Nonfinancial and financial firms do not have the same capital structure because of differences in the financial condition

and nature of operations. Banks have to provide liquidity through current account demands and credit to their depositors. In order to meet depositors demand banks are concerned with liquidity The banks are also concerned with successively managing the market and credit risk competitive forces with in the banking sector and regulatory pressures from regulatory authorities play important role in determining overall banking strategy.

Theories of capital structure

Irrelevance theory is considered as starting point of modern capital structure theories presented by Modigliani and Miller (MM) in 1958. They argued that that source of finance of a firm does not have effect on firm market value assumes that that there will be no taxes, no brokerage costs, etc.

Trade off theory (TOT) the target debt to equity ratio is set by balancing between the benefits and costs of equity and debt. Firms assume optimal capital structure. The debt is provided with tax shield results in lowering of the cost of capital and maximizing value of firm.

According to pecking order theory (POT) This theory argued that the firms would use its internal funds first than would go for borrowing. There would be no target capital structure or fixed debt to equity ratio internal equity, short term borrowing, long term borrowing and equity financing.

The agency cost theory (ACT) Agency costs between equity and debt play main role in determining optimal capital structure. The principle agent conflict and asymmetric information are the prime causes of agency costs

Signalling theory (ST) The external borrowing is used to give positive signals to the market. As a result share holders trust increases in the firms. Issuing new equity give negative signals showing that firms have no stable cash flows.

Determinants used in previous studies conducted in developing countries

The variables used in most of the previous studies are profitability, firm size, growth, tangibility of assets, operating risk and nondebt tax shields.

Ferri and Jones, 1979 identified four determinants i.e. business risk; industry type operating leverage and firm size. Carleton and Silberman, 1977; and Marsh, 1982 used fixed assets; growth opportunities; operating risk; firm size; and non-debt tax; expenditures of advertisement; research and development; insolvency; volatility of earnings; profitability; and uniqueness of products as determinants of capital structure

 In 1981 Aggarwal used growth rate; international risk; profitability and country effect is an important factor in determining of capital structure. Park (1998) also identified national culture as independent variable.

 Myres and Majluf, 1984 proved that capital structure is positively correlated with firm size, while profitability can either be negative or positively related to leverage. Smith and Warner, 1979 showed that dividend policy also play important role in determining capital structure

 Shahjahanpour et al., 2010 used variables as, product uniqueness, dividend policy, non-debt tax shields, liquidity, and effective tax rate.

Determinants used in previous studies conducted in Pakistan

In 2007 Shah conducted a study by using textile industry data. This study used three independent variables (size, profitability and tangibility). In 2007 Shah and Khan extended the previous research by adding more year s data, explanatory variables and relevant models of panel data.

Determinants used in previous studies conducted relating banks

Amidu (2007) used profitability, growth, tax, assets structure, risk and size as explanatory variables. Gropp and Heider, 2009 used profitability, assets risk, dividend, market to book ratio, collateral and size as explanatory variables. a layan and Sak (2010) used tangibility, size, market to book value of assets and profitability as explanatory variables.

Firm level determinants of capital structure

Profitability Growth Assets Tangibility Size Tax Payout ratio

Profitability
POT assumes that first firms utilize their internal funds such as retained earnings and then go for leverage and a negative relation exists between leverage and profitability. Amidu, 2007 found that total and short term debts are negatively related, whereas long term debts are positively related to profitability Gropp and Heider, 2009 also proved the negative relation between leverage and profitability of US and European banks. TOT assumes that when firms have stable cash flows, are profitable then they prefer to use debt because of having more debt serving capacity and more earnings to benefit from tax shield and a positive relationship exits between profitability and leverage

Growth