THE IMPACT OF CAPITAL STRUCTURE ON BANK PERFORMANCE
Capital Structure of a bank refers to their volatile financial liquidity standing. Most bank capital, especially during start-up came from combinations of various debts and equity proportion coming from shareholders to finance the company’s needs this will balance their leverage that signifies a good standing of the bank. Debts can be acquired in the form of bonds and long term credit while equity can be acquired through the participation of stakeholders or common stocks and retained earnings. A combination and proportion of such acquisition of funds can be used as a working capital.
It is also a common belief that the impact of Capital Structure can be determined to be strong if through the estimation of capital on hand is less their debt just like most business and this is the best conditions of a Capital Structured Banks although this may not mean that a bank will be stable in their future conditions but most likely they will if they have learned to maintain their good capital structure. Business may change depending on operation and eliminating the risk of liquidity is hard to determine but a good capital structure can prevent the bank from imbalance debt and equity proportion. This does not mean that the bank structure will hold their capital in this stagnant position. Most banks will play-up with basic restructuring let’s say that a certain bank start-up in good capacity and they have already acquired such balance.
Banks will need to engage in various investments or asset building business opportunities and they will naturally use the capital to this engagement and it is only through this participation they are going to earn and grow their capital. In particular they will need to leverage their capital in acquisition of land, machineries and buildings. With the increased amount of asset and decrease in the capital the question would be do they have a good return in their investment that can compensate to the equity or to their debt? This is remain to be seen in their future operation if they have a good investment and the return of investment is quiet doing well they have established a good capital structure but if their investments turns out to be non soluble this means that their liquidity is at risk it can affect their capital structure up to the extent of bankruptcy.
In a situation like this, banks should not overspend through acquisition and business participation but they need to budget their money in various investment if they want to keep their liquidity beyond risk. Putting all eggs in one basket is a major risk in capital re structuring therefore banks can divide their investment from various business engagements until they found the right one to invest their largest shares. To be able to safe-keep their hard earn capital they may choose to engage in a low risk business but it can also acquire only a lower earning opportunity so they have an option to also engage themselves to high risk but high profit margin.
It is up to them to decide if they want to participate in high risk but high income business but the capital restructuring with this thing in mind promotes a high risk investments and banks should be ready to prepare themselves with a lot re-structuring. In a simple term the impact of capital restructuring depends on their allocation and business distribution. The stakeholders as a capital provider of equity and debt capital will also be affected through risk so they should also be kept in mind during this time since they are highly involved in such decisions. As a stakeholder they may want to know if such engagement is secure so they may feel comfortable that their investment is protected. The right choice of capital restructuring is what they want.
Capital Structure in a simple understanding should benefit the bank positively and should not be the reasons for their downfall. Another impact of Capital Structure is capital scarcity; this happens in Argentina, Argentine Domestic Retail Banks that most of these banks have gone through several periods of changes including Capital Restructuring during 1994. They are able to manage the changes and they have reduced asset risk brought about by foreign banks Mexican devaluation. They have adjusted immediately in their situations and able to cope up with such situations. They may have used excess assets from retained earnings as an emergency source of funds but if a certain bank does not have this kind of Capital Structure the impact can be as damaging as insolvency or bankruptcy that can also result in total sales or prohibition of the bank to act as a balance of payment for their equity and debt.
References:
http://www.casact.org/library/astin/vol38no1/341.pdf http://www.imf.org/external/pubs/ft/wp/wp98121.pdf http://www.ecb.int/pub/pdf/scpwps/ecbwp1096.pdf
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