The effect of capital structure on bank profitability in Ghana
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Date
2008
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Abstract
capital structure has attracted intense debate and scholarly attention across industries in the corporate finance literature over the past four decades. Nonetheless, in the context of the banking industry, the subject has received a limited research attention. Capital structure is the combination of debt and equity that make up the total capital of firms. The choice and level of this mix is crucial for efficient running of organisations (Abor, 2005)
The study investigated the relationship between capital structure and profitability of fourteen Ghanaian banks over a 10-year period, (between 1997 and 2006) using a panel data methodology. Panel data technique involves the pooling of observations on a cross-section of units over several time periods and provides results that are simply not detectable in pure cross-sections or pure time-series studies (Baltagi, 2005).
The study revealed that approximately 87% of the total capital of banks in Ghana is made up of debt. Of this, 65% constitute short-term debts while 22% is made up of long-term debts. This has re-emphasised the fact that banks are highly levered institutions and also highlights the knportance of short-term debts over long-term debts in bank financing in Ghana.
Furthermore, the study found that deposits are not important in determining shareholder value or POE) in the banking sector of Ghana. This may be due to increasing costs of doing the business f banking in Ghana, which is driving down profits among other things. However, the study has ndicated that net interest margin or profitability is significant and negatively related to debt. This implies that as deposits increase in the banking sector of Ghana, profitability expressed as net interest margin falls. This suggests that deposits are not being fully utilised in Ghanaian banks and further indicate that profitable banks in Ghana depend more on internally generated funds relative to external financing. This lends support for the pecking order theory of firm financing and also supports Amidu (2007).
Finally, the study revealed that as banks in Ghana increase in size, their profitability falls, which implies that diseconomies of scale exist in the banking sector of Ghana. However, the study observed that banks in Ghana increase their profitability as their level of sales grows.
Description
A thesis submitted to the Board of Postgraduate Studies, Kwame Nkrumah University of Science and Technology, Kumasi, in partial fulfilment of the requirements for the award of the Degree of Master of Business Administration (Banking and Finance Option)
Keywords
Capital Structure, Profitability, Debt ratios, Base Accord, Fixed effects, Panel data