PONDICHERRY UNIVERSITY

Analysis of Capital Structure of

Banking Industry in India
Department of Commerce, School of Management
Pondicherry University
Guide D.Lazer (Associate Professor)

Abhishek Kumar Soni

Ajit Sahu
Subramanyam Sahoo
Meghavat Rajesh
11/07/2016

This paper analyzes the explanatory power of some of the recent theories of optimal
capital structure. This paper emphasizes on empirical and comparative study of the
top 10 largest banks in India.

Introduction

The primary objective of a firm is to maximization of its value. As the quantum and size of firm
increasing day by day, firms are having more alternatives to finance their projects. Organizations
are financing their capital needs by various alternatives according to their repaying capacity and
future orientation.
Today, financial managers are facing more problems in selecting appropriate sources of their
finance, than ever. The Capital Structure of an organization includes Long-Term Debt and Share
Capital (Equity and Preference Share) with Retained Earnings.
Sometimes financial managers prefer Debt over Equity as latter has fixed expense bearing which
are generally lower than the expectation of Equity Shareholders. But the results of the above are
not always the same. The relevance of Capital Structure is after all maximizing the Value of the firm
and Wealth of the Shareholders.
So in this regard many thinkers have given their approaches and theories to make Capital Structure
viable to the firm as well as directed towards the ultimate objective of the firm.
NEED AND SIGNIFICANCE
Capital structure decision is one of the strategic decisions taken by the financial
management.
Considerable attention is required to decide the mix up of various sources of finance. A judicious
and right capital structure decision reduces the cost of capital and increase the value of a
firm while a wrong decision can adversely affect the value of the firm various sources of
finance differ in terms of risk and cost. Hence, there is utmost need of designing an appropriate
capital structure. Capital structure decisions are of great significance due to the following reasons:

Capital structure determines the risk assumed by the firm.

Capital structure determines the cost of capital of the firm.
It affects the flexibility and liquidity of the firm.
It affects the ownership control on the firm.

Objectives of study

To analyze the Balance Sheet and Income Statements of 10 major Banks operating in India
with focus on capital structure.
Comparative study on their capital in order to get the legal and profitability position.
Why Banks?
As per Section 5(c) of the banking Regulation Act, 1949 a Banking Company means any company
which transacts the business of banking in India. Here banking transaction is explained as the

accepting, for the purpose of lending or investments, of deposits of money from public, repayable
on demand or otherwise.
From above definition it can be inferred that unlike other industries banking faces more risk in the
way of deposits from others. Whatever they borrow either as debt or equity they return to them
only as the difference of Interest on lending and Interest on deposits they receive and give
respectively.
Thats why rational decision on capital structure is not mere important but compulsory as legal
constraints because after all they manage others money.
Legal Constraints
BASEL Norms- Banking industry is governed by Bank for International Settlement (BIS), the
governing body. BIS set up Basel Committee on Banking Supervision generally known as Basel
norms. Following is the data given.

Capital Adequacy Ratio

To strengthen the capital base of the banks, the Reserve Bank of India, on the recommendations of
the Narshimham Committee introduced in April 1992, paid up capital and reserves of a bank after
writing off bad debts should form an adequate percentage (8% to 10%) of the assets of the bank,
its investment, loans and advance. All assets are assigned a risk weights. The following are data
given:

Assets

Risk

Cash in hand

0%

Balance or deposits with other Banks

20%

Investment in Govt. securities

2.5%

Investment in Govt. approved securities in other

Banks

22.5%

Other Investments

100%

Loan Guaranteed by Govt.

0%

Loan to Govt. Companies

100%

Loan covered by ECGC etc.

50%

Other Assets

100%

Acceptance, endorsements and other obligations.

100%

Literature Review:
Jaffry (2005) examined the efficiency of banking sector of Indian sub-continent over the period
1993 to 2001. An output oriented DCA is used for the estimation of the efficiency of banks. Two
outputs, i.e. interest income and non-interest income and two inputs i.e. interest expenses and
non-interest expenses were used for DEA specification to estimate the efficiency of banks under
variable returns to scale. To estimate the impact of bank characteristics, macroeconomic indicators
and financial structure variables on estimated efficiency score, they used Tobit model.
Stewart C. Myers (2005) examined the capital structure of various organizations used in different
countries in the world. He also analyzed median debt to capital ratio in 1991 in different countries.
Mohammed Getahun (2014)examined the determinants of capital structure and its impact on the
performance of Ethiopian insurance industry. He showed significant negative relationship between
leverage and performance.
Anup Chowdhury, Suman Paul Chowdhury (2014) has given the research paper on impact of
capital structure on firms value in Bangladesh perspective. He has analyzed the contrary situation
of Modigliani and Miller (M&M).
SHERIDAN TITMAN and ROBERTO WESSEL (1988) analyze the explanatory power of some of the
recent theories of optimal capital structure. The study extends empirical work on capital structure
theory in three ways. First, it examines a much broader set of capital structure theories, many of
which have not previously been analyzed empirically. Second, since the theories have different
empirical implications in regard to different types of debt instruments, the authors analyze
measures of short-term, long-term, and convertible debt rather than an aggregate measure of
total debt. Third, the study uses a factor-analytic technique that mitigates the measurement
problems encountered when working with proxy variables.
Methodology
Theories of Capital Structure
Theories of Capital Structure are conflicting in their approaches and assumptions. Some of them
are Modigliani and Miller (M&M) for which they got Nobel Prize in Economics and Durand put
forth the theories of Net Income Approach (NI) and Net Operating Income Approach (NOI)
which is also called as Traditional approach.
The traditionalists believe that capital structure affects the firms value while Modigliani and
Miller (M&M), under the assumptions of perfect capital markets and no taxes, argue that
capital structure decision is irrelevant. M&M reverse their position when they consider
corporate taxes. Tax savings resulting from interest paid on debt create value for the firm.
The Net Income and the traditional view without taxes: there are several variations of the
traditional theory. But the thrust of all views is that capital structure impact or matter for the firms
value. The earlier version view that capital structure is relevant is Net Income (NI) approach. It
works in no tax model.
The firm which finances its assets by equity and debts both is called levered firm. The firm which
finances its assets only by equity is called unlevered firm.

So the value of the levered firm would be sum of equity and debt.
V=S+B
Here V= value of the firm
S= value of equity = Net Income/Cost of equity= discounted value of net income
Net Income=NOI-Interest
B= value of debt=

= Interest/cost of debt

So cost of capital or Ko can be found out by

or

I /k d
Under the assumption that and kd and Ke remain constant, the value of the firm will be:
Ko=Ke*[1-D/v]+Kd*D/V

+
=

Net Operating Income (NOI) approach and MM hypothesis without taxes

Modigliani and Miller (MM) do not agree with the traditional view as it argue that in perfect capital
markets without taxes, a firms market value do not change with capital structure decision or
remain invariant with the change in cost of capital. It says the value of the firm depends on the
earnings and risk of its assets rather in which these are financed. MM hypothesis shows that firm
with identical net operating income and business risk, but differing capital structure, should have
same total value. For firms in the same risk class, the total market value is independent of the debtequity ratio and is given by capitalizing the expected NOI by the capitalization rate.
Value of Levered firm= Value of unlevered firm
=

Value of the firm = Net operating income/cost of capital

v=NOI/kd

Relevance of MM hypothesis under corporate taxes

MM hypothesis show that the value of the firm will increase with debt due to the deductibility of
interest charges for tax computation, and the value of levered firm will be higher than of the
unlevered firm as it enjoy tax shield on interest payment on debts.
ANALYSIS AND INTERPRETATION
The large size of the dominant market position of the bank has helped it to build up a loan portfolio
which is well diversified across industries as well as region thus cushioning the impact of problems
in certain industries moreover the increased focus on its top clients and the size of relationship
banking approach subsequent to the formation of the corporate accounting groups (CAG) has
helped the bank in retaining its top clients and also increasing them share of business from them.
METHODS OF COLLECTING DATA
Since the report required studying the theoretical as well as practical aspects of Project Finance,
the books have provided in the theoretical aspects of the study. To get the latest information,
Internet was also used as a medium at various stages. The data for the project report has been
collected from the secondary sources. Bloomberg database was very crucial for the projects.

Banks

Establishment

Headquarter NPA(in crore)

Kotak Mahindra
Bank

2003

Mumbai

Axis Bank

1990

Mumbai

HDFC Bank

1994

Mumbai

Bank Of Baroda

1908

Vododara

19406

State Bank of
India

1955

Mumbai

30313

ICICI Bank

1994

Mumbai

267.21

Punjab National
Bank

1894

Delhi

35423

Corporation
Bank

1906

Mangalore

9882

Canara Bank

1906

Bangalore

21887.07

Indian Bank

1907

Chennai

1206

Comparative and empirical study of Kotak Mahindra Bank and Axis Bank

Table 1 Axis Bank

Table 1: Axis Bank Cost of Capital (Amount in INR million)

EBIT

214077.6

268194.4

301456.1

346399

402586.8

139769

175163.1

186895.2

212544.6

241550.7

5464

7004.9

7782.5

8661.3

9782.2

82,871.6

117,812.5

153,269.3

195,598.7

258,077.7

Net Debt

441,660.5

441,051.0

527,392.2

843,935.0

1,044,937.3

Share Capital

143,945.5

213,771.3

230,691.1

253,897.2

277,509.8

Total Capital

668477.604

772634.728

911352.725

1293430.982

1580524.897

Interest
Dividend
Retained Earnings

Table 1: Axis Bank Capital Structure

Table 2 Kotak Mahindra Bank

Particulars
EBIT

FY2012

FY2013

FY2014

FY2015

FY2016

53227.5

69934.2

76242.2

84935.9

135249

Interest

36675

48368.2

50470.7

5496.13

94838.1

Dividend

372.8

450.8

543.9

684.8

791.4

73,588.0

91,494.2

111,619.4

136,723.3

185,936.5

Share capital
Net Debt

55,770.7
295,371.7

61,179.1
361,719.6

79,225.9
290,071.4

84,839.9
314,148.8

147,704.1
437,297.9

Total Capital

424730.378

514392.958

480916.713

535711.912

770938.482

Retained Earning

From the above data, it is visible that as the cost of debt (kd) increases, overall cost of capital (Ko)
increases, because of the higher portion of financing by debt. In the both companys graph it can be
interpreted that because of external factors effect cost of debt decreases drastically as cost of
capital. In 2015 Indian banks received 19.7 growth in deposits and 20.7% increase in lending.
Because of high NPA, banks are forced to retain their earning in highest proportion ever. Also
increase in market value of share and value of company they restricted their cost of capital at 3% to
4% for Axis Bank and for Kotak Mahindra it varies between 0.5% to 0.9%. The year 2015 was highly
volatile for banking industry thats why their value as well as capital affected drastically.
By the following data we can see the value change in both the companies.

The above data also affected the EPS and Profit of the company as visible in the following graph.
Constant Dividend give stability in business whereas increasing EPS gives better increased value to
the company.

Comparative analysis of HDFC Bank and Bank of Baroda Capital structure

Bank Of Baroda
Highest ever quarterly loss by an Indian bank of Rs.3,342 crore in the quarter ended December
2015.This happened on accounts of an almost five times increase in provision for bad loans.

In the above graph we can find that the EPS for the year ended 31-03-2016 has declined
tremendously. The banks net interest income for the quarter declined to Rs.2759 crore from
Rs.3,286 crore a year ago. BOBs capital adequacy ratio was 12.18 percent ratio with Tier-1 of 9.57
at the end of December 2015.Its share has fallen 6% over 6 months.

HDFC Bank
The bank had reported annual profit growth of at least 20% year since 1998, a feat unmatched by
any of the worlds 2000 biggest lenders.
HDFC Bank has been able to maintain its relatively superior performance in terms of asset quality
(stress assets ratio below 1.3%) and margins (4% levels) along with clocking healthy business
growth (20% YoY). Going ahead, we believe that with a revival in the economy and capex cycle, the
bank may see a higher than expected trajectory in corporate book, which is 44% of loan at Rs
470623 crore as on Q1FY17. Retail traction would continue to remain strong driven by personal
loans, credit cards, auto and home loans. This would enable the bank to gain market share.
We observe HDFC Bank has strategized to dig deep in the rural belt to expand markets with 900
branches opened in the last two years and 600 in rural areas of Punjab, Gujarat and other states.
The bank has a strong liability franchise with CASA of 43% (in FY05-16) and retail term deposit
comprising 85% of total deposit of Rs 546424 crore as on FY16.

Historic price and simple moving average31-03-2006

Current

%Gain / Loss

Open Price

154.3

1250

High Price

156.8

1251

Low Price

152.4

1242

Last Price

154.7

1243.7

703.94

Volume

573085

314855

-45

The stock is valued at 5.6 times net assets, within 5% of the highest level since 2008 as per data
compiled by Bloomberg show.
In 2008 Centurion bank was acquired by HDFC bank for Rs. 95,100 million. HDFC has a capital
adequacy ratio of 15.7% at the end of September & a gross bad loan ratio of 1%.That compares
with 12.8% and 4.5%, respectively, for Indian banking system as a whole.

Comparative Study of SBI and ICICI

ICICI and SBI are the two largest banks in India, having around 40 percent domestic market share.
Both enjoy better reputation as well as customer loyalty than any other banks in India. We are
analyzing capital structure and its impact on value of both the company.

Particulars
EBIT
Interest
Dividend

FY 2012 FY 2013 FY 2014 FY 2015 FY 2016

331949.7 394084.1 442971.6 497714.4 553789.3
228085 262091.8 277025.9 300515.3 315153.9
16816.9 20150.7 24250.4 26276.6 26281.4

Long term Borrowing

Share Capital
Retained Earning
Total Capital

1,612,966.2 1,728,882.2 1,835,420.7 2,112,520.0 2,203,776.6

325,527.4 326,073.6 327,153.9 330,725.7 333,692.2
287,237.6 361,550.6 437,144.6 516,319.8 607,415.0
2225731.178 2416506.324 2599719.213 2959565.467 3144883.687

Table 1: ICICI Bank Capital Structure

Particulars
EBIT
Interest
Dividend
Retained Earnings
Share Capital
Long term Borrowing
Total Capital
Table 2 State Bank of India capital structure

FY 2012
FY 2013
FY 2014
FY 2015
FY 2016
948039.1 1064075.2 1191778.7 1362953.2 1500613
632303.7
753258 870686.2 973818.2 1068034.9
20521.6
24627.9
19412.6
20366.3
16838.1
770,451.2 928,477.9 1,051,792.8 1,191,962.8 1,300,466.1
291,848.9 321,852.3 421,912.6 421,912.6 505,457.5
1,579,913.6 2,037,232.0 2,237,597.1 2,446,634.7 2,582,143.9
2642213.728 3287562.186 3711302.456 4060510.099 4388067.567

From the above data it is clear that, SBI is running cautiously because of NPA and creating higher
reserves by retaining its earnings, whereas ICICI showing stable growth over the year. In the year
2015, SBI became paralyze in growth perspective.
ICICI Bank
16
14
12
10
Ke
8
6

Kr
Kd
WACC

4
2
0
FY 2012 FY 2013 FY 2014 FY 2015 FY 2016

The overall cost of capital remained somehow constant over the period of five years for both the
companies.
We also analyzed the effect of Capital Structure on EPS and we found something obvious that

Both the companies suffered huge reduction in EBIT which has proportionate impact on EPS.
As the Capital of both the companies are increasing the value is also increasing , as visible in the

Value as per NI Approach

Value as per NOI Approach

2642213.728 3287562.186 3711302.456 4060510.099 4388067.567

3543028.481 4120721.095 4712930.434 5262117.054 5836572.448

following data:

Value as per NI Approach

Value as per NOI Approach

2225731.178 2416506.324 2599719.213 2959565.467 3144883.687

2844493.42 3126565.039 3451218.196 4004789.195 4473966.148

Comparative analysis of Canara Bank and Indian Bank

EBIT
Interest
D iv id end

2 9 1 0 4 .4 7
2 3 1 6 1 .3 1
4073

D eb ts
Retain ed Earn in g s
S h are Cap ital
Tota l C a p ita l

EB IT
In teres t
D iv id en d
D eb t
Retain ed Ea rn in g s
S h a re cap ital
To t a l C a p it a l

3 2 0 8 8 .9 5
2 6 1 9 8 .9 4
4780

3 7 3 9 9 .3 6
3 0 6 0 3 .1 7
4 2 1 1 .5

4 1 0 3 6 .7 4
3 4 0 8 6 .3 7
4 3 0 2 .1

4 1 4 0 5 .4 3
3 4 2 5 8 .7 7
0

1 5 6 ,1 4 4 .2
2 0 3 ,5 5 0 .9
2 7 3 ,0 9 7 .2
2 5 7 ,6 2 8 .2
2 6 9 ,6 3 4 .2
1 6 6 ,2 8 9 .4
1 5 6 ,7 1 2 .2
1 9 5 ,2 1 2 .9
2 0 5 ,8 3 7 .6
1 8 0 ,3 3 9 .6
6 4 ,1 4 4 .6
9 5 ,0 5 2 .0
1 0 6 ,5 4 9 .8
1 1 9 ,0 7 9 .5
1 4 3 ,7 5 7 .2
3 8 6 5 7 8 .2 0 1 4 5 5 3 1 5 .1 5 2 5 7 4 8 5 9 .8 6 2 5 8 2 5 4 5 .2 8 6 5 9 3 7 3 0 .9 7 4

3 2 1 3 .2
2 5 6 1 .6 9
5 7 0 .5

4 0 0 2 .0 5
3 1 5 3 .4 6
7 8 2 .4

4 5 0 0 .6 4
3 6 1 6 .2 9
8 9 2 .4

4 8 0 1 .9 9
3 9 1 9 .9 9
6 4 0 .6

4 9 2 6 .7 8
4 0 4 7 .5
5 3 7 .7

7 5 ,4 3 5 .2
6 7 ,4 0 6 .1
3 7 ,6 9 7 .3
180 538.6

2 8 ,6 2 5 .6
7 5 ,2 7 0 .9
4 1 ,6 5 7 .3
1 45553 .8

4 9 ,6 3 8 .7
9 1 ,6 7 9 .1
4 4 ,5 5 7 .3
18587 5.1

2 6 ,4 6 0 .9
9 6 ,4 1 7 .4
5 3 ,8 7 2 .2
17675 0.5

3 5 ,0 9 3 .2
1 0 9 ,2 4 7 .7
5 5 ,6 5 0 .7
199 991.6

The debt portion is almost 45% for Canara Bank of Total Capital and for Indian Bank it is 17%.
Retained Earning (30% ) and Equity almost (25%) contribute almost 55% of the total capital for Canara Bank and it is
almost 82% for Indian Bank.
The cost of capital for Indian Bank is almost 42% less than Canara Bank as it is visible from graph below.

Cost of Capital remained below 4% in all five years for Indian Bank whereas, for Canara Bank it decreased every year
but remained above 6%.
EPS cause great concern for both the companies. Canara Bank EPS declined to negative at -45 because of high NPA
which stood at 21887.09 crore for the 2nd quarter of the FY 2015-16. Indian Bank also faced decreasing EPS because
of NPA which was stood at Rs.1206.35 crore for the same period.

Comparative and Empirical study of Punjab National Bank and Corporation Bank

Table 7 PNB

Table 8 Corporation Bank

As the data shows both the companies was not able to allot dividend to their shareholders because of high retained
earnings for provision of NPA. Punjab National Bank total capital his almost 20 percent higher than Corporation Bank.
Almost 66 percent capital was financed by debt by PNB whereas, it was almost 54 percent for Corporation Bank.
Retained earning was almost 18% and 22% for PNB and Corporation Bank respectively of total capital.
Cost of debt for PNB was 3% whereas for Corporation Bank it was almost 14% as shown in the following graph.

The average cost of capital is declining for both the company, because of less EPS and Higher Debt for Ke and Kd
respectively.

EPS for both the companies are negative for the FY 2015-16, As NPA mounted to Rs.35423 crore for PNB and
Rs.9882.15 crore for Corporation Bank.

Conclusion
From all the above data and calculation it can be inferred that:
The variation in capital structure always affects the profitability of the company.
In current scenario the NPA is most influential factor for profitability of the companies.
Constant dividend should be followed continuously.
Debt form most crucial part of the capital which is averagely costs less than other sources of
capital.
In practical, some assumptions of NOI and NI approaches do not work because of variations
in both the sources i.e. Equity and Debt.
EBIT is the most influential factor for determining market value of a company.

References
Bloomberg Database at University Library
Companies Website
Moneycontrol.com
The Economics Time
The Business Line
CMIE Prowess database at School of Management
Abhinav International Monthly Refereed Journal of Research In Management and
Technology
Researchgate
UGC Sodhganga.