Bank Capital and the Cost of Equity

IMF Working Papers, December 4, 2019

Source details

Sample: publicly listed banks from 62 countries over the 1991-2017 period.
Research question: impact of capital on banks’ cost of equity.
Core theoretical prediction referenced: more equity in the capital mix leads to a fall in firms’ costs of equity.

Better capitalized banks enjoy lower equity costs.
Baseline estimate: a 1 percentage point increase in a bank’s equity-to-assets ratio lowers its cost of equity by about 18 basis points.
The negative effect of capital on banks’ cost of equity holds in both developed and developing countries.

Investors value sheer equity capital the most.
Other forms of capital, such as Tier 2 regulatory capital, are less (or not at all) valued by investors.

Provides direct empirical evidence relevant to debates on the effects of higher capital requirements on banks’ funding costs.
Suggests that increasing equity-based capitalization may reduce banks’ cost of equity, mitigating concerns that higher capital requirements necessarily raise funding costs.

Subject: Banking; Capital adequacy requirements; Financial institutions; Financial markets; Financial regulation and supervision; Loan loss provisions; National accounts; Return on investment; Stock markets; Stocks.
Keywords: bank capital; bank capital measure; bank capitalization; bank cost; Banking regulation; Capital adequacy requirements; capital measure; capital requirement; capitalized bank; Cost of equity; financial leverage decrease; financial risk; Financial stability; funding cost; Global; Loan loss provisions; return on equity; Return on investment; risk profile; Stock markets; Stocks; WP.