The influence of capital structure on the profitability of selected banks in Malta : an empirical study

Abstract

Capital structure and profitability are two fundamental factors of a bank. The 'capital structure' combination of a firm refers to the mix between its debt and equity employed. This decision has a significant impact on the going concern of the firm and should influence the firm's profitability. Since the publication of Modigliani and Miller's seminal papers, studies relating to capital structure have grown tremendously. However, up until recently, limited research could be found on this area, in Malta. The purpose of this dissertation is to empirically evaluate how the bank's different capital structures are affecting profitability. It will also show and analyse how selected banks are structured and funded. This dissertation provides general statistics describing the sample selected. The study uses seven year time-series regression models in order to determine a statistical relationship between short-term debt, long-term debt and profitability of banks measured through return on equity and net interest margin. The study is subdivided into five main sections. The first section describes the importance and relevance of capital structure for firms. It shows why such a study should be interesting for both academics and practitioners alike. The second section discusses the theoretical and empirical literature which other authors have written. The third section explains how the required data for the completion of this study has been carried out. The fourth section presents and discusses the empirical results, and the last section identifies the important points, draws up conclusions on the test, explains the limitations encountered, and puts forward recommendations. The analysis made highlights the differences and similarities amongst the banks sampled. The gener This implies that the banks are not accessing the long-term capital market. The reasons for this may be two-fold and are explained within the study. The relationship results obtained are in line with the empirical literature reviewed. From a statistical significance standpoint, the results are also similar to the empirical research found. The relationship between long-term debt and profitability for one bank appears to be statistically significant. This result, together with the empirical tools available, could be utilised by banks in order to improve the capital structure decisions taken. One must also point out that the statistical insignificance may be the result of the sample limitations faced by the study.