XXV Edition

1-2 December 2016"

The Determinants of European Banks’ Capital Structure during the Last Decade and the Role Played by Regulation and Supervision: Do they really matter?

Oliveira Vitor, Bank of Portugal and University of Lisbon
Raposo Clara , University of Lisbon

In this paper we examine the determinants of European banks’ capital structure. We enlarge Gropp and Heider’s (2010) sample in order to include also private and small and medium sized banks, for a better, more comprehensive, characterization of the European banking system. Using an international sample of 494 banks from 21 European Union countries for the period between 2000 and 2012, we find that leverage is positively correlated with size and collateral, and that it is negatively correlated with profits, market-to-book and risk, which is broadly consistent with the Pecking Order and Market Timing theories. However, this is not true under all circumstances – in the case of private banks and when banks are close to the regulatory minimum of capital requirements, the “usual” capital determinants lose significance, leaving room for the supervisory and regulatory explanatory variables to play the main role. Furthermore, we find that the speed of adjustment towards target leverage is material in banks, and that the Trade-off Theory outperforms the other theories in our sample of banks. Considering that the determinants of some banks’ capital structure are similar to those of non-financial firms, showing some evidence of market discipline (mainly through the correlation between leverage and asset risk or market-to-book ratios), one might think that it would be fair for banks’ shareholders and creditors to bear the first losses and second losses respectively, in accordance with the Directive on Banking Recovery and Resolution (BRRD). Notwithstanding, one should be cautious in these interpretations, as the capital structure of some type of banks, in particular private banks, is shown to be driven by supervisory power rather than by market discipline.

Area: Banking

Keywords: Capital Structure; Banks; Europe; Regulation.

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