter value and capital structure decisions is procyclical. Their regression results showed that during
economic booms situation, high charter value banks posses a higher capital ratio. Nevertheless, during economic recessions, higher charter value banks uphold higher losses of charter value. The most important finding of this paper is that charter value may not able to lessen the amount of risky activities that banks involved. Morrison and White (2001) state that capital adequacy requirements are then useful mainly in restricting bank size to be small enough to avoid moral hazard problems. Such regulation can be looser the better is the regulator’s reputation for auditing ability. This also suggests that capital regulation can be looser in economies where accounting procedures are more transparent. Tanaka (2002) analyzes the effect of bank capital adequacy regulation on the monetary transmission mechanism. The results suggest that using a general equilibrium framework and a representative bank, the model demonstrates that the monetary transmission mechanism is weakened if banks are poorly capitalized or if the capital adequacy requirement is stringent. Moreover, it predicts that Basel II may reduce the effectiveness of monetary policy as a tool for stimulating output during recessions. Ghoshi et al. (2003) found that Indian public sector banks have not resorted to assets substitution across the risk-weight categories by substitute low risk government securities for high risk loans in order to meet their capital requirement. This show that capital regulation does influence the banks decisions making. Chen (2003) reviews the situation and regulation of the capital adequacy of state commercial banks in China. He finds that while government support is proved to be the invisible treasure of state banks, capital enhancement is always desired and the most practical method is to use subordinated debt to increase their supplementary capital. Chami and Cosimano (2003) show that the overemphasis by regulators and market practitioners on Tier I or equity capital as the relevant constraint for banks is not necessarily supported by the Basel Accord. They show, in contrast, that the Basel Accord intended for total capital-a minimum of 8%- and not for equity capital to be the binding constraint. Navapan and Tripe (2003) explained that comparing banks’ return on equity is one way of measuring their performance relative to each other. They asserted that the proposition that there should be a negative relationship between a bank’s ratio of capital to assets and its return on equity may seem to be selfevident as to not need empirical verification. They found negative relationship between capital and profitability exists. Thampy (2004) shows the impact of capital adequacy regulation on loan growth. Since loans have the highest risk weight, a capital constrained bank would want to conserve its capital by allocating fewer assets to loans. This trend becomes more severe as the capital constraint becomes binding which is the case for banks with less than the required capital level. However, for banks with high capital adequacy ratios, there is little impact on loan growth. He also shows that in a capital
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constrained environment banks will reduce the supply of loans. It also provides an explanation for the high proportion of investments held by banks. The reduction in the supply of loans is greater for banks which are inefficient. The impact of higher capital standards on the supply of bank credit in the economy would have a greater impact in economies which have a bank dependent or dominated financial system as opposed to a capital markets dominated system. Asarkaya and Özcan (2007) analyzed the determinants of capital structure in the Turkish banking sector. They proposed an empirical model in order to identify the factors that explain why banks hold capital beyond the amount required by the regulation. They used a panel data set that employs bank-level data from the Turkish banking sector covering the period 2002 – 2006 and estimated the model with generalized method of moments. The findings of their study suggested that lagged capital, portfolio risk, economic growth, average capital level of the sector and return on equity are positively correlated with capital adequacy ratio and share of deposits are negatively correlated with capital adequacy ratio. Ahmad et al. (2008) reported new findings on determinants of bank capital ratios in Malaysia. This study presents a positive relationship between regulatory capital and banks’ risk taking behavior. The study also observes that capital requirement regulations introduced in 1996 was ineffective whereas those mandated in 1997 are proved successful in the financial crises period. Also, the study finds inconsistency with developed country literature where results shows that bank capital ratios not to been motivated by bank profitability. Toby (2008) intended to determine the effects of bank liquidity management practices (monetary policy outcomes) on industry asset quality, measured with the proportion nonperforming loans in the loans portfolio. He also investigated the effects of capital adequacy regulation on selected bank asset quality and efficiency measures. He found that the use of the minimum liquidity ratio is irrelevant in controlling industry non-performing loans. The cash reserve ratio is a more effective tool in controlling the level of non-performing loans in the industry as a whole and the distressed banks in particular. As the ratio of equity to loans advances increases, he should expect the classified loans ratio to decrease and
CAR =
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asset quality to rise, and vice versa. Under regimes of rising equity-to-total-assets ratio, he should expect the loan loss reserves ratio to fall, and vice versa. Mathuva (2009) finds that bank profitability is positively related to the core capital ratio and tier 1 risk based capital ratio. The study, using the return on assets and return on equity as proxies for bank profitability for the period 1998 to 2007, also establishes that there exists negative relationship between the equity capital ratio and equity. Ho and Hsu (2010) examine the relation between firms’ financial structures and their risky investment strategy in Taiwan’s banking industry. Their first result demonstrates that the restrictions on capital adequacy ratio have indeed affected firms’ risky investment strategies, as market share and leverage are positively related. Second, the firm performance is significantly and positively related to firm size, leverage and financial cost. Finally, the regression results show that financial structures for banking firms are positively related to the states of business cycle. DATA AND METHODOLOGY Data description and variable definitions The purpose of this study is to investigate the determinants of Turkish banks' capital adequacy ratio and its effects on financial positions of banks covered by the study. This study used secondary data and the data get from annual reports of the sample banks. Data directly took from the commercial banks balance sheet statement, profit and loss statement and from notes to account. Time study period is five years from 2006 to 2010. In Turkey have a population of commercial banks of 32 banks comprising 3 stateowned banks, 11 privately-owned banks, 1 bank under deposit insurance fund, 11 foreign banks founded in Turkey and 6 foreign banks having branches in Turkey. The study excluded bank under deposit insurance fund and foreign banks having branches in Turkey. After this selection, our final sample contains 24 banks. Panel data methodology is used in this study and analyze relationships between bank specific variables [bank size (SIZE), deposits (DEP), loans (LOA), loan loss reserve (LLR), liquidity (LIQ), profitability (ROA and ROE), net interest margin (NIM) and leverage (LEV)) and a dependent variable which is capital adequacy ratio (CAR)]. The total capital requirement requires a total risk-weighted capital adequacy ratio of 8 per cent is used as the proxy for bank capital adequacy ratio in this study. CAR is calculated according to the Formula 1, presented as below:
Shareholders' Equity Amount Subject to Credit Risk + Amoun Subject to Market Risk + Amount Subject to Operational Risk (1)
Nine bank specific variables, that are hypothesized to influence CAR, are examined. These bank specific variables are SIZE, DEP, LOA, LLR, LIQ, ROA, ROE, NIM and LEV. Their selection criteriaand a priori expectations of expected relationship with bank capital adequacy ratio are referred to previous country bank studies.
Explanatory variables and hypotheses Bank size (SIZE) The natural logarithms of total assets are used as a proxy of banks’ size. Banks' size is important because of its relationship to bank
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ownership characteristics and access to equity capital. Bank access to equity capital may reflect a relative importance of bankruptcy cost avoidance or managerial risk aversion. Jackson et al. (2002) propose that the large banks wish to keep their good ratings and therefore have considerable market-determined excess capital reserves. However, Gropp and Heider (2007) and earlier Shrieves and Dahl (1992) found that a banking organization’s asset-size is an important determinant of its capital ratio in an inverse direction, which means that larger banks have lower capital adequacy ratios. This may occur because firm size might serve as a proxy for a banking organization’s asset diversifications which reduces their risk exposure. Therefore, we hypothesize either a positive or negative relationship between bank size and capital adequacy ratio. H1: Bank size has no statistically significant impact on banks’ capital adequacy ratio.
Deposits (DEP) Share of deposit is a ratio of total deposits to total assets. Deposits are generally considered cheaper sources of funds compared to borrowing and similar financing instruments (such as financing by bond or syndication and securitization loans) for banks (Kleff and Weber, 2003). When deposits increase, banks should be more regulated and controlled to guarantee the depositors rights, and to protect a bank from insolvency. If depositors cannot assess financial soundness of their banks, banks will maintain lower than optimal capital ratios. Optimal capital ratios are those that banks would have observed if depositors could have assessed their financial positions properly. But if depositors can assess a bank's capital strength, a bank will maintain a relatively strong capital positions because greater capital induces depositors to accept lower interest rates on their deposits. Asarkaya and Özcan (2007) found a negative sign between share of deposit and capital adequacy ratio. H2: Share of deposit has no statistically significant impact on banks’ capital adequacy ratio.
bad financial situation. Blose (2001) found that reserve of loan losses caused a decline in capital adequacy ratio. Hassan (1992) and Chol (2000) also argued a negative relationship between capital adequacy ratio and loan loss reserve. H4: Loan loss reserve has no statistically significant impact on banks’ capital adequacy ratio. Liquidity (LIQ) A liquid asset to customer and short term funding are included to proxy bank liquidity. Angbazo (1997) states that as the proportion of funds invested in cash or cash equivalents increases, a bank's liquidity risk declines, leading to lower liquidity premium in the net interest margins. Therefore, an increase in bank liquidity (high LIQ) may have a positive impact to capital ratio. H5: Liquidity has no statistically significant impact on banks’ capital adequacy ratio. Profitability (ROA and ROE) In this study return on assets and return on equity are used as a proxy for profitability. In general, banks have to rely mainly on retained earnings to increase capital. Profitability and the capital adequacy ratio is most likely positively related, because a bank is expected to have to increase asset risk in order to get higher returns in most cases. Gropp and Heider (2007) found that more profitable banks tend to have more capital relative to assets. Thus, a positive relationship is expected between profitability and capital adequacy ratio. H6: Return on assets has no statistically significant impact on banks’ capital adequacy ratio. H7: Return on equity has no statistically significant impact on banks’ capital adequacy ratio.
Net interest margin (NIM) Loans (LOA) Share of loans is a ratio of total loans to total assets. This ratio is important because of it’s relationship with diversification and the nature of investment opportunity set. It measures the impact of loans in assets portfolio on capital. When risk increases, depositors should be compensated for loss so capital adequacy ratio should increase. Mpuga (2002) found a positive relationship between capital adequacy ratio and share of loans. Therefore, a positive relationship is expected between share of loan and capital adequacy ratio. H3: Share of loan has no statistically significant impact on banks’ capital adequacy ratio.
Loan loss reserve (LLR) Loan loss reserve defined as a valuation reserve against a bank's total loans on the balance sheet, representing the amount thought to be adequate to cover estimated losses in the loan portfolio. We consider loan loss reserves to gross loans ratio as a proxy of bank risk as this ratio may indicate the banks’ financial health. A negative impact of loan loss reserve in capital could mean that banks in financial distress have more difficulties in increasing their capital ratio. In contrast, a positive effect could signal that banks voluntarily increase their capital to a greater extent in order to overcome their
Net interest margin is defined as the ratio of net interest income to average earning assets. It is a summary measure of banks' net interest rate of return. While it is well known that the net interest margin is a significant element of bank profitability, however the effects of market interest rate volatility and default risk on the margins are not well recognized. The net interest margins are set by banks to cover the costs of intermediation besides reflect both the volume and mix of assets and liabilities. More specifically, adequate net interest margins should generate adequate income to increase the capital base as risk exposure increases (Angbazo, 1997). The charter value which discussed in introduction predicts a positive relationship between bank management quality and bank capital. However, bank management may reduce the capital cushioning if the default risk is very low. As a result, a negative relationship is expected between net interest margin and capital adequacy ratio. H8: Net interest margin has no statistically significant impact on banks’ capital adequacy ratio.
Leverage (LEV) The final bank specific variable is the bank leverage factors which proxy by the total equity to total liabilities ratio. Shareholder will find high leveraged banks are more risky compared to other banks,
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Table 2. Bank specific variables and predicted signs.
Bank specific variable Bank Size (SIZE) Deposits (DEP) Loans (LOA) Loan Loss Reserve (LLR) Liquidity (LIQ) Profitability (ROA and ROE) Net Interest Margin (NIM) Leverage (LEV)
Predicted sign +/+ + +/+ + and + +/+
Table 3. Descriptive statistics of study variables.
Variable Mean Median Maximum Minimum Std. Dev. Skewness Kurtosis Jarque-Bera Probability Observation
CAR 0.200 0.170 0.713 0.118 0.091 2.832 12.721 632.874 0.000* 120
SIZE 22.973 23.160 25.742 19.692 1.676 -0.107 1.832 7.055 0.029** 120
DEP 0.616 0.625 0.879 0.123 0.138 -0.973 4.840 35.858 0.000* 120
LOA 0.523 0.564 0.762 0.036 0.160 -0.933 3.337 17.993 0.000* 120
LLR 0.042 0.037 0.193 0.000 0.031 1.737 7.977 184.210 0.000* 120
LIQ 0.578 0.536 1.359 0.140 0.232 0.616 3.385 8.330 0.016** 120
ROA 0.016 0.016 0.055 -0.027 0.013 0.151 4.882 18.167 0.000* 120
ROE 0.129 0.136 0.344 -0.247 0.098 -0.486 4.409 14.656 0.001* 120
NIM 0.039 0.038 0.073 -0.085 0.018 -3.215 22.015 2014.607 0.000* 120
LEV 0..168 0.141 0.969 0.071 0.116 4.703 29.628 3987.645 0.000* 120
Note: Asterisks (*) and (**) denote the null of normality was rejected at 1% and 5% significance levels respectively.
therefore this increase required rate of return of the shareholders. Consequently, the high leveraged banks may find raising new equity difficult due to the high cost of equity capital. Ultimately, the high leveraged banks may hold less equity than low leveraged banks. Therefore, a positive relationship is expected between leverage and capital adequacy ratio. H9: Leverage has no statistically significant impact on banks’ capital adequacy ratio. Table 2 presents the summary of the selected bank specific variables that affect the capital adequacy ratio. The expected relationship between the bank specific variables and the bank capital adequacy ratio also indicated.
capital adequacy ratio by using a multivariate panel regression model. This model was useful and suitable because the research focus lied in examining the contemporaneous relationships between capital adequacy ratio and bank specific variables. Based on both theoretical and empirical literature reviewed, this study hypothesize the model between CAR and nine bank specific variables, namely SIZE, DEP, LOA, LLR, LIQ, ROA, ROE, NIM and LEV. The hypothesized model is represented as follows:
CAR = f SIZE, DEP, LOA, LLR, LIQ, ROA, ROE, NIM, LEV (2) In order to see whether the above identified bank specific variables could explain CAR, the multivariate panel regression model is formed:
Econometric model This study examined the effects of bank specific variables on
CARit = β0 + β1 SIZEit + β2 DEPit + β3 LOAit + β4 LLRit + β5 LIQit + β6 ROAit + β7 ROEit + β8 NIM it + β9 LEVit + εit In the above equation variables while
it
0
is constant and
is coefficient of
is the residual error of the regression. The
multivariate panel regression method is used to compute the estimates of the regression model stated above and all estimations have been performed in the econometrical software program EViews 5.1 whereas the ordinary calculations in Excel.
(3)
EMPIRICAL RESULTS Various descriptive statistics are calculated of the variables under study in order to describe the basic characteristics of these variables. Table 3 shows the descriptive statistics of the data containing sample means, medians, maximums, minimums, standard deviations, skewness,
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Table 4. The pairwise correlation matrix for dependent (CAR) and explanatory variables.
CAR SIZE DEP LOA LLR LIQ ROA ROE NIM LEV
CAR 1 -0.363* -0.373* -0.773* -0.234** 0.665* 0.275* -0.039 -0.611* 0.503*
SIZE
DEP
LOA
LLR
LIQ
ROA
ROE
NIM
LEV
1 0.362* 0.122 0.131 -0.322* 0.362* 0.648* 0.183** -0.425*
1 0.266* 0.181** -0.354* -0.121 0.171 0.165 -0.542*
1 0.046 -0.698* -0.274* -0.120 0.506* -0.309*
1 -0.089 -0.087 -0.034 0.196** -0.135
1 0.162 -0.150 -0.401* 0.501*
1 0.824* -0.121 0.326*
1 0.096 -0.173
1 -0.264*
1
(*) and (**) indicate significance at 1 and 5% respectively.
kurtosis as well as the Jarque-Bera statistics and probabilities (p-values). As it can be seen from the Table 3, all the variables are asymmetrical. More precisely, skewness is positive for five series, indicating the fat tails on the right-hand side of the distribution comparably with the left-hand side. On contrary, SIZE, DEP, LOA, ROE and NIM have a negative skewness which indicates the fat tails on the left-hand side of the distribution. Kurtosis value of all variables also shows data is not normally distributed because values of kurtosis are deviated from 3. The calculated Jarque-Bera statistics and corresponding pvalues are used to test for the normality assumption. Based on the Jarque-Bera statistics and p-values this assumption is rejected at 1% level of significance for CAR, DEP, LOA, LLR, ROA, ROE, NIM and LEV and rejected at 5 percent level of significance for SIZE and LIQ. The dependent and independent variables are tested for multicollinearity based on a simple correlation matrix. As depicted in Table 4, all of them are have no collinearity problem. Having concluded that none of the bank specific variables are highly correlated and no multicollinearity amongst these variables exist; the effect of bank specific bank variables on the capital adequacy ratios is examined by the Panel Data estimation. The regression results of panel data are reported in Table 5. The dependent variable (CAR) is the capital adequacy ratio. Model I and Model II correspond to cross-section fixed effects, that is, least-square-dummy-variables (LSDV) or fixed effects and cross-section random effect models respectively (Since the errors are expected to be correlated, we used panel estimates generalized least squares (EGLS) in order to get efficient estimates). The models are estimated using a panel of 120 observations for the period 2006 to 2010 derived from 24 Turkish banks. The estimated coefficients are also assigned for the ith banks with the aim of capturing the influence of specific characteristics of each individual bank.
Then, we extended the regression results in order to select which model is better; fixed effects or random effects model. A central assumption in random effects estimation is the assumption that the random effects are uncorrelated with the explanatory variables. One common method for testing this assumption is to employ a Hausman (1978) test to compare the fixed and random effects estimates of coefficients (Baltagi, 2001; Wooldridge, 2002). The intention is to find out whether there is significant correlation between the unobserved individual specific random effects (αi) and the regressors. The result of Hausman test based on chi-squared statistic as reported in Table 6 suggested that the corresponding effects are statistically significant, hence the null hypothesis is rejected by our data and fixed effects model is preferred. Finally, the analysis of the regression results is as follows. In both models, the result for LOA, LLR, ROA and ROE reveal a consistent signs and significant relationship with CAR. However, further analysis will be based on fixed effects model (Table 5, 2nd column). As Table 5, 2nd column reports that the values of adjusted R Square (0.8146) suggest that model serves its purpose in determining the effect of bank specific variables on capital adequacy ratio. In other words, 81.46% variability of the capital adequacy ratio can be explained by the SIZE, DEP, LOA, LLR, LIQ, ROA, ROE, NIM and LEV. Before analyzing the coefficients, one should look at the diagnostics of regression. In this matter, Durbin-Watson (DW) statistic can show us the serial correlation of residuals. As a rule of thumb, if the DW statistic is less than 2, there is evidence of positive serial correlation. The DW statistic in our output is 1.8606 and this result confirms that there is no serial correlation. With computed F-value of 17.3348 (p
