1.0 capital structure effects on the performance of banking

1.0             Statement of the Problem Whenconsidering about the capital structure effects on the performance of banking sector,ithas some impacts on the performance. Therefore the capital structure of thebanking sectors has the influence on the performance of banking sector. Further,in many countries, many investors or public don’t have the perfect knowledgeand understandings when dealing with the investment activities.

Therefore, itshould be made clear understanding on the impact of capital structure on thebanking sector performance. The main problem of thisresearch is to study how the capital structure negatively or positivelyinfluences on signaling the banking sector’s performance in Sri Lanka. 1.

1             Research Question Theresearch question is what the research intends to answer, and how it willexpand the academic body of knowledge. For this study the research question isto explore the relationship between capital structure and banking sector’sfinancial performance. In this respect, the specific questions are presentedbelow:·        Does capital structure influence or is it influenced byfinancial performances and value of the banking sectors?·        What is theinterrelationship between capital structure and performance? 1.2             Objectiveof the Study Inthis research, in line with the problem statement a few objectives are outlinedas the guiding principle to this study. The research objective is the answer toa question, what will be the result of this research, or what can be learnedfrom this research? In order to answer the research questions, the objectivesare grated towards the following:·        Toidentify the relationship between capital structure and financial performanceof banking sector in Srilanka·        Toevaluate the interrelationship between capital structure and performance.·        Tofind out the impact of capital structure on profitability.·        Todetermine the determinants of a capital structure.

1.3             Significance ofthe study  A cautious attention has to be paid as faras the optimum capital structure is concerned. With unplanned capitalstructure, banking sectors may fail to economize the use of their funds.

Consequently, it is being increasingly realized that a company should plan itscapital structure to maximize the use of funds and to be able to adapt moreeasily to the changing conditions. Theoretically, the financial managershould plan an optimum capital structure for banking sectors. The optimumcapital structure is one that maximizes the market value of the firm. Inpractice, the determination of an optimum capital structure is a formidabletask, and one has to go beyond the theory. There are significant variationsamong industries and among banking sectors within an industry in terms ofcapital structure. Since a number of factors influence the capital structuredecision of a banking sector, the judgment of a person making the capitalstructure decision plays a crucial role.

Two similar banking sectors may havedifferent capital structures if the decision-makers differ in their judgment ofthe significance of various factors. A totally theoretical model perhaps can’tadequately handle all those factors, which affect the capital structuredecision in practice. These factors are highly psychological, complex andqualitative and do not always follow accepted theory, since capital markets arenot perfect and the decision has to be taken under imperfect knowledge andrisk. The board of directors of the bankingsectors should develop an appropriate or target capital structure, which ismost advantageous to the bank.

This can be done only when all those factors,which are relevant to the banking sector’s capital structure decision, areproperly analyzed and balanced. The capital structure should be plannedgenerally keeping in view the interests of the equity shareholders and thefinancial requirements of banking sectors. The equity shareholders, being theowners of the banking sectors and the providers of risk capital, would beconcerned about the ways of banking sectors operations. However the interestsof other groups, such as employees, customers, creditors, society andgovernment, should also be given reasonable consideration. In practice, for most banking sectorswithin an industry there may be a range of an appropriate capital structurewithin which there would not be great differences in the market value pershare. One way to get an idea of this range is to observe the capital structurepatterns of banking sector’s vis-à-vis their market prices of shares.

It may befound empirically that there are no significant differences in the share valueswithin a given range. The management of the banking sectors may fix its capitalstructure near the top of this range in order to make maximum use of favorableleverage, subject to other requirements such as flexibility, solvency, controland norms set by the banking sectors.