This website uses cookies.

By clicking the "Accept" button or continuing to browse our site, you agree to first-party and session-only cookies being stored on your device to enhance site navigation and analyze site performance and traffic. For more information on our use of cookies, please see our Privacy Policy.

« Back to Results

Bank Cost of Capital

Paper Session

Saturday, Jan. 4, 2020 8:00 AM - 10:00 AM (PDT)

Manchester Grand Hyatt, Seaport F
Hosted By: American Finance Association
  • Chair: Juliane Begenau, Stanford University

The Cost of Capital for Banks

Jens Dick-Nielsen
,
Copenhagen Business School
Jacob Gyntelberg
,
Nordea Group
Christoffer Thimsen
,
Aarhus University

Abstract

We use analyst earnings forecasts to extract cost of capital measures for banks. Both the cost of equity and debt capital are decreasing in the tier 1 ratio, whereas total cost of capital is independent of the tier 1 ratio. Our findings suggest that investors adjust their expectations in accordance with the conservation of risk principle (Modigliani and Miller, 1958), also around episodes of equity issuances. Extrapolating from our results; a 10 pp increase in the tier 1 ratio is associated with a 2-8 bps increase in customer borrowing rates due to a loss of tax shield. Finally, we find that increased deposits and off-balance sheet liabilities tend to lower total cost of capital.

Distressed Banks, Debt Overhang, and Regulation

Itzhak Ben-David
,
Ohio State University and NBER
Ajay Palvia
,
U.S. Office of the Comptroller of the Currency
Rene Stulz
,
Ohio State University

Abstract

Existing literature predicts that highly-levered distressed banks suffer from a debt overhang that leads them to take more risk and avoid actions that decrease their leverage. Using two distinct periods that include financial crises and are subject to different regulations (1985-1994, 2005-2014), we investigate whether these predictions are supported. We find that distressed banks reduce their leverage in various forms: increase their equity, reduce the size of their balance sheet, reduce the number of branches and employees. They also decrease observable measures of riskiness. The global financial crisis is associated with weaker deleveraging. We show that the deleveraging of distressed banks increases after the adoption of FDICIA and does not increase after the adoption of Dodd-Frank compared to the pre-global financial crisis period.

Can Risk Be Shared Across Investor Cohorts? Evidence from a Popular Savings Product

Victor Lyonnet
,
Ohio State University
Johan Hombert
,
HEC Paris

Abstract


This paper shows how one of the most popular savings products in Europe – life insurance financial products – shares market risk across investor cohorts. Insurers smooth returns by varying reserves that offset fluctuations in asset returns. Reserves are passed on between successive investor cohorts, causing redistribution across cohorts. Using regulatory and survey data on the 1.4 trillion euro French market, we estimate this redistribution to be quantitatively large: 1.4% of savings value per year on average, or 0.8% of GDP. These findings challenge a large theoretical literature that assumes inter-cohort risk sharing is impossible. We develop and provide evidence for a model in which the elasticity of investor demand to predictable returns determines the amount of risk sharing that is possible. The evidence is consistent with low elasticity, sustaining inter-cohort risk sharing despite predictable returns. Demand elasticity is higher for investors with a larger investment amount, suggesting that low investor sophistication enables inter-cohort risk sharing.
Discussant(s)
Malcolm Baker
,
Harvard Business School
Laura Blattner
,
Stanford University
Motohiro Yogo
,
Princeton University
JEL Classifications
  • G2 - Financial Institutions and Services