The impact of capital structure on bank profitability: evidence from Vietnam

Pham, Nam Hai; Hoang, Tri M.; Pham, Nhung Thi Hong Article The impact of capital structure on bank profitability: evidence from Vietnam Cogent Business & Management Provided in Cooperation with: Taylor & Francis Group Suggested Citation: Pham, Nam Hai; Hoang, Tri M.; Pham, Nhung Thi Hong (2022) : The impact of capital structure on bank profitability: evidence from Vietnam, Cogent Business & Management, ISSN 2331-1975, Taylor & Francis, Abingdon, Vol. 9, Iss. 1, pp. 1-25, https://doi.org/10.1080/23311975.2022.2096263 This Version is available at: https://hdl.handle.net/10419/289014 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/4.0/ Full Terms & Conditions of access and use can be found at https://www.tandfonline.com/action/journalInformation?journalCode=oabm20 Cogent Business & Management ISSN: (Print) (Online) Journal homepage: www.tandfonline.com/journals/oabm20 The impact of capital structure on bank profitability: evidence from Vietnam Nam Hai Pham, Tri M. Hoang & Nhung Thi Hong Pham To cite this article: Nam Hai Pham, Tri M. Hoang & Nhung Thi Hong Pham (2022) The impact of capital structure on bank profitability: evidence from Vietnam, Cogent Business & Management, 9:1, 2096263, DOI: 10.1080/23311975.2022.2096263 To link to this article: https://doi.org/10.1080/23311975.2022.2096263 © 2022 The Author(s). This open access article is distributed under a Creative Commons Attribution (CC-BY) 4.0 license. Published online: 10 Jul 2022. Submit your article to this journal Article views: 9209 View related articles View Crossmark data Citing articles: 5 View citing articles BANKING & FINANCE | RESEARCH ARTICLE The impact of capital structure on bank profitability: evidence from Vietnam Nam Hai Pham 1 , Tri M. Hoang 2 and Nhung Thi Hong Pham 3 Abstract: The purpose of this research is to determine the effect of capital structure on the profitability of Vietnamese commercial banks. Specifically, it investigates the relationship between capital structure and profitability using an imbalanced panel data set of Vietnamese commercial banks from 2012 to 2018, a critical period for implementing the Prime Minister’s decision (254/QD-TTg) on restructuring the Vietnamese commercial banking system. To depict the capital structure of Vietnamese commercial banks, the authors employ customer deposits and nondeposit liabilities. The study findings, based on a dataset of 30 Vietnamese commercial banks, indicate that customer deposits have a negative effect on bank profitability, whereas non-deposit liabilities have a positive effect on bank profitability. Study findings imply that Vietnamese commercial banks should conduct more thorough and equitable evaluations before lending to assure the quality of both assets and loans. Additionally, it is essential to conduct a more thorough analysis of investment projects and long-term loans to assure the bank’s asset quality. This study contributes to the existing literature by examining how capital structure affects the profitability of Vietnamese commercial banks, an area where prior research has been deficient. Subjects: Economics; Finance; Banking Keywords: Capital structure; profitability; commercial bank; panel data; Vietnam JEL Classification: G20; G21; C23 1. Introduction Because many highly leveraged banking institutions collapsed or had to be bailed out by authorities, the financial crisis has reignited interest in the function of bank capital. Bank collapses result in high social costs, which explains capital requirements for financial organizations (Berger et al., 1995). Increased capital levels enable banks to withstand greater disruptions and reduce shareholders’ motivation to take on unnecessary risks. Since The Prime Minister (2006) approved a scheme to develop Vietnam’s banking sector, Basel II has been an essential goal for banks to set out and fulfill. According to Circular no. 41/2016/TT-NHNN (The State Bank Of Vietnam, 2016), commercial banks and foreign bank branches must comply with Basel II’s capital adequacy ratio of at least 8%. In 2018, The State Bank Of Vietnam (2018) issued Circular no. 13/2018/TT-NHNN to regulate the internal control system of commercial banks and foreign bank branches in compliance with the Basel II standards. Until 2021, 13 major banks complete the Basel II requirements and embark on the Basel ABOUT THE AUTHOR About the authorTri M. Hoang is a Ph.D. student at the University of Economics Ho Chi Minh City, Vietnam. He is also a lecturer at Vietnam’s Ho Chi Minh City University of Technology (HUTECH). His research interests include behavioral finance and markets, as well as empirical asset pricing. Nam Hai Pham is a lecturer at Banking University Ho Chi Minh City. His research interest includes bank risk management and bank governance. Pham et al., Cogent Business & Management (2022), 9: 2096263 https://doi.org/10.1080/23311975.2022.2096263 Page 1 of 25 Received: 24 January 2022 Accepted: 22 June 2022 Corresponding author: Tri M. Hoang, Faculty of Finance and Commerce, HUTECH University, Ho Chi Minh City, Vietnam Postal Address: 475A Dien Bien Phu, Ward 25, Binh Thanh District, Ho Chi Minh City, E-mail: [email protected] Reviewing editor: David McMillan, University of Stirling, Stirling, UK Additional information is available at the end of the article © 2022 The Author(s). This open access article is distributed under a Creative Commons Attribution (CC-BY) 4.0 license. III implementations (Nhue Man, 2021). The Basel III agreements, in particular, provide a more stringent framework for bank capital standards. By demanding larger amounts of common equity, this policy enforces an improvement in capital quality. It also mandates a minimum leverage ratio that takes into consideration the overall assets of institutions as well as off-balance-sheet entities. Such capital restrictions are justified as being socially beneficial since they minimize financial volatility in the economy. According to Carney (2013), only well-capitalized banks can satisfy the actual economy’s demands to generate strong, long-term expansion. Banking institutions and economies have succeeded when capital has indeed been restored and balance sheets reconstructed. Conversely, such capital demands may force the economy to make trade-offs. Excessive capital standards, banks contend, will imperil their profitability. This may happen, for instance, if the cost of funding for banks rises dramatically as a result of increased capital holdings. Higher finance costs may translate into a reduced return on investment (ROI) for banks, as well as a disruption in lending. Economic theory is ineffective in resolving this argument since there is no agreement on the impact of capital structure on bank profitability. Furthermore, as the current financial crisis has shown, greater risk—which can be related to greater leverage—is generally linked to higher potential (Admati et al., 2013), therefore the ROE assessment should account for risk-taking. Different perspectives on capital structure can be found in the literature. Modigliani and Miller’s (1958) theorem, which is based on the notion of perfect markets, states that a bank’s capital structure choice has little bearing on its total value. Another body of research focuses on the disciplinary effect of debt on managers (Diamond & Rajan, 2000; Hart & Moore, 1995). As a result, expanding capital may cause managers to lose their discipline, resulting in poor performance. Lastly, the third point of view contends that optimal capital structure reduces the moral hazard between shareholders and debtholders (Diamond, 1984). Monitoring, on the other hand, is expensive, and banks require inducement to monitor on behalf of their debtors. Greater amounts of capital, according to this theory, improve the banks’ interests to supervise their debtorsas shareholders will receive a bigger proportion of asset payoffs and suffer further in the event of failure. This illustrates why capital ratios may have a favorable impact on the profitability of banks. Larger margins, either from improved efficiency or from increased market dominance, could be used to generate such a rise in ROE and ROA. Our empirical technique is to look at the numerous factors that influence the ROE and ROA and see if the leverage ratios play a role. Yet, it is beyond the scope of this study to discuss how the ROE and ROA might change. This research adds to the body of knowledge in several ways. First, the paper is the first to examine what determines the bank capital structure in Vietnam. The conventional textbook response is that banks’ financing choices do not have to be investigated because capital regulation is the overarching divergence from Modigliani and Miller’s hypotheses. For example, due to the high expenses of retaining capital, bank management frequently desires to maintain less bank capital than the regulated amount. The level of bank capital required in this situation is defined by the bank capital standards (Mishkin, 2016). Interpreted correctly, this means that the leverage ratio of banks subject to the Basel I regulatory framework may have little cross-sectional change, as it mandates a consistent capital ratio. The capital ratios of banks vary, but the average number has dipped from 9.931% (2012) to 7.825% (2019), which is below the minimum capital adequacy ratio (8%), according to the Circular no. 41/2016/TT-NHNN (International Monetary Fund, 2021). The figures suggest that the capital structure of banks should be investigated thoroughly. Second, according to J. A. J. A. Batten and Vo (2016), Vietnamese banks are under stress to diversify their sources of non-traditional revenue. Income differentiation, on the other hand, necessitates modifications in the capital structure of the bank. Greenlaw et al. (2008) believe that rather than legal restraints, banks’ active control of their capital structures in connection to internal value-at-risk was a primary destabilizing element. Aside from current concerns over high levels of non-performing loans, the traditional practices of Vietnamese commercial banks are also causing worry among many stakeholders (J. J. Batten & Vo, 2019). It is interesting to investigate how bank capital structure supports income diversification and Pham et al., Cogent Business & Management (2022), 9: 2096263 https://doi.org/10.1080/23311975.2022.2096263 Page 2 of 25 complies with authority regulations. Finally, while the State Bank of Vietnam is still a central bank, it is now regarded as a ministerial-level institution of the Vietnamese government (Vo, 2016), raising concerns about giving state-owned banks preferential treatment over other banks. Such incentives assist state-owned banks in becoming preferred lenders for public infrastructure projects, which may be a significant source of revenue. As a result, state-owned banks may have a different capital structure than other banks to sustain their operations and investments and create profits. Banks can better meet their debt obligations with Basel II and Basel III of CAR regulations. With a higher CAR ratio, the bank’s capital structure is financed with more bank capital and is safer to operate. However, too high or too low a CAR ratio is not good, and a reasonable CAR ratio is needed for banks (Nguyen et al., 2021). In Vietnam, 92.4% of the banks have the optimal CAR higher than the minimum ratio of 10.5% defined in BASEL III (Nguyen et al., 2021). It means that Vietnamese banks need to increase capital and reduce debt in their capital structure for better profits and safer operations. 2. Literature review 2.1. Theoretical perspectives There is a large theoretical literature on the impact of capital on bank worth. There are three points of view, each leading to an opposite conclusion. The first is built on Modigliani and Miller (1958)’s framework (hereinafter referred to as M&M), which states that the ratio of capital to assets has little or no influence on the value of banks. The second hypothesis is that too much capital will depreciate the value of banks. A third contends, on the other hand, that more capital has a favorable impact on bank profitability, resulting in increased value. Assessing the relationship between capital and bank performance remains an empirical topic owing to such diverse beliefs (Berger & Bouwman, 2013; Oyetade et al., 2021). Financing options have no impact on asset cash flows under the M&M framework. As a result, altering the equity/debt balance does not influence the firm value. When equity financing is increased, the cost of equity drops as asset risk and leverage reduce. This impact illustrates why, notwithstanding that the cost of stock is higher than the cost of debt, the funding composition is neutral for the firm value. Miller (1995) questions the applicability of this approach to banks and claims that nothing stops the cost of capital from falling as capital rises. He further points out that deviations from the M&M hypotheses, which are based on taxes and agency problems, do not justify the varying capital levels of enterprises across sectors in a systematic way. Besides, the conventional opinion is that capital regulation represents an extra, overriding divergence from the Modigliani-Miller irrelevance argument when it comes to bank capital structures (Begenau, 2020; Berger et al., 1995; Miller, 1995; Santos, 2001). Deposits in commercial banks are guaranteed to safeguard depositors and maintain financial stability. Commercial banks must be compelled to keep a minimum level of capital to offset the moral hazard of this coverage. The study sample comprises major commercial banks in Vietnam that offer unambiguous deposit protection throughout the implementation of Basel I’s standard capital requirement. In the end, traditional corporate finance variables should have no predictive power for the capital structure of the banks in our sample when it comes to regulation. According to the second view, Berger and Bouwman (2013) point out that banks frequently claim that adopting stricter capital requirements will result in a drop in banking performance. This viewpoint has received some support in the literature. Agency tensions between managers and shareholders can be increased with additional bank capital, according to Jensen and Meckling (1976) and Schwert (2018). The disciplinary role of debt is well-documented in the field of corporate finance (Crouzet, 2018; Hart & Moore, 1995). By developing an equity buffer, the manager might attempt to detach herself from market discipline. On the other hand, debt financing forces management to make effective decisions to pay back creditors regularly. Due to the presence of information asymmetries, debt may offer benefits over the capital. Executives may have access to confidential information about the progression of a company’s yields or investment prospects. By issuing debt, the company Pham et al., Cogent Business & Management (2022), 9: 2096263 https://doi.org/10.1080/23311975.2022.2096263 Page 3 of 25 demonstrates to outside investors its capacity to settle the principal and debt interest, as well as its financial stability (Leland & Pyle, 1977; Ross, 1977; Zeitun & Goaied, 2022). Bank debt, on the contrary, is distinct from corporate debt. In truth, a significant portion is owned by minor insured depositors who lack the motivation or capacity to oversee institutions (Bertomeu et al., 2022; Dewatripont & Tirole, 1994). Hence, bank debt may not have as strong a disciplinary effect as corporate debt indicates in the literature. Diamond and Rajan (2001) provide a banking model called “fragile financial structure” (i.e. funding based on a substantial percentage of deposits) that is required for a bank to legitimately pledge to extract all of the benefits from its partnership lendings. The bank might decide not to supervise after lending on a whim. Yet, the theory predicts that in that situation, depositors can run on the bank, forcing it to keep an eye on the debtor. In this situation, expanding capital could result in lower loan valuation and lower liquidity formation. The third view states that banks holding capital cushions see their profitability and value increase. Banks keep excessive (cushioned) capital, or discretionary capital, over the regulatory minimum to prevent the burden of getting to issue new shares on an urgent basis (Ayuso et al., 2004; Migueis, 2019; Peura & Keppo, 2006). As a result, banks that must issue stock at a greater cost might be less leveraged. According to Myers and Majluf (1984) and Himmelberg and Tsyplakov (2020), firms keep cushioned capital because asymmetric information increases the cost of raising capital. Because dividend-paying banks, banks with larger profits, or banks with higher market-tobook ratios are either better recognized by external investors and have more financial flexibility, they should anticipate experiencing reduced costs of issuing stock. The impact of bank size on cushion size is unclear. If larger banks are more known in the market, they may have lower cushions. Major banks, on the other hand, may keep more cushions if their operations are more complicated, making asymmetric information more valuable. Cushion sizes should be determined by the likelihood of going underneath the regulatory level. Besides, the moral hazard between shareholders and debt holders explains the third view in two ways. The first channel depends on the debt holders’ risk premium. Due to the limited liability of shares, the possible shortfall of equity investors is restricted. Risk-taking, on the other hand, increases gains. This encourages people to take unnecessary risks at the cost of the other stakeholders. Debt holders expect this action and demand a higher interest rate from banks to finance them. As a result, debtors’ market discipline drives banks to hold positive capital reserves (Anderson et al., 2021; Calomiris & Kahn, 1991). Increased capital decreases shareholders’ readiness to assume unnecessary risks. Besides, when the bank is better funded, debt holders want a smaller premium. Finally, increased capital requirements mean lower financing costs, resulting in a higher ROE. The presence of a deposit protection plan, which makes deposits risk-free, diminishes the efficiency of this mechanism since covered depositors do not need to pay a premium when the bank’s risk level rises. This method might still work via uninsured borrowers if they don’t believe the bank is too large to collapse. The second route is built on the bank’s surveillance activities. The (expensive) monitoring effort is reliant on bank capital: larger capital embodies the expected losses associated with insufficient monitoring. As a result, the bank has more motivation to keep track of its capital ratio as it rises. Bank’s capital structure is expected to influence asset cash flows because monitoring impacts loan payoffs. Holmstrom and Tirole (1997) propose a model in which the monitoring activities of banks are proportional to their capital ratio. Mehran and Thakor (2011) provide a dynamic framework that incorporates the costs and advantages of increasing capital ratios. Holding capital is expensive in their model, although the marginal cost varies for every bank. Monitoring is a function of capital ratio: banks have a greater motivation to monitor if they have more capital. Allen et al. (2011) propose a model in which the capital ratio encourages the bank to assess the situation more closely. Higher capital ratios result in excess banking relationships. They find a rationale for the presence of capital buffers in addition to the regulator’s requirements. Rising capital ratios are thus compatible with profit creation. Yet, it is logical to believe that increased capital yields lower marginal returns, hence the beneficial effects of rising capital ratios on ROA and ROE would not last above a certain level. Pham et al., Cogent Business & Management (2022), 9: 2096263 https://doi.org/10.1080/23311975.2022.2096263 Page 4 of 25 2.2. Empirical evidence After the empirical investigation of Short (1979), Molyneux and Thornton (1992), Angbazo (1997), and Michelle Clark and David (1997), a large body of research looked at the variables that impact bank performance for a variety of economies and nations throughout the globe. Performance is determined by the individual features of banks, sectors, and nations. Others researched areas and territories (Athanasoglou et al., 2008; Berger & Bonaccorsi Di Patti, 2006; Demirgüç-Kunt & Huizinga, 1999; Oyetade et al., 2021), while others focused on a single country (Amidu, 2007; Athanasoglou et al., 2008; Nguyen et al., 2021; Saona, 2016). Considering that profitability is driven by unique features of banks, sectors, and nations (A et al., 2013; Molyneux et al., 2019), another class of studies aimed to assess the importance of capital structure factors on bank-level performance indices (Ayalew & McMillan, 2021; Berger & Bonaccorsi Di Patti, 2006; Berger & Bouwman, 2013). Unfortunately, these previous studies produced inconsistent results about the effect of capital structure on the bank performance (in respect of sign, degree, and importance), resulting in the lack of a coherent and shared view of the ideal capital decision for banks. Over the period 1990–1997, Demirgüç-Kunt and Huizinga (1999) discover a positive and substantial association between capitalization and bank performance in the OECD and developing nations. Better capitalized banks, in particular, experience reduced bankruptcy costs, lowering capital costs and increasing profitability. Recent studies confirm evidence when they examine banks in the Sub-Saharan region from 2000 to 2006 and find that capital structure does not influence bank effectiveness, whereas profitability has a negative and significant impact on capital structure (Adesina et al., 2015; Sufian & Habibullah, 2009). Similarly, Amidu (2007) looked at 19 Ghanaian banks from 1998 to 2003 and discovered that short-term debt hurt profitability, meaning that competitive banks have less short-term debt on their financial statements. According to Gupta and Mahakud (2020), bank scale, non-performing loan ratio, and income dispersion are the primary factors of the success of commercial banks in India via an examination of 19 years for 64 Indian commercial banks. In addition, the data demonstrate that the influence of bank size, bank age, labor productivity, and income dispersion on the profitability of Indian banks throughout the crisis period is substantial. The increased non-government shareholding improves the efficiency of India’s commercial banks. The bank’s efficiency improves as its capital adequacy increases. The bigger banks generate fewer profits. The findings give a deeper understanding of the factors that influence the performance of Indian banks. According to Mohanty and Lin (2021), the expense and revenue effectiveness of the Chinese banking business has increased dramatically from the pre-Basel II period, between 1996 and 2006, to the Basel II era, between 2007 and 2017. Subperiod evaluations indicate that the risk-based capital ratio is positively related to profitability between 1996 and 2017. 2.3. Hypothesis development Empirical data on the relationship between capital structure and bank profitability yields conflicting and inconsistent conclusions and few studies on frontier markets have been done. Furthermore, whereas most theories and empirical data about bank capital structure done in advanced nations assume a positive relationship between capital structure and bank profitability, research undertaken in emerging and frontier markets has indicated mixed results. Specifically, Berger and Bonaccorsi Di Patti (2006) demonstrate that data from the banking industry supports the corporate governance theory that leverage impacts agency costs and hence improves bank performance. Besides, banks have a distinct capital structure than non-financial businesses since their capital is primarily supported by client deposits (Gropp & Heider, 2010). The capacity of a bank to raise capital on a routine basis is shown by customer deposits. In the entire capital structure of commercial banks, this is the greatest source of capital. Gropp and Heider (2010) use the data of the U.S banks and European banks to confirm the positive relationship between customer deposits/ non-deposit liabilities and bank profitability. Anderson et al. (2021) examine banks in Ethiopia and find that higher profitability measures are positively related to total and short-term leverage ratios. Pham et al., Cogent Business & Management (2022), 9: 2096263 https://doi.org/10.1080/23311975.2022.2096263 Page 5 of 25 However, Amidu (2007) and Adesina et al. (2015) examine banks in the Sub-Saharan region and find a negative relationship between bank profitability and capital structure. Using Vietnam as a typical frontier market, we formulate the hypothesis as follows: H1: There is a positive relationship between leverage and bank profitability in Vietnamese commercial banks. H1a: There is a positive relationship between the customer deposit and bank profitability in Vietnamese commercial banks. H1b: There is a positive relationship between the non-deposit liabilities and bank profitability in Vietnamese commercial banks. 3. Methodology 3.1. Data The study uses unbalanced panel data from 2012 to 2018. The data is collected from the financial statements of 30 Vietnamese commercial banks, and the macroeconomic data is collected from the General Statistics Office of Vietnam. The commencement date for the data was selected due to significant problems in gathering adequate data before 2007, as well as the effects of State Bank of Vietnam’s Decision No. 457/2005/Q-NHNN, Circular no. 41/2016/TT-NHNN, and Circular no. 13/ 2018/TT-NHNN requiring Vietnamese banks to apply the Basel I and II. In 2018, Vietnamese banks that complete the implementation of Basel II embarks on the Basel III application. The data were organized in a panel format to make use of the benefits of estimating with a larger set of observations or degrees of freedom, hence enhancing estimator efficiency. Furthermore, panel data analysis allows for the management of unobserved time-invariant heterogeneity such as cultural variables or variations among organizations; and it allows for the assessment of the dynamics of individual behaviors that cannot be calculated using crosssectional data. Lastly, using panel data, instrument variables are simpler to get to tackle endogeneity, which is a prevalent issue in studies-in particular, exogenous factors in prior periods used as instruments for endogenous variables in the present period Arellano and Bond (1991). As a result, panel data give a plethora of instruments. 3.2. The variables 3.2.1. Measure of bank profitability Financial ratios determined from financial statements, firm market value, and Tobin’s q, which combines market and accounting valuation, were all employed in previous studies (Berger & Bonaccorsi Di Patti, 2006). When market ratios are harder to achieve, academics turn to book performance ratios like return on assets (ROA), return on equity (ROE), earnings per share (EPS), and net interest margin (NIM). ROA and ROE are also employed in banking research (Ercegovac et al., 2020; Flamini et al., 2009; Obamuyi, 2013; Zeitun, 2012; Zeitun & Goaied, 2022). Given the comparatively low equity of banks in developing countries, ROA, frequently combined with ROE, is the most often used measure of bank performance (Flamini et al., 2009; Saona, 2016; Sufian, 2011; Zeitun, 2012; Zeitun & Goaied, 2022). ROA represents the capacity of management to gain from bank assets (Obamuyi, 2013). The return on equity (ROE) is a financial statistic that assesses a bank’s earnings from its equity. The figure demonstrates how well the bank’s management is utilizing the shareholders’ funds. This study employs ROA because Vietnamese banks have limited off-balance sheet operations that relate directly to their profitability, as indicated by the low share of investment in total assets Pham et al., Cogent Business & Management (2022), 9: 2096263 https://doi.org/10.1080/23311975.2022.2096263 Page 6 of 25 (Trujillo-Ponce, 2013). The ROE is used as a secondary measure to ROA because it disregards the financial risk of leverage (Athanasoglou et al., 2008). 3.2.2. Measure of capital structure Banks have a distinct capital structure than non-financial businesses since their capital is primarily supported by client deposits (Gropp & Heider, 2010). Bank capital structure can be represented by different proxies, including total debt ratio (TD)-the total debt to total asset and short-term debt ratio (SDT)- the short-term debt to the total asset (Ayalew & McMillan, 2021), customer deposits-total deposits to total assets and non-deposit liabilities to total assets (Gropp & Heider, 2010; Al-Qudah., 2014 #1337}. This researchuse customer deposits and non-deposit liabilities as capital structure measures. 3.2.3. Measure of control variables Based on the work of J. J. Batten and Vo (2019), D. V. Tran et al. (2020), Nguyen and Nguyen (2016), and other studies, this study included a variety of control factors. Table 1 summarizes the control variables employed in this investigation, as well as their measures. 3.3. Data analysis For the panel data regression model, three commonly used methods are (1) The least-squares estimator (Pooled OLS); (2) the Fixed Effect Model (FEM); and (3) Random Effect Model (REM; Zdaniuk, 2014). Considering the factors in the study, the OLS model is: xit¼αþyi;tβþμit where i is bank and t is time and x it : the dependent variable of bank i in year t y it : K × 1 vector of explanatory variables β: K × 1 vector of constants μ it : error term However, the OLS model considers banks as homogeneous, all observations are grouped regardless of whether there are differences between banks. This often does not reflect reality because each bank is an entity with its characteristics. Thus, the OLS model can lead to biased estimates when these individual effects are not taken into account. With REM and FEM models, we can control these separate effects, specifically as follows: xit¼αþyi;tβþwit Where w it = u i + µ it , where u i represents the discrete effects that do not change over time and are unobserved for each bank i. The main difference between OLS and the two models REM & FEM is the existence of index u i . While OLS does not consider this factor, REM and FEM allow and control Table 1. Control variables employed in this study Control variables Definition Expected results Bank size Natural logarithm of total assets + Bank loans Total loans/total assets + Operating costs Operating costs/total assets - Inflation Annual inflation rate - GDP growth Annual GDP growth + Pham et al., Cogent Business & Management (2022), 9: 2096263 https://doi.org/10.1080/23311975.2022.2096263 Page 7 of 25 Table 5. The effect of capital structure on bank profitability -RE and FE models Dependent variable: ROA Dependent variable: ROE (1) (2) (3) (4) (5) (6) (7) (8) RE RE FE FE RE RE FE FE DEP -0.0166* -0.0194* -0.1445* -0.1578* (0.0036) (0.0041) (0.0343) (0.0394) NONDEP 0.0100* 0.0116** 0.1405* 0.1332* (0.0037) (0.0044) (0.0343) (0.0412) SIZE 0.0015* 0.0012* 0.0012 0.001 0.0310* 0.0280* 0.0425* 0.0364* (0.0004) (0.0004) (0.0012) (0.0014) (0.0029) (0.0029) (0.0121) (0.013) LOAN 0.0098 0.0067** 0.0115** 0.0072 0.1019* 0.1046* 0.1128** 0.0982** (0.0039) (0.004) (0.0049) (0.0052) (0.0326) (0.0333) (0.0469) (0.0132) OPE 0.3838* 0.4332* 0.2997* 0.3831* 3.7399* 4.0567* 1.8079* 2.3666** (0.0753) (0.0776) (0.1002) (0.1018) (0.608) (0.6127) (0.9433) (0.9345) INFLAT 0.0281 0.0382** 0.0286 0.0395** 0.2761 0.2804 0.2847 0.3446*** -0.0176 -0.0183 -0.0188 -0.0194 -0.2182 -0.2189 -0.1772 -0.1787 GGDP 0.0746 0.0951 0.0795 0.1021 1.4236*** 1.2671 0.762 0.957 (0.0744) (0.0776) (0.1045) (0.1087) (0.8554) (0.8669) (0.9839) (0.8669) Constant -0.0498* -0.0555* -0.0401 -0.0503 -1.0531* -1.0840* -1.3499* -1.3038* (0.0121) (0.0148) (0.0381) (0.0409) (0.1049) (0.1045) (0.359) (0.3762) Observations 206 206 206 206 206 206 206 206 Adj R–squared 0.3228 0.3398 0.3597 0.3192 0.4125 0.4465 0.4719 0.4685 F-test 21.3576 19.0654 32.45 22.0621 27.1565 22.4178 25.1576 23.3102 Prob > F 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 Standard error in parentheses; *significant at the 10% level; **significant at the 5% level; ***significant at the 1% level. Pham et al., Cogent Business & Management (2022), 9: 2096263 https://doi.org/10.1080/23311975.2022.2096263 Page 14 of 25 4.7.2. Non-deposit liabilities Unlike customer deposits, non-deposit liabilities have a positive impact on ROA and ROE in all regression models. When commercial banks mobilize more with non-deposit liabilities, the bank’s financial leverage also increases accordingly. Different from mobilizing capital from customer deposits, which often have many different terms or demands, Vietnamese commercial banks mobilize capital from non-deposit liabilities with higher interest rates and longer terms. The positive relationship between non-deposit liabilities shows that the use of capital from nondeposit liabilities is effective and increases ROA and ROE. Vietnamese commercial banks use nondeposit liabilities to finance projects or loan portfolios with long terms and high-interest rates, increasing the efficiency of assets and equity. This result is consistent with the agency theory, research hypothesis, and studies of Berger and Bonaccorsi Di Patti (2006) but different from the study of D. E and R (2007). 4.7.3. Control variables Research results show that bank size (SIZE) has a positive impact on the ROA and ROE of Vietnamese commercial banks, supporting the view of the market power theory. This research result is consistent with the research hypothesis and studies of Sufian (2011), Alexiou and Vogiazas (2009), and Kosmidou et al. (2007). Large-scale banks have better access to customers, more diversified products, reputable brands, and a high level of trust among customers and investors, and can invest in more modern technologies and have a competitive advantage due to scale, favoring the concept of scale-efficiency. As a result, commercial banks with large scale achieve higher profitability. Table 6. The effect of capital structure on bank profitability—FGLS method Dependent ROA Dependent ROE (1) (2) (3) (4) DEP −0.0129* −0.1445* (0.0032) (0.0337) NONDEP 0.0081* 0.1405* (0.0044) (0.0337) SIZE 0.0014* 0.0012* 0.0310* 0.0280* (0.0002) (0.0002) (0.0029) (0.0029) LOAN 0.0086* 0.0066** 0.1019* 0.1046** (0.0031) (0.0052) (0.0321) (0.0327) OPE 0.4566* 0.4467* 3.7399* 4.0567* (0.0571) (0.0588) (0.5975) (0.6022) INFLAT 0.0264 0.0375** 0.2761 0.2804 (0.0205) (0.021) (0.2145) (0.2151) GGDP 0.0786 0.0923 1.4326*** 1.2671 (0.0804) (0.0832) (0.8407) (0.8521) Constant −0.0519* −0.0553 −1.0531* −1.0840* (0.0098) (0.01) (0.1031) (0.1027) Observations 2056 2056 2056 2056 Prob > F 0.0000 0.0000 0.0000 0.0000 This table reports the results of examining the relationships between capital structure measured by customer deposits to total assets (DEP) and Non-deposit liabilities to total assets (NONDEP), and bank profitability measured by ROA, and ROE. Statistics were based on annual data for the years 2012–2018. Columns 1 and 2 examined the effects respectively of DEP and NONDEP on return on assets (ROA). Columns 3 and 4 examined the effects respectively of DEP and NONDEP on return on equity (ROE). There are five control variables: bank size (SIZE), bank loans (LOAN), operating costs (OPE), inflation (INFLAT)), and GDP growth (GGDP). Standard error in parentheses; *significant at the 10% level; **significant at the 5% level; ***significant at the 1% level. Pham et al., Cogent Business & Management (2022), 9: 2096263 https://doi.org/10.1080/23311975.2022.2096263 Page 15 of 25 Bank loan has a positive impact on the profitability of Vietnamese commercial banks, consistent with the study of Sufian (2011), Le (2017), and Rahman et al. (2015). A bank with a high loan-toasset ratio means that it strategically focuses on lending and holds more interest-bearing assets. In other words, the more banks expand their lending activities, the more financially efficient they will be. This is the main revenue and profit-generating activity for Vietnamese commercial banks, but the risks that banks face are also higher. Operating costs (OPE) have a positive impact on profitability. Banks with high operating costs can increase the profitability of Vietnamese commercial banks. The period 2012–2018 is the period when Vietnamese commercial banks restructure and rearrange the banking system, and renovate the banking administration system towards modernity, in line with international practices and standards (The Prime Minister, 2012). At the same time, banks also restructured business activities towards safer and healthier. As a result, the management and administration activities of banks have become more professional, approaching modern banking governance standards, actively cooperating in technology transfer, and strategic cooperation with global banks. This result is consistent with the study of Molyneux and Thornton (1992) and the research hypothesis. The results show that inflation has a positive impact on the ROA and ROE of Vietnamese commercial banks. High inflation can help banks to impose high lending rates, but there is a potential risk in the future because high loan interest rates will create a burden on the debt repayment budget. When interest rates rise, the difference between deposit rates and lending rates will increase, leading to an increase in the bank’s profit. Table 7. The effect of capital structure on bank profitability—System two-step GMM estimator Dependent ROA Dependent ROE (1) (2) (3) (4) DEP −0.044* −0.0536** (0.0017) (0.0696) NONDEP 0.001 0.7720* (0.0013) (0.0287) SIZE 0.0007* 0.0008* 0.0342* 0.0281* (0.0002) (0.0003) (0.0115) (0.0122) LOAN 0.0026 0.0004 0.0896* 0.1005* (0.0021) (0.002) (0.0291) (0.0304) OPE 0.4976* 0.5267* 2.8768* 3.0351* (0.0453) (0.047) (0.6593) (0.6316) INFLAT 0.0410* 0.0454* 0.2627* 0.2767* (0.0088) (0.0089) (0.1066) (0.1032) GGDP 0.2088* 0.2233* 0.749 0.8932 (0.0453) (0.0464) (0.6471) (0.6246) Constant −0.0428* −0.0501* −1.1974* −1.0719* (0.0082) (0.0092) (0.345) (0.3552) Sargan-Hansen test 0.2042 0.2229 0.1149 0.1273 AR(2) p-value 0.4996 0.5325 0.5849 0.6494 This table reports the results of examining the relationships between capital structure measured by customer deposits to total assets (DEP) and Non-deposit liabilities to total assets (NONDEP), and bank profitability measured by ROA, ROE, which are estimated by the system GMM estimator. Statistics were based on annual data for the years 2012–2018. Columns 1 and 2 examined the effects respectively of DEP and NONDEP on return on assets (ROA). Columns 3 and 4 examined the effects respectively of DEP and NONDEP on return on equity (ROE). There are five control variables: bank size (SIZE), bank loans (LOAN), operating costs (OPE), inflation (INFLAT)), and GDP growth (GGDP). Standard error in parentheses; *significant at the 10% level; **significant at the 5% level; ***significant at the 1% level. Pham et al., Cogent Business & Management (2022), 9: 2096263 https://doi.org/10.1080/23311975.2022.2096263 Page 16 of 25 When the economic growth is high, the borrower’s ability to repay is also guaranteed and the loan quality is better. In addition, the good quality of economic growth has a positive impact on the investment portfolio, increasing the asset value, and cash flow of banks, resulting in higher profitability. The research result is similar to the studies of Kohlscheen et al. (2018), Athanasoglou et al. (2008), Trujillo-Ponce (2013), Athanasoglou et al. (2008), and Nguyen and Nguyen (2016), and Le (2017), and Tran (2014) and is consistent with the research hypothesis. Additional analysis on the use of Tier 1 capital to total assets as the dependent variable in the models are stated in the Appendix section (see Appendix Table 8–11). 5. Conclusion and policy implications The study was conducted to evaluate the impact of capital structure on the profitability of Vietnamese commercial banks. Due to the difference between the capital structure of enterprises and commercial banks, the author uses customer deposits and non-deposit liabilities to represent the capital structure of Vietnamese commercial banks. Using the dataset of 30 Vietnamese commercial banks from 2012–2018, the research results show that customer deposit hurts bank profitability and non-deposit liabilities have a positive on bank profitability in all regressions. Besides, the factors of bank size, bank loan, operating costs, inflation, and GDP growth have positive impacts on the profitability of Vietnamese commercial banks. On that basis, the authors propose some solutions to the capital structure of Vietnamese commercial banks to be more reasonable to achieve better profitability, specifically as follows: Firstly, it is necessary to use customer deposits more effectively. Vietnamese commercial banks need to make a more thorough and reasonable appraisal when lending to ensure the quality of assets as well as the quality of the bank’s loans. When a bank’s assets increase but its asset quality is worse, it will lead to long-term consequences, such as the inability to recover capital to meet customers’ withdrawal needs, increasing liquidity risk, and default risk of banks. Second, non-deposit liabilities are sources of long-term loans for banks. Banks often invest in projects or long-term loan portfolios with higher interest rates and longer terms. Although nondeposit liabilities increase the bank’s profitability, it is necessary to carefully evaluate the use of this capital. Specifically, it is necessary to more thoroughly appraise investment projects as well as long-term loans, ensuring the quality of the bank’s assets in the long term. Finally, commercial banks need to consider increasing capital to reduce financial leverage and balance harmoniously between the profit of shareholders and the risks of commercial banks. The limitation of this study is that it only evaluates the impact of capital structure on the profitability of Vietnamese commercial banks. Meanwhile, the capital structure can affect both profitability and risk of a bank. Therefore, in the next studies, the author will evaluate the impact of capital structure on the risk of commercial banks in Vietnam and expand to Southeast Asian countries. Funding The authors received no direct funding for this research. Author details Nam Hai Pham 1 Tri M. Hoang 2 E-mail: [email protected] ORCID ID: http://orcid.org/0000-0001-8311-3972 Nhung Thi Hong Pham 3 1 Faculty of Banking, Ho Chi Minh University of Banking, Ho Chi Minh City, Vietnam. 2 Faculty of Finance and Commerce, HUTECH University, Ho Chi Minh City, Vietnam. 3 Ho Chi Minh City College of Economics, Ho Chi Minh City, Vietnam. Disclosure statement The authors declare that they have no conflicts of interest. Correction This article has been corrected with minor changes. 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The nexus between debt structure, firm performance, and the financial crisis: Non-linear panel data evidence from Japan. Applied Economics, 54(40), 1–19. https://doi.org/10.1080/ 00036846.2022.2033680 Pham et al., Cogent Business & Management (2022), 9: 2096263 https://doi.org/10.1080/23311975.2022.2096263 Page 20 of 25 Appendix Table 8. The effect of capital structure on bank profitability—pooled OLS regression Dependent ROA Dependent ROE CAP 0.0564*** (0.0109) 0.0391 (0.1227) SIZE 0.0024*** (0.0003) 0.0298*** (0.0029) LOAN 0.0006 (0.0026) 0.0316 (0.0326) OPE 0.3348** (0.0619) 3.7848** (0.6915) INFLAT 0.0524 (0.0196) 0.5222* (0.2194) GGDP 0.2125 (0.0795) 2.1866* (0.8554) _cons −0.1012** (0.0138) −1.1315*** (0.1458) Observations 206 206 Adj R–squared 0.3829 0.4251 F-test 22.02 24.53 Prob > F 0.0000 0.0000 Table 8 reports the results of examining the relationships between capital structure and bank profitability, which were estimated by Pooled OLS models. Statistics are based on annual data for the years 2012–2018. The capital structure is measured by Tier 1 capital to total assets (CAP), and bank profitability is measured by ROA and ROE. Statistics were based on annual data for the years 2012–2018. There are five control variables: bank size (SIZE), bank loans (LOAN), operating costs (OPE), inflation (INFLAT)), and GDP growth (GGDP). Standard error in parentheses; *significant at the 10% level; **significant at the 5% level; ***significant at the 1% level Pham et al., Cogent Business & Management (2022), 9: 2096263 https://doi.org/10.1080/23311975.2022.2096263 Page 21 of 25 Table 9. The effect of capital structure on bank profitability—RE and FE models Dependent ROA Dependent ROE RE FE RE FE CAP 0.0764** (0.0117) 0.0193** (0.0136) 0.1898 (0.1253) 0.4094** (0.1449) SIZE 0.0033*** (0.0005) 0.0087*** (0.0013) 0.0379*** (0.0065) 0.0754** (0.0147) LOAN 0.0002 (0.0034) 0.0025 (0.0040) 0.0226 (0.0369) 0.0341 (0.0430) OPE 0.2002** (0.0808) 0.0830 (0.0970) 2.3454** (0.8794) 1.5148 (1.0330) INFLAT 0.0547** (0.0159) 0.0333* (0.0166) 0.5488** (0.1658) 0.4005** (0.1767) GGDP 0.2148* (0.0704) −0.0430 (0.0960) 2.1958*** (0.7491) 0.3873 (1.0226) Constant −0.1297* (0.0179) −0.0519* (0.2868) −1.3845* (0.2052) −2.4575* (0.4398) Observations 206 206 206 206 Adj R–squared 0.3702 0.4243 0.3053 0.3325 F-test 25.72 20.88 35.56 24.11 Prob > F 0.0000 0.0000 0.0000 0.0000 Table 9 reports the results of examining the relationships between capital structure and bank profitability, which were estimated by fixed and random effect models. Statistics are based on annual data for the years 2012–2018. The capital structure is measured by Tier 1 capital to total assets (CAP), and bank profitability is measured by ROA and ROE. Statistics were based on annual data for the years 2012–2018. There are five control variables: bank size (SIZE), bank loans (LOAN), operating costs (OPE), inflation (INFLAT)), and GDP growth (GGDP). Standard error in parentheses; *significant at the 10% level; **significant at the 5% level; ***significant at the 1% level To select the appropriate model between FE and RE, the Hausman test was performed. The results of chi-square statistics are all insignificant at the 10% level, favoring the RE model over the FE model. The Wald test also shows that the FE model is better than pooled OLS. Hence, the RE estimator was used to investigate the effect of capital structure on bank profitability. The results of the LM tests show that Prob>Chi2 > 0.05, showing that the models do not have heteroscedasticity. Wooldridge tests result show that Prob>F = 0.0000 < 0.05, so it is concluded that autocorrelation occurs in all models. To control this problem, the FGLS method (Feasible Generalized Least Square) was applied. Pham et al., Cogent Business & Management (2022), 9: 2096263 https://doi.org/10.1080/23311975.2022.2096263 Page 22 of 25 Table 10. The effect of capital structure on bank profitability—FGLS method Dependent ROA Dependent ROE CAP 0.0546*** (0.0100) 0.0391 (0.1206) SIZE 0.0024*** (0.0003) 0.0298*** (0.0039) LOAN 0.0006 (0.0026) 0.0316 (0.0292) OPE 0.3348* (0.0608) 3.7048** (0.6796) INFLAT 0.0524* (0.0193) 0.5222** (0.8727) GGDP 0.2125* (0.0781) 2.1866* (0.9727) Constant −0.1012** (0.0128) −1.1357 (0.1433) Observations 206 206 Prob > F 0.0000 0.0000 Table 10 report the results of examining the relationships between capital structure and bank profitability, which were estimated by FGLS models. Statistics are based on annual data for the years 2012–2018. The capital structure is measured by Tier 1 capital to total assets (CAP), and bank profitability is measured by ROA and ROE. Statistics were based on annual data for the years 2012–2018. There are five control variables: bank size (SIZE), bank loans (LOAN), operating costs (OPE), inflation (INFLAT)), and GDP growth (GGDP). Standard error in parentheses; *significant at the 10% level; **significant at the 5% level; ***significant at the 1% level Using the FGLS method can help to control unobserved effects as well as heteroskedasticity; however, the endogenous issue, which leads to biased and inconsistent estimators, may still exist. This is caused by the inability to ascertain if a simultaneous reverse relation link exists between capital structure and bank profitability. In addition, the capital structure can be considered simply an indicator of unobserved features that influence profitability. To strengthen the research outcomes, a system two-step GMM was applied to cope with the endogenous problem. Pham et al., Cogent Business & Management (2022), 9: 2096263 https://doi.org/10.1080/23311975.2022.2096263 Page 23 of 25