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Estimating the impact of higher capital requirements on the cost of equity: an empirical study of European banks

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  • Oana Toader
Abstract
The new regulatory framework imposes an increase in capital requirements for banks. Although core capital (equity) is more expensive than other liabilities (debt), it strengthens banks’ stability and improves its loss-absorbing capacity. In this paper, we investigate the link between high-quality capital requirements and systematic risk. We further analyze the extent to which an improvement in the quality of the banks’ balance-sheet will affect the expected return on equity. We show the impact of shifts in funding structure on information asymmetries (especially implicit guarantees) and on the average funding cost. Our results demonstrate that core capital is essential for increasing banks stability and for reducing the average funding cost for banks. Our empirical analysis provides support for the introduction of strengthened prudential requirements defined in Basel III. Copyright Springer-Verlag Berlin Heidelberg 2015

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  • Oana Toader, 2015. "Estimating the impact of higher capital requirements on the cost of equity: an empirical study of European banks," International Economics and Economic Policy, Springer, vol. 12(3), pages 411-436, September.
    • Handle: RePEc:kap:iecepo:v:12:y:2015:i:3:p:411-436
    DOI: 10.1007/s10368-014-0303-x
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    Cited by:

    1. David Grossmann & Peter Scholz, 2017. "Bank Regulation: One Size Does Not Fit All," Journal of Applied Finance & Banking, SCIENPRESS Ltd, vol. 7(5), pages 1-1.
    2. Andersen, Henrik & Juelsrud, Ragnar Enger, 2024. "Optimal capital adequacy ratios for banks," Latin American Journal of Central Banking (previously Monetaria), Elsevier, vol. 5(2).
    3. Dimitrov, Daniel & van Wijnbergen, Sweder, 2023. "Macroprudential Regulation: A Risk Management Approach," CEPR Discussion Papers 17846, C.E.P.R. Discussion Papers.
    4. McInerney, Niall & O'Brien, Martin & Wosser, Michael & Zavalloni, Luca, 2022. "Rightsizing Bank Capital for Small, Open Economies," Research Technical Papers 4/RT/22, Central Bank of Ireland.
    5. Gimber, Andrew & Rajan, Aniruddha, 2019. "Bank funding costs and capital structure," Bank of England working papers 805, Bank of England.
    6. Brooke, Martin & Bush, Oliver & Edwards, Robert & Ellis, Jas & Francis, Bill & Harimohan, Rashmi & Neiss, Katharine & Siegert, Caspar, 2015. "Financial Stability Paper No. 35: Measuring the macroeconomic costs and benefits of higher UK bank capital requirements -," Bank of England Financial Stability Papers 35, Bank of England.
    7. Beltrame, Federico & Previtali, Daniele & Sclip, Alex, 2018. "Systematic risk and banks leverage: The role of asset quality," Finance Research Letters, Elsevier, vol. 27(C), pages 113-117.

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    More about this item

    Keywords

    Modigliani-Miller; Banks; Leverage; Regulation; Beta; G3; G21; G28;
    All these keywords.

    JEL classification:

    • G3 - Financial Economics - - Corporate Finance and Governance
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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