Impact of Financial Sector Opacity on the Capital Structure Choice of Asian Banks

Abstract

This study investigates the role of market imperfections on the optimal capital structure choice of value maximizing banks, by investigating the impact of information asymmetry on bank liabilities. Random effects estimation (GLS) is used to test the effect of market imperfections on the capital structure of banks by employing 7 years of unbalanced panel data from the largest 15 countries of Asia based on GDP. The study finds evidence of specific individual characteristics impacting the capital structure of Asian banks. However, banking sector market imperfections are also found to play a major role in the capital structure choice of banks. In the presence of a high level of information asymmetry between the bank and the depositor, the bank retains a lower than optimal capital ratio. Transparent banks may be successful in achieving the optimal leverage, consequently lowering their capital cost. Evidence suggests a need to reduce banking sector opacity regarding their risk exposures. To ensure banking sector stability, stronger capital requirements need to be imposed on banks in those Asian countries where information asymmetry is high. The limitations of the study include limited data and the choice of information asymmetry proxies. Future research can address this limitation by employing additional proxies for information asymmetry and increasing the number of countries.