1. Zoya Khan, PhD Scholar, Bahria University, Islamabad, Pakistan.
The Third Islamic
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Determinants of capital structure of Islamic and conventional commercial banks: Evidence from Pakistan
Zoya Khan, PhD Scholar, Bahria University, Islamabad, Pakistan.
Dr. Muhammad Yar Khan, Assisant Professor, COMSATS Institute of Information Technology, Wah Campus, Pakistan.
Ehsan Karim, COMSATS Institute of Information Technology, Wah Campus, Pakistan. 1

2. Introduction The Third Islamic Finance Conference
The ideal mix of debt and equity for a firm is the one that maximizes the value of the firm and minimizes the overall cost of capital.
The debt irrelevance proposition of Modigliani and Miller (1958) in perfect capital markets.
However, if corporate taxes exist then capital structure matters a great deal because of the fact that interest is a tax deductible expense and generates a valuable tax shield (Modigliani and Miller, 1963). 3

3. Introduction The Third Islamic Finance Conference
But considering risk and consequent costs of higher debt, the trade-off theory states that firms can determine an optimal capital structure by weighing the costs and benefits of an additional dollar of debt.
The costs of debt include potential bankruptcy costs and agency conflicts between shareholders and debt holders (Fama and French, 2002).
Alternatively, pecking order theory says that firm will borrow, rather than issuing equity when internal funds are insufficient to finance the capital expenditure program (Myers and Majluf, 1984).
In sum, different conditional theories of capital structure suggest different debt levels due to the fact that each theory is based on different assumptions.

4. Introduction The Third Islamic Finance Conference
Studies have excluded the financial firms from their analysis due to the reasons that their decisions are by-product of various regulations.
Bank assets and functions are not the same as those of non-financial firms.
Little empirical research on the factors that affect the capital structure.
Comparison of commercial and Islamic Banks.
Mixed findings of earlier empirical studies. 3

5. The Third Islamic
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Introduction
Since 1947 conventional commercial banks got a dominant position in the economy of Pakistan due to limited and underdeveloped equity market.
The process of Islamization of banking and financial system of Pakistan was started in 1977.
In early 1980s several measures were taken to introduce the interest-free banking in Pakistan and as a parallel and compatible system in line with the best international practices.
Consequently, Islamic Banking Department (IBD) was established at State Bank of Pakistan on 15th September 2003. 4

6. The Third Islamic
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Objectives
1. How Islamic and conventional commercial banks choose their capital structure?
2. What are the most significant bank-specific factors that affect the capital structure of Islamic and conventional commercial banks? 2

7. LITERATURE REVIEW The Third Islamic Finance Conference
Gropp and Heider (2010) analyzed the data of 200 largest public ally traded banks in the United States and 15 European countries during
to investigate the factors that affect the capital structure.
Amidu (2007) analyzed the data of 19 banks in Ghana during to investigate the factors that affect the capital structure. Results indicate that profitability, bank size, asset structure, growth and corporate taxes are some important factors that affect the capital structure of banks.
PROFILTABILITY:
Qureshi (2009), Sheikh and Wang (2011), Sheikh and Qureshi (2014)
SIZE
Titman and Wessels (1988), Booth et al. (2001),
GROWTH
Deesomsak et al. (2004)
TANGIBILITY
Berger and Udell (1994), Nivorozhkin (2004)
EARNING VOLTALITY
Booth et al. (2001), Fama and French (2002), de Jong et al. (2008). Shibru et al. (2015)

8. Data The Third Islamic Finance Conference
To estimate the relationship between book leverage and bank-specific variables, data was taken from annual reports published by the banks listed on Karachi Stock Exchange (KSE) Pakistan during
The data of 20 conventional and 5 Islamic commercial banks was found complete for the period under study. Consequently, we obtained an unbalanced panel data due to the fact that different conventional and Islamic commercial banks listed on KSE at different point in time during the study period.
Moreover, one year data is lost due to taking change in total assets to determine the level of growth, and change in profit before taxes to measure the variations in earnings. Consequently, final sample consist of 177 bank-year observations of conventional commercial banks and 39 bank-year observations of Islamic commercial banks over a period of ten years. 5

9. VARIABLES The Third Islamic Finance Conference
Table 1: Variables’ Definition
Variable
Abbreviation
Definition
Book leverage
BLev
Total Liabilities divided by Total Assets
Profitability
Profit
Profit after tax divided by Total assets
Bank size
BSIZE
Natural log of total assets
Tangibility
Tang
Fixed operation assets divided by Total assets
Growth
Earnings volatility EV
Profit before tax-Profit before tax t-1 divided by profit after tax 6

10. Descriptive Statistics (Islamic)
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Table II: Descriptive statistics (Islamic banks)
Variable
Observation
Mean
Standard deviation
Minimum
Maximum
BLEV it 41
0.9664
0.1420
0.6023
0.8425
PROFit
0.0133
0.0177
SIZE it
18.711
0.911
16.218
19.316
GROW it
0.4904
0.6627
3.6699
TANG it
0.0495
0.0355
0.0190
0.2196
EVOL it
9.5933
53.255
16.339 8

11. Descriptive Statistics (commercial)
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Table III: Descriptive statistics (commercial banks)
Variable
Observation
Mean
Standard deviation
Minimum
Maximum
BLEV it
176
0.931
0.0544
0.678
0.984
PROF it
0.004
0.032
0.078
0.039
SIZE it
19.155
1.1044
15.92
21.392
GROW it
0.3000
0.2584
0.2277
2.9000
TANG it
0.0394
0.0267
0.0034
0.2245
EVOL it
4.394
33.544
14.580 8

12. Pair-wise correlation of Islamic banks
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Table VI: Pair-wise correlation of Islamic banks
Variable
BLEV it
PROFit
SIZE it
GROW it
TANG it
EVOL it
1.000
⃰ ⃰ ⃰
0.876 ⃰ ⃰ ⃰
0.635 ⃰ ⃰ ⃰
0.045
-0.117
-0.043
⃰ ⃰ ⃰
⃰ ⃰ ⃰
⃰ ⃰ ⃰
-0.086
0.029
0.415 ⃰
-0.006
0.228 ⃰ ⃰ ⃰
-0.114 10

13. Pair-wise correlation of Commercial banks
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Table VII: Pair-wise correlation of commercial banks
Variable
BLEV it
PROFit
SIZE it
GROW it
TANG it
EVOL it
1.000
0.067
0.307 ⃰ ⃰ ⃰
0.496 ⃰ ⃰ ⃰
⃰ ⃰
-0.007
⃰ ⃰ ⃰
⃰ ⃰ ⃰
⃰ ⃰ ⃰
⃰ ⃰ ⃰
-0.061
0.212
0.080
0.100
0.397 ⃰ ⃰ ⃰
-0.096 10

14. Pair-wise correlation of Commercial banks
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Table VII: Pair-wise correlation of commercial banks
Variable
BLEV it
PROFit
SIZE it
GROW it
TANG it
EVOL it
1.000
0.067
0.307 ⃰ ⃰ ⃰
0.496 ⃰ ⃰ ⃰
⃰ ⃰
-0.007
⃰ ⃰ ⃰
⃰ ⃰ ⃰
⃰ ⃰ ⃰
⃰ ⃰ ⃰
-0.061
0.212
0.080
0.100
0.397 ⃰ ⃰ ⃰
-0.096 10

15. The Third Islamic Finance Conference
Regression (Islamic Banks)
Variable: Dependent Variable: BLEV it
OLS FE RE
Co-efficient
t-statistics C
***
-4.62
-0.50
***
-4.61
PROFit
-1.50 **
-2.76
-1.37
SIZE it
0.0880***
6.62
0.0719***
5.54
0.0990***
GROW it
0.0147
0.84
0.0096
0.82
0.0139
0.95
TANG it
-1.53
***
-4.48
EVOL it
0.0005
0.51
-0.59
0.0002 N 41 R2
0.6195
0.5886
0.618
F-statistics
27.990
34.971
27.17
Prob (F)
0.000

16. The Third Islamic Finance Conference
Regression (conventional Banks)
Table IX: Effects of Independent variables on dependent variable of commercial banks
Variable: Dependent Variable: BLEV it
OLS FE RE
Co-efficient
t-statistics C
0.7070***
7.52
0.9458***
7.95
0.7235***
8.33
PROFit **
-3.26
-0.659***
-4.63
***
-3.75
SIZE it
0.0177***
3.67
0.0044
0.95
0.0065
2.44
GROW it
-2.47
***
-3.22
***
-3.99
TANG it *
-2.91
***
-3.77
***
-3.74
EVOL it
0.0006
0.33
0.0009*
2.77
0.0006*
2.71 N
176 R2
0.5459
0.5182
0.5434
F-statistics 16
Prob (F-stat)
0.0001
0.0000

17. The Third Islamic
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Conclusion
Results suggest that conventional commercial banks are more levered than Islamic commercial banks.
Regression results indicate that profitability is negatively related to book leverage. The negative relationship confirms the prophecy of pecking order theory.
Bank size is positively related to book leverage. The positive relationship confirms the predictions of trade-off theory.
Growth is negatively related to book leverage of conventional banks. The negative relationship is congruent with the predictions of pecking order theory and agency explanations. 12

18. The Third Islamic
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Conclusion
Tangibility is negatively while earnings volatility is positively related to book leverage. Both of the relationships are incongruent with the predictions of trade-off theory.
Only three variables namely profitability, size and tangibility have material effects on capital structure choice of Islamic commercial banks.
Alternatively, profitability, size, growth tangibility and earnings volatility are important factors that determine the capital structure choice of conventional commercial banks in Pakistan.
The notable finding of this study is that all commercial banks are highly leveraged than non-financial firms in Pakistan. 12

19. The Third Islamic
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Thank You