IMF Working Papers

Bank Capital and the Cost of Equity

Author/Editor:

Mohamed Belkhir ; Sami Ben Naceur ; Ralph Chami ; Anis Semet

Publication Date:

December 4, 2019

Electronic Access:

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Summary:

Using a sample of publicly listed banks from 62 countries over the 1991-2017 period, we investigate the impact of capital on banks’ cost of equity. Consistent with the theoretical prediction that more equity in the capital mix leads to a fall in firms’ costs of equity, we find that better capitalized banks enjoy lower equity costs. Our baseline estimations indicate that a 1 percentage point increase in a bank’s equity-to-assets ratio lowers its cost of equity by about 18 basis points. Our results also suggest that the form of capital that investors value the most is sheer equity capital; other forms of capital, such as Tier 2 regulatory capital, are less (or not at all) valued by investors. Additionally, our main finding that capital has a negative effect on banks’ cost of equity holds in both developed and developing countries. The results of this paper provide the missing evidence in the debate on the effects of higher capital requirements on banks’ funding costs.

Series:

Working Paper No. 2019/265

Subject:

Banking Capital adequacy requirements Financial institutions Financial markets Financial regulation and supervision Loan loss provisions National accounts Return on investment Stock markets Stocks