Bank leverage, capital requirements and banks' implied cost of (equity) capital
Schmidt, Christian
Document Type:
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Conference presentation
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Year of publication:
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2018
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Conference title:
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25th Annual Meeting of the German Finance Association (DGF) 2018
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Location of the conference venue:
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Trier, Germany
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Date of the conference:
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21.09.2018
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Publication language:
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English
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Institution:
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Business School > ABWL, Risikotheorie, Portfolio Management u. Versicherungswissenschaft (Albrecht 1989-2021)
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Subject:
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330 Economics
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Classification:
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JEL:
C33 , G21 , G28 , G32,
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Individual keywords (German):
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Verschuldung von Banken , Implizite Kapitalkosten , EBA Capital Exercise , Kapitalanforderungen , Bank Regulierung , Modigliani-Miller
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Keywords (English):
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Bank Leverage , Implied Cost of Capital , EBA Capital Exercise , Capital Requirements , Bank Regulation
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Abstract:
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Do heightened capital requirements impose private costs on banks by adversely affecting
their cost of capital? And if so, does the effect differ across different groups of banks? Using
an international sample of listed banks over the period from 1990 to 2017, I find that equity
investors adjust their expected return weakly in accordance with the Modigliani and Miller
(1958) Theorem when banks decrease their leverage. The adjustment is stronger for smaller
banks, banks that rely more on deposit financing and when debt is reduced rather than deposits,
which never triggers a statistically significant adjustment. In any cases, the adjustment is not
strong enough to keep banks' cost of capital constant which is estimated to increase by 10 to
40bps, representing a relative increase of 2.8% to 12.6%, when shifting equity from 8% to 16%.
When using the 2011 EBA capital exercise as a quasi-natural experiment to identify the impact
of capital regulation on bank's cost of capital, results indicate a strong reduction in required
returns for the treated banks. However, the reduction is mainly caused by shifts in asset risk,
highlighting the importance of differentiating between short-run and long-run effects.
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