Effect of Capital Ratios on listed banks Stock Returns: Evidence from Pakistan

Abstract

The study examined the market-valued capital ratio (MLR) as an indicator to measure the riskiness of banks. After examining the cross-section relationship between market-value capital ratios and banks’ stock returns in the Pakistani banking sector from 2005 to 2018 by using Fama & French three-factor model. The study shows that banks in Pakistan with lower market capital ratios have had higher average stock returns of banks than those with higher market capital ratios, which means there is a negative relationship between market-value capital ratios (MLR) and banks’ stock returns (SR). Furthermore, the result also revealed that banks in Pakistan with high market-value capital ratios (MLR) had low future average returns than those banks with lower market-value capital ratios (MLR). The low future returns are not just because of high market-value capital ratios there is a common risk-factor related to average future returns. Evidence from the analysis of sample data shows the existence of a positive causal relationship between market-value capital ratios (MLR) and bank efficiency. Based on these results, we conclude that Pakistani banks with high market-value capital ratios (MLR) are associated with high bank efficiency as compared to banks with low market-value capital ratios (MLR). Additionally, the outcomes examine that the bank's size has a positive effect on the relationship between market-value capital ratios and bank stock returns and in the financial crisis there is a positive relationship between market-value capital ratios and bank stock returns.