Capital Structure Effect On Islamic Banking Performance

Published Date: 02 Nov 2017

TABLE OF CONTENTS

Islamic banking can be defined as a system of banking that complies with Islamic law also known as Shariah law. Islamic banking contracts are the back bone to the Islamic banks’ products and services. Mutual risk and profit sharing between parties are the fundamental principles that govern Islamic banking, while the assurance of fairness for all and the transactions are based on an underlying business activity or asset.

These principles are supported by Islamic banking's core values whereby activities that cultivate entrepreneurship, trade and commerce and bring societal development or benefit is encouraged. Activities that involve interest (riba), gambling (maisir) and speculative trading (gharar) are prohibited.

Definition by Bank Negara of Malaysia

‘Through the use of various Islamic finance concepts such as ijarah (leasing), mudharabah (profit sharing), musyarakah (partnership), financial institutions have a great deal of flexibility, creativity and choice in the creation of Islamic finance products. Furthermore, by emphasizing the need for transactions to be supported by genuine trade or business related activities, Islamic banking sets a higher standard for investments and promotes greater accountability and risk mitigation.Islamic finance has grown tremendously since it first emerged in the 1970's. There are over 300 Islamic financial institutions worldwide across 75 countries According to the Asian Banker Research Group. Malaysia's Islamic finance industry has been in existence for over 30 years.  The enactment of the Islamic Banking Act 1983 enabled the country's first Islamic Bank to be established and thereafter, with the liberalization of the Islamic financial system, more Islamic financial institutions have been established. Malaysia's long track record of building a successful domestic Islamic financial industry of over 30 years gives the country a solid foundation - financial bedrock of stability that adds to the richness, diversity and maturity of the financial system. Islamic banking in Malaysia began in September 1963 when Perbadanan Wang Simpanan Bakal-Bakal Haji (PWSBH) was established. The first Islamic bank in Malaysia was established in 1983. In 1993, commercial banks, merchant banks and finance companies were allowed to offer Islamic banking products and services under the Islamic Banking Scheme (IBS). These institutions however, are required to separate the funds and activities of Islamic banking transactions from that of the conventional banking business to ensure that there would not be any co-mingling of funds. In Malaysia, the National Syariah Advisory Council additionally set up at Bank Negara Malaysia (BNM) advises BNM on the Shariah aspects of the operations of these institutions, as well as on their products and services. In June 2005, Dow Jones and Company of New York and RHB Securities of Kuala Lumpur, teamed up to launch a new "Islamic Malaysia Index" — a collection of 45 stocks representing Malaysian companies that comply with a variety of Shariah-based criteria.’– Sources from Bank Negara of Malaysia, 2010.

CHAPTER 1: INTRODUCTION

1.1 Introduction

During the global financial crisis recently (2008), many banks are experiencing losses and poor performance. Plus, the global economic and financial crisis has had a direct impact on the performance position of banks and other sectors. This global financial crisis has pushed the world economy into a severe contraction. No country is immune to the downturn. As a result, lots of research has been done to study how to measure the performance of banks and what really affects the value of the company. Many studies have shown capital structure has an impact on value or performance of the firms. Damodaran (2001) once suggest capital structure decision is the mix of debt and equity that a company uses to finance its business. He added the relationship between capital structure decisions and firm value has been extensively investigated in the past few decades. The capital structure referred to includes enterprise mixture of debt and equity financing.

Zuraidah et al. (2012) once said that bank can measure its performance by analyzing the correlation between its operating performances. For example, measure of bank’s profit efficiency (EFC) as to know the value of the company according to Berger and di Patti (2002) which used ratio of equity capital to gross total assets(CAP), standard deviation over time of the bank return on equity (SDROE), size, loan and total bank investment in securities (SEC) as variables for the result. These all variables have been used to have an influence on bank operating performance and mostly founded by most literature and been used as control variables (Berger and di Patti, 2002). Meanwhile, the bank’s profit efficiency will be based on return of asset (ROA).

According to Damodaran (2001), capital structure decision is the combination of debt and equity that been used by most of banks to it businesses. Therefore, the role of capital structure decisions have been broadly studied as to measure the bank value in the past many years. Therefore, capital structure is still one of the important financial decisions for any bank nowadays. This is because, financial decision of a company is apart from investment decisions and it is important since it involves big amount of money and has long-term implications on the bank. Besides that, decision also will help the bank’s ability to deal with its competitive environment.

In this study, return on asset (ROA) will be measurement tool as to measure the performance of the bank. Return on assets can be defined as an indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Therefore, the value of company can be measure. By doing this research, we can analyze whether there is relationship between changes of return on asset of bank with the changes of its capital structure. It will take long term debt (LTB), short term debt (STD), return on equity (ROE), total debt to capital ratio and size of bank as the capital structure.

1.2 Problem Statement

In a world full of challenge, no doubt there are some banks or companies that have succumbed to success in their race. The banks need to achieve high performance to maintain its success. Plus, high performance is not easy to attain. Many banks suffer of having deficit and bad result from their performance. These effects are more felt the impact on Islamic banks which are new in Malaysia since the system is not widely used in here. Therefore, lack of branding and perception of the brand have been the biggest problem among Islamic banking for several years. Hence, the banks have to bring the positive perception to them.

The phenomenal worldwide development over the past decade of Islamic banking and finance is drawing much attention to Southeast Asia, which, on the platform of its own economic growth success, is also proving to be the gateway for Middle Eastern petrodollar investments into the two great emerging markets of India and China. Malaysia is no exception in taking the advantage of demand. About sixty percent Malaysians are Muslims who strongly believe in prohibition of bank interest, whereas bank interest plays the pivotal role in conventional banking that had been prevalent exclusively in the country until 1983. Then realizing the issue of contradiction in faith and practice, Malaysian government established two full-fledged Islamic banks, Bank Islam in 1983 and Bank Muamalat in 1999, and encouraged conventional banks to open Islamic banking windows to make up deficiency of interest-free products and services. Accordingly, a number of local and international banks currently operate Islamic banking windows. In this highly competitive environment, Bank Muamalat has to prove its worth. Being aware of this challenge, bank management has been dynamically reviewing its strategic plans and projects. This study is an attempt in the same direction.

Another matter of concern is that bank customers having big business feel that the pricing of term-financing products of the bank is not very competitive. They also view fixed-return modes of financing significantly different from PLS modes. Furthermore, customers with longer period of relationship with the bank suggest that the bank should increase hibah payments to current account holder in order to attract more customers.

As a conclusion, banks have to maintain its good performance as to show their business in a good record. The recent financial crisis has raised important issues regarding bank capital (Berger and Bouwman, 2011). Various reform proposals involve requiring banks to hold more capital. Even though the performance can either be analyzed from the return of asset (ROA) and return of equity (ROE), but refer to Berger and di Patti (2002) the bank’s profit efficiency EFC is the closest to this research. Thus, this study will overlook in more details on how to bring the bank’s performance on a good pace by referring to return on assets (ROA) as the key to performance measurement.

1.3 Research Objectives

The main objective of this study is to measure whether capital structure can define performance of Islamic bank. Besides, it is as stated below:

1. To investigate the relationship between long term debt and Islamic bank performance (ROA).

2. To investigate the relationship between short term debt and Islamic bank performance (ROA).

3. To investigate the relationship between return on equity (ROE) and Islamic bank performance (ROA).

4. To investigate the relationship between total debt to capital ratio and Islamic bank performance (ROA).

5. To investigate the relationship between size of company and Islamic bank performance (ROA).

1.4 Research Questions

Research question is the most critical part in research. It defines the whole process, it guides the arguments and inquiry, and it provokes the interests of the reviewer. If question does not work well, no matter how strong the rest of the research, the endeavor is unlikely to be successful. Research question can be defined as statements of the specific components of the problem. This means the components of the problem will clarify the problem in specific terms, which will help in developing an approach. The research questions are constructed in order to answer the research objective. This study is aimed at answering the following questions:

1. Does long term debt has relationship with the Islamic bank performance (ROA)?

2. Does short term debt has relationship with the Islamic bank performance (ROA)?

3. Does return on equity (ROE) has relationship with the Islamic bank performance (ROA)?

4. Does total debt to capital ratio has relationship with the Islamic bank performance (ROA)?

5. Does size of company has relationship with the Islamic bank performance (ROA)?

1.5 Scope of Study

This study focuses on performance among Islamic banking institutions in Malaysia. Throughout the study, capital structure variables will be used as the factors to determine the result of performance. Hence, capital structure will be a part of method in findings the efficiency of Islamic banking institutions’ performance.

Pure Islamic banking institutions will be chosen as selected organization for target population since it is quite new in Malaysia and trying to find how efficiency of its performance since it is newly implemented here. This study will take 10 years of performance by looking at its annual financial report that will be collected from data stream. In a meantime, it is easy to track Islamic banks in Malaysia because of their population still minor in number. As a Muslim country, this study will support and justify to the world that Islamic method has its own brand and change the perception of public towards Islamic banking. This study also will promote Islamic banking system since it is still in recognition stage to the world. It is also easy to gather information since the scope is in Malaysia and close to us because it is our practice (Muslim).

1.6 Background of Study

This research intends to study on the relationship between capital structure and Islamic banking performance in Malaysia. 10 years of review will be the minimum requirement to analyze the effectiveness of the study and it is quite enough to obtain the result. In capital structure, there have two main variables as to see the bank’s performance. There are debt and equity. Capital structure theory was introduced first by Modigliani and Miller in 1958 who examined the bank's value (performance) changes though changing its capital structure. After that, lots of studies have been take part and written investigating the subject and trying to find the effect of capital structure on banking performance. Financial scholars have put great attention of an issue of capital structure and its influence on the bank financial performance and overall value since the decisive research of arguing that under perfect market setting capital structure doesn’t influence in valuing the bank (Modigliani & Miller, 1958).

The terms of capital structure has been defined by Investopedia (2013) as a mix of a company’s long-term debt, specific short-term debt, common equity and preferred equity. The capital structure is how a bank finances its overall operations and growth by using different sources of funds. Debt comes in the form of bond issues or long-term notes payable, while equity is classified as common stock, preferred stock or retained earnings. Short-term debt such as working capital requirements is also considered to be part of the capital structure (Investopedia, 2013). In a meantime, the definition of Islamic banking that been explained by Bank Negara of Malaysia (2009) is ‘banking based on Islamic law (Shariah). It follows the Shariah, called fiqh muamalat (Islamic rules on transactions). The rules and practices of fiqh muamalat came from the Quran and the Sunnah, and other secondary sources of Islamic law such as opinions collectively agreed among Shariah scholars (ijma’), analogy (qiyas) and personal reasoning (ijtihad)’.

Through the time, Malaysia's Islamic finance today continues to grow firm. This is because it has been surrounded and supported by a conducive environment that is renowned for continuous product innovation, a diversity of financial institutions from across the world, a broad range of innovative Islamic investment instruments, a comprehensive financial infrastructure and adopting global regulatory and legal best practices. Besides, Malaysia has also placed a strong emphasis on human capital development alongside the development of the Islamic financial industry to ensure the availability of Islamic finance ability. All of these value propositions have transformed Malaysia into one of the most developed Islamic banking markets in the world (Bank Negara of Malaysia, 2010).

1.7 Significance of Study

Upon completing this research I hope to have clearer understanding of what leads capital structure to Islamic banking performance. The significance of the study will be to understand how long term debt can potentially help in improve and developing performance of Islamic bank in Malaysia. In other words, knowing the relationship of the Islamic bank performance with the short term debt will theoretically help to raise the performance of the company. This research actually can give advantage to the bank as it can determine whether return on equity, total debt to capital ratio and size relate with the performance. Thus, this research can help to turn up the performance of Islamic bank.

CHAPTER 2: LITERATURE REVIEW

2.1 Capital structure and Islamic Banking performance

This literature review will be looking at two different angles which is positive and negative relationship to take on the characteristics that are closely related to each other and have similarities in the study to be performed. Various angles expressed opinion of many research papers by various experts study. This is intended to support and provide a variety of opinions in the solving of this study. Literature review can be defined as the process of reading, analyzing, evaluating, and summarizing scholarly materials about a specific topic. The results of a literature review may be compiled in this report or may serve as part of a research article, thesis, or grant proposal.

Research on the theory of capital structure was pioneered by the seminal work of Modigliani and Miller (1958). They found that the value of a firm is not affected by its financing mix when the study of financing choices initially received little attention. From the research, they concluded that the financial leverage does not affect the firm’s market value under perfect market condition on the broadly known theory of "capital structure irrelevance".

Meanwhile, according to Berger and di Patti (2002), the impact of capital structure on firm performance can be determined by analyzing the relationship between operating performance of Malaysian Islamic banks, and it will be measured by bank’s profit efficiency with looking at equity and debt of the banks generally. Hence, there are five variables founded by most literature to have an influence on Islamic bank operating performance, namely, equity capital to gross total assets (CAP), standard deviation over time of the bank return on equity (SDROE), size of bank, loan and the bank’s investment in securities. These are used as control variables. The model is written as follows:

EFC = CAP + SDROE + SIZE + LOAN + SEC

EFC: Return on Asset

CAP: Ratio of equity capital to gross total assets.

SDROE: Standard deviation return on equity

SIZE: Size of bank

LOAN: Loan obtained by bank

SEC: Investment in securities

According to the research done by Saeed et al. (2013) on the study of the impact of capital structure on performance of Pakistani banks which took five years from 2007 to 2011 to be examined, performance is measured by return on assets, return on equity and earnings per share. While the determinants of capital structure includes long term debt to capital ratio, short term debt to capital ratio, short term debt to capital ratio and total debt to capital ratio. As a result, findings of the study validated a positive relationship between determinants of capital structure and performances of banking industry.

On paper studied by San and Heng (2011), they investigate the relationship of capital structure and corporate performance of firm before and during crisis (2007). The study was focuses on construction companies which are listed in Main Board of Bursa Malaysia from 2005 to 2008. All the 49 construction companies are divided into big, medium and small sizes, based on the paid-up capital. The result shows that there is relationship between capital structure and corporate performance and there is also evidence shows that no relationship between the variables investigated. For big companies, return on capital (ROC) with debt to equity market value (DEMV) and EPS with long-term debt to capital (LDC) have a positive relationship whereas EPS with debt to capital (DC) is negatively related. In the interim, only operating margin (OM) with LDCE has positive relationship in medium companies and EPS with DC has a negative relationship in small companies. In sum, the outcome reveals that the relationship exists between capital structure and corporate performance in selected proxies.

Meanwhile, a research made by Antwi et al. (2012) on the study of capital structure and firm value: empirical evidence from Ghana showing the result that in an emerging economy like Ghana, equity capital as a component of capital structure is relevant to the value of a firm, and long-term debt was also found to be the major determinant of a firm’s value. Following from the findings of the study, corporate financial decision makers are advised to employ more of long-term debt than equity capital in financing their operations since it impacts more on a firm’s value.

A research study by Berger and Bouwman (2011) have had mentioned about capital that affect bank performance. The research addresses the issues empirically by formulating and testing hypotheses regarding the effect of capital on three dimensions of bank performance – survival, market share, and profitability – during financial crises and normal times. It has two main results. First, capital helps banks of all sizes during banking crises. Higher capital helps these bank increase their profitability of survival, market share, and profitability during such crises. Second, higher capital improves the performance of small banks in all three dimensions during market crises and normal times as well, but the effect on medium and large banks during these periods is less pronounced. Overall, the research suggests that capital is important for small banks at all times and is important for medium and large banks primarily during banking crises.

Another research examined by Salteh et al. (2010) which investigate the impact of capital structure on firm performance. The study use fifth performance measures (including return on equity, return on assets, earning per share, market value of equity to the book value of equity and Tobin’s Q) as dependent variable and four capital structure measures ( including short –term debt, long- term debt and total debt to total assets, and total debt to total equity ) as independent variable. The study was used sample of 28 Iranian companies listed in Tehran Stock Exchange (TSE). These companies belong to Vehicles and Parts Manufacturing economic sector. Companies were selected on the basis of availability of information necessary for conducting the study and the readiness of Annual Reports of the financial year 2005-2009. The results show that firm performance, which is measured by (ROE,MBVR & Tobin’s Q) is significantly and positively associated with capital structure, while report a negative relation between capital structure and (ROA, EPS). Thoroughly, the study provides evidence that indicates firm performance is positively or even negatively related to capital structure.

Luper and Isaac (2012) ever mentioned about the topic discussed which is capital structure and firm performance: evidence from manufacturing companies in Nigeria. They used annual financial statement of 15 manufacturing companies listed on the Nigeria Stock Exchange which cover a period of five years from 2005-2009. Multiple regression analysis was applied on performance indicators such as Return on Asset (ROA) and Profit Margin (PM) as well as Short-term debt to Total assets (STDTA), Long term debt to Total assets (LTDTA) and Total debt to Equity (TDE) as capital structure variables. The results show that there is a negative and insignificant relationship between STDTA and LTDTA, and ROA and profit margin (PM); while TDE is positively related with ROA and negatively related with PM. STDTA is significant using ROA while LTDTA is significant using PM. Therefore, they conclude that capital structure is not a major determinant of firm performance.

It is in similar to studies done by Khan (2012) when he studied on the relationship of capital structure decisions with firm performance: a study of the engineering sector of Pakistan. The results show that financial leverage measured by short term debt to total assets (STDTA) and total debt to total assets (TDTA) has a significantly negative relationship with the firm performance measured by Return on Assets (ROA), Gross Profit Margin (GM) and Tobin's Q. The relationship between financial leverage and firm performance measured by the return on equity (ROE) is negative but insignificant. Asset size has an insignificant relationship with the firm performance measured by ROA and GM but negative and significant relationship exists with Tobin’s Q. Firms in the engineering sector of Pakistan are largely dependent on short term debt but debts are attached with strong covenants which affect the performance of the firm.

Leverage has a negative impact on the market value of the bank, and a strong positive relationship between market value and ROA and bank deposits to total deposits is a result of research done by Abbadi and Abu-Rub (2012) on the topic to study the effects of capital structure financial performance of Palestinian institutions. The study aims at finding the relationship between the market efficiency and capital structure of Palestinian financial institutions. The study establishes a model to measure the effect of capital structure on the bank efficiency measured by ROE, ROA, Total deposit to assets, total loans to assets and total loans to deposits were used to measure capital structure. It is found that leverage has a negative effect on bank profits, an increase in each ROA and Total Deposit to Assets increase bank efficiency.

The relationship between capital structure and firm performance has long been a topic in modern capital structure literature (Shen, 2012). On the study of the effect of capital structure on firm’s performance based on 2007 data from 4 big economies in Europe: Germany, France, Italy, and UK, the study finds a negative relationship between firm’s leverage and firm’s performance and finds the relationship between capital structure and firm performance may not be linear in case of Germany and France.

2.2 Hypotheses

Hypothesis can be defined as a logical conjectured relationship between two or more variables expressed in the form of testable statement. It is also explained the influence of variables which are independent and dependent. There are two types of hypothesis which are null hypothesis and the alternate hypothesis. Null hypothesis (H0) stand for statistics that shows the result of there is no relationship or no variation exists between variables. It is the conjecture that proved no relationship between variables. It is assumed to be true until there is a result or an experiment that can be proven to show that there is a relationship between two variables, therefore alternate hypothesis (H1) take place. The alternate hypothesis is one that to considered only when null hypothesis are proving to be wrong. It is the conjecture that proved the relationship between variables.

2.2.1 Long Term Debt

Long term debt has been explained as loans and financial obligations lasting over one year. Long term debt for a bank would include any financing or leasing obligations that are to come due in a greater than 12-month period. Such obligations would include bank bond issues or long-term leases that have been capitalized on a firm’s balance sheet. Therefore, hypothesis 1 will determine the relationship long term debt and Islamic bank performance (ROA).

H1: There is a significant relationship between long term debt and Islamic bank performance (ROA).

2.2.2 Short term debt

Short term debt is an account shown in the current liabilities portion of a bank's balance sheet. This account is comprised of any debt incurred by a bank that is due within one year. The debt in this account is usually made up of short-term loans taken out by a bank. The value of this account is very important when determining a bank's financial health. If the account is larger than the bank's cash and cash equivalents, this suggests that the bank may be in poor financial health and does not have enough cash to pay off its short-term debts. Although short-term debts are due within a year, there may be a portion of the long-term debt included in this account. This portion pertains to payments that must be made on any long-term debt throughout the year. Thus, hypothesis 2 is to determine the relationship between short term debt and Islamic bank performance (ROA).

H2: There is a significant relationship between short term debt and Islamic bank performance (ROA).

2.2.3 Return on equity

The amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation's profitability by revealing how much profit a bank generates with the money shareholders have invested. Roe is more than a measure of profit and a measure of efficiency. A rising ROE suggest that a bank is increasing its ability to generate profit without needing as much capital. It is also indicates how well a bank’s management is deploying the shareholders’ capital. Therefore, hypothesis 3 is to determine the relationship between return on equity and Islamic bank performance (ROA).

H3: There is a significant relationship between return on equity and Islamic bank performance (ROA).

2.2.4 Total debt to capital ratio

Total debt to capital ratio is refers as a measurement of a bank’s financial leverage, calculated as the bank’s debt divided by its total capital. Total debt includes all short-term and long-term debt obligations. Total capital includes the bank’s debt and shareholders’ equity, which includes common stock, preferred stock, minority interest and net debt. Hypothesis 4 will determine the relationship between total debt to capital ratio and Islamic bank performance (ROA).

H4: There is a significant relationship between total debt to capital ratio and Islamic bank performance (ROA).

2.2.5 Size of banks

Size of bank will be defined as dummy variables, value of 1 if the bank has assets more than RM 1 billion and value of 0 if the bank has assets less than RM 1 billion. The more higher the assets of bank, the more bigger the size of the bank. Hypothesis 5 is to determine the relationship between size of bank and Islamic bank performance.

H5: There is a significant relationship between size of bank and Islamic bank performance (ROA).

2.3 Theoretical framework

Most research is founded on a question. The researcher or writer of the report not only questions, but ponders and develops thoughts or theories on what the possible answers could be. These thoughts and theories are then grouped together into themes that frame the subject. This is what is known as a theoretical framework. Theoretical framework can be defined as a process of identifying a core set of connectors within a topic and showing how they fit together or are related in some way to the subjects or variables. Variable has two type which are independent and dependent variables. An independent variable is the variable that is changed in a scientific experiment to test the effects on the dependent variable. Meanwhile, dependent variable is the variable being tested in a scientific experiment. In this research, capital to gross total assets, standard deviation of return on equity, size, loan and securities will be independent variable and bank’s profit efficiency tend to be its dependent variable. The framework for this theoretical study as shown below:

H1

Long Term Debt

Short Term Debt

Bank’s Performance (ROA)

H2

H3

Return on Equity

H4

H5

Total debt to capital ratio

Size

Independent Variables Dependent Variable

CHAPTER 3: METHODOLOGY

3.1 Introduction

Methodology can properly refer to the theoretical analysis of the methods appropriate to a field of study or to the body of methods and principles particular to a branch of knowledge. The data for the study are selected figures from the financial statements of 2 out of 16 from listed Islamic banks which are Bank Islam Malaysia Berhad and Bank Muamalat Berhad and been shortlisted based on the requirement, such as financial statement more than 10 years since the system implemented in Malaysia and purely deals with Islamic banking system without any mixture of other banking system. All the information will be gathered from Bank Negara Malaysia records and from the websites of the banks itself.

3.2 Research design

Research design is a detailed outline of how an investigation will take place. It will typically include how data is to be collected, what instruments will be employed, how the instruments will be used and the intended means for analyzing data collected. The study will involve the evaluating the role of Capital Structure in affecting the Islamic banking sector performance in Malaysia. Consequently, the research will be designed to achieve the objectives set out by the researcher to investigate the relationship between capital and the performance of Islamic bank. This study used survey strategy that collects quantitative data which is through the secondary data such as annual financial report.

3.3 Measurement

Measurement is at the core of doing research. Measurement is the assignment of number to things. Measurement consists of two basic processes called conceptualization and operationalization. Conceptualization is the process of taking a construct or concept and refining it by giving it a conceptual or theoretical definition. Meanwhile, operationalization is the process of taking a conceptual definition and making it more precise by linking it to one or more specific, concrete indicators or operational definitions. Thus, the study will use financial statement or annual report of Bank Islam Malaysia Berhad and Bank Muamalat Berhad. All the information and data will be obtained from the report which related to the study topic. The required data will be collected from data stream. Only Islamic bank which has 10 years and above of financial statement and type of bank will be focus only on pure based Islamic banking system will be took. The variables of used are long term debt, short term debt, return on equity, total debt to capital ratio and size of bank.

3.4 Data collection method

Secondary data is an instrument that use in this study. Secondary data is a data that have already been collected and are readily available from sources. For example, journal, magazines, internet, previous research report, company annual report, books and many more. This study tends to use secondary data since most of the finding can be found based on the information given by the bank itself such as financial statement and annual report. Method of searching and finding of data is through the bank’s website and data stream. List of Islamic banking in Malaysia can be found in the Bank Negara Malaysia website.

3.5 The Regression Model

The multiple regression analysis will be used to examine the correlation between independent variables with the dependent variables. In order to analyze all the related and interpret the finding result, the specific methods is needed to define this study. There are regression technique that includes such as the Regression coefficient (R), Empirical methodology/framework, Analytical approach, T-Test statistics, and F-Statistics.

3.5.1 Multiple Regressions

General function:

ROA = a + bLTD + cSTD + dROE + eTDCR + fSIZE

Where;

ROA = Return on Asset

LTD = Long-Term Debt

STD = Short-Term Debt

ROE = Return on Equity

TDCR = Total Debt to Capital Ratio

SIZE = Size of bank

a = Constant

b, c, d, e, f = Regression Coefficient

3.5.2 R-Squared (R2)

R2 is coefficient of determination where it is used to test the goodness of fit. It is used to determine how well the regression line fits the data. It measure how many percent of a change in the dependent variable (ROA) can be explained by the change in the independent variables, capital structure (LTD, STD, ROE, TDCR and Size).

If R2 = 0

This means none of the change in the independent variable can be measured by the change in the independent variables. The equation has no explanatory power.

If R2 = 1

This means none of the change in the dependent variable can be explained by the change in the independent variables. The equation has full explanatory power.

R2 = Sum of Square due to Regression

Total Sum of Score

Rule of thumb: The higher the value of R2, the higher the explanatory power of the estimated equation.

3.5.3 T-Statistics

T-statistics is used to determine if there is a significant relationship between the dependent variable and each independent variable. It is also used to analyses the strength of the relationship between variables and to determine the existence of correlation.

T-Stats= Value of Coefficient (b)

Standard Error of Coefficient (SE)

T= (n-k-1)

T= the critical value at certain level of significance

N= the number of observation

K= the number of independent variables

Compare computed t to book t;

Computed T value > Book T Value = Reject H0, accept H1

Computed T value < Book T Value = Reject H1, accept H0

The differences between computed – T and T – distribution will give a significant or insignificant relationship between dependent and each of the independent variables.

3.5.4 F-Statistics

F-statistics is used to test the hypotheses that the variation in the independent variables explained a significant portion of the variation in the dependent variable. F-statistic can be calculated as follows:

F= Explained variation / (k-1)

Unexplained Variation / (n-k)

The calculated F values will compared with the critical value of the F value of the F value obtain from the F distribution table. If the calculated F value is greater than book table F, there is a significant relationship between the independent variables and the dependent variable. Therefore, the overall regression model is said to be significant and vice versa.

F value > tabulated F value = Significant relationship between the independent variables and dependent variable.

3.5.5 Pearson Correlation Analysis

Pearson Correlation Analysis is a statistical analysis to describe the strength of the relationship between the dependent variables. According to the Pearson Correlation analysis, the can be ranked as follows:

Less than 0 – No or Negligible Relationship

Less than 0.30 – Weak Relationship

0.30 to 0.49 – Moderate Relationship

0.50 to 0.69 – Strong Relationship

0.70 to 0.99 – Very Strong Relationship

1.0 – Perfect Relationship

3.5 Conclusion

This research attempts to show the relationship and effect of capital structure and Islamic banking performance in Malaysia. This is aimed to meet the objectives and solve the questions regarding to the topic discuss. I hope to have clearer understanding of what leads capital structure (long term debt, short term debt, return on equity, total debt to capital ratio, and size) to Islamic banking performance. By based on the result gained soon, those sector can determine how these variables can potentially help to improve and developing performance of Islamic bank in Malaysia. As a conclusion, level and understanding of public towards Islamic banking sector in Malaysia can be more understandable in tandem with other banking sectors.