Determinants of Capital Structure: Analysis of the Islamic Banking Industry in the ASEAN Region

Abstract

<p><em>This study aims to evaluate the factors that influence the capital structure of the Islamic banking industry in the ASEAN region using the trade-off theory as a basis for decision-making. In trade-off theory, book leverage can proxy capital structure as the dependent variable and bank-specific factors, including profitability, earnings volatility, bank size, asset growth, asset structure, and bank age, as independent variables. In addition, it also considers macroeconomic conditions, which are manifested in the gross domestic product and the inflation rate. The study results show that total assets can affect the level of debt because fixed assets can be used as collateral when the bank takes on debt. While other factors do not have a significant effect on the debt level of Islamic banks. These results are the first empirical study to explore the determinants of the capital structure of Islamic banks in the ASEAN region with different variables from previous research and updated sample data, namely the 2016-2020 period.</em></p>

Internal Determinants of Capital Structure of Islamic Banks: Evidence from the Middle East

“…The results showed a positive impact of profitability on book leverage, and the descriptive statistics showed that ROA is close to 1.56%. This result supports the trade-off theory and Signaling Theory in the fact that highly profitable banks can increase the amount of debt to reduce taxes (Waluyani & Muflih, 2022). In other words, the increase in profit will provide a positive signal to shareholders about the financial affairs of the future of the bank for investors.…”

“…Anggareni et al (2021) and Fauziah et al (2020) showed a positive impact of Return on Assets (ROA) on the capital structure of Islamic banks. These results support the trade-off theory, in which highly profitable banks increase the amount of debt to reduce taxes (Waluyani & Muflih, 2022). In contrast, the pecking order theory predicts a negative impact of profitability on capital structure, so banks start using internal sources to finance their assets, then they use debt to finance their assets (Guizani, 2021;Sheikh & Qureshi, 2017;Saif-Alyousfi et al, 2020).…”

“…A bank with stable profits will have larger deposits and incur higher fixed expenses than a bank with fluctuating profits. A less stable bank may face a higher risk of bankruptcy so that the bank reduces its debt level (Waluyani, & Muflih, 2022). Trade off theory also predicts a negative relationship between earnings volatility and leverage.…”

“…A bank with a high growth rate of assets increases its growth opportunities. As the value of assets grows, the company has a higher growth opportunity and thus requires more capital (Waluyani, & Muflih, 2022). Khan et al (2021), Al-Harby (2019), and Gropp and Heider (2010) showed a positive impact of growth opportunities on the capital structure.…”

“…According to agency theory, pecking order theory, and theory of free cash flow, increasing the size of the bank increases customer confidence in saving their money in the bank and attracts investors to invest their money in the bank (Waluyani & Muflih, 2022). Guizani (2021), Bukair (2019), Khan et al (2021,) and Saif-Alyousfi et al ( 2020) showed a positive effect of the size of the bank.…”