Do Strict Capital Requirements Raise the Cost of Capital? Bank Regulation, Capital Structure and the Low Risk Anomaly

By Malcolm P. Baker, Jeffrey Wurgler. 2015

239 citations recorded by the source corpus.

Traditional capital structure theory predicts that reducing banks' leverage reduces the risk and cost of equity but does not change the weighted average cost of capital, and thus the rates for borrowers. We confirm that the equity of better-capitalized banks has lower beta and idiosyncratic risk. However, over the last 40 years, lower risk banks have not had lower costs of equity (lower stock returns), consistent with a stock market anomaly previously documented in other samples. A calibration suggests that a binding ten percentage point increase in Tier 1 capital to risk-weighted assets could double banks' risk premia over Treasury bills.

Subfields: Economics and Econometrics, Finance

View Paper: https://www.semanticscholar.org/paper/eb747c3c025ae436beeded0b3d3fb5832e6b91b3

Citations in the corpus

• Why Does Fast Loan Growth Predict Poor Performance for Banks (2018, unknown): “We include a capitalization ratio in the regression because Baker and Wurgler (2015) show that there is an anomaly in which lesser-capitalized banks underperform better-capitalized banks.”
• Bank capital (requirements) and credit supply: Evidence from pillar 2 decisions (2016, unknown): “Bernanke and Lown (1991), Berger and Udell (1994), Berrospide and Edge (2010), among many others, rely on a panel, VAR or matching analysis of bank-level data, while Hubbard et al. (2002), Ashcraft (2006), Mora and Logan (2012) and Berger and Bouwman (2013), among others, focus solely on bank-level ”
• The FinTech Opportunity (2016, unknown): “The substantial increase in bank capital that (11)In addition, as Baker and Wurgler (2015) argue, leverage can be rewarded by institutional investors who would like to lever up, but are precluded by charter or regulation.”