The effect of bank capital structure and financial indicators on CI's financial strength ratings: The case of the Middle East

Abstract

This paper aims to integrate the theory of bank financial performance with the practice of bank ratings. The paper studies the effect of bank capital structure and financial indicators in Middle Eastern commercial banks associated with high and low ratings issued by Capital Intelligence (CI). The authors also investigate how bank capital structure and financial indicators can be differentiated between banks with high and low ratings, using the multinomial logit technique. A sample of 65 rated commercial banks from eleven countries is used. The article focuses on commercial banks in order to avoid comparison problems between various types of banks. The data is taken from the Bankscope database and covers the period of 1994-2007. The results reveal that the financial indicators of the highly-rated banks are associated with decreases in the ratio of impaired loans to gross loans, the ratio of loan loss reserve to gross loans, the ratio of non-interest expenses to total assets, the ratio of net loans to deposits and short-term funding and the ratio of net loans to total assets. In contrast, these financial indicators are allied to an increase in the ratio of non-operating income to net income, the gap ratio, the interbank ratio and the equity ratio. The robustness of the results is quite obvious since the financial indicators associated with highly-rated banks are the opposite of those associated with low-rated banks. In view of the findings, some policy implications can be drawn that may be useful for bank management and policymakers in the Middle East region.