Capitalization - profitability nexus: Applicability of capital theories in banking sector of BRICS Countries

The purpose of this research is to assess the nexus between capitalization and profitability in context of prevailing five theories of capitalization and profitability nexus. For testing the prevalence of capital theories in the banking sectors of the BRICS, the ARDL and VECM/VAR Granger causality tests are used in panel and individual setting on the data of BRICs banking sector from 2000 to 2020. Long-term empirical findings of the study corroborate the signalling theory and the bankruptcy cost hypothesis for the BRICS, Brazil, Russia, and India. While capitalization appears to have a significant negative impact on profitability in China and South Africa, this supports the agency theory. Profitability appears to have a significant favourable impact on capitalization in the long run, consistent with pecking order theory of Myers and Majluf (1984) theory for BRICS and Brazil. Profitability has a negative impact on capitalization in India and South Africa, confirming the findings of Modigliani and Miller (1958), and Miller (1977). The short-term estimation results are similar to the long-run results, although the significance is lower in most cases. The short-run and long-run assessments of the interrelationship between capital and profitability are especially important for the development of "macroprudential" measures.