The effect of higher capital requirements on banks' valuation

Abstrakt

Executive Summary: The Basel III requirements were published in 2010, and the impact of these requirements have been, widely and publicly, debated between politicians, scholars and practitioners. Thus, the purpose of this thesis was to investigate to what extent banks’ valuations would increase or decrease, when the Tier 1 ratio was hypothetical increased. In order to answer the research question, four sub questions were developed, which led to four interrelated analyses. This then led to the fifth analysis, which sat the frame needed to answer the overall research question, using inputs from the previous analyses. The focus of the thesis was on the CRD-IV capital requirements, and exclusively on the Tier 1 capital. The analyses were based on data from twenty-five banks headquartered in twelve different European countries. All the banks were of significant importance, as they are all SIFI or G-SIFI banks. Lastly, the time period of interest was from 2006 to 2012. The first analysis was a strategic framework analysis, which sought to answer whether the sample banks were able to affect their own profitability. The second analysis was a financial analysis, which sought to answer what affected the sample banks’ financial value drivers. The third analysis sought to investigate to what extent Modigliani & Miller’s theory would hold in real life. This was analysed by using the same approach as Miles et al. (2012), and through multiple regression analyses. The effect of M&M’s theory, in real life, was between -4.08% to 6.25%, with no taxes, and between -4% and 3.66%, with taxes, based on level and first difference regressions respectively. Thus, it was concluded that M&M’s theory holds to a limited extent in real life. The fourth analysis sought to investigate how a higher Tier 1 ratio affected the banks’ financial statements, which was investigated by developing a simple model. It was concluded, within the scope of this thesis, that the Tier 1 ratio affected the banks’ financial statements through retained capital, the cost of facilitating the loans, the amount of equity, risk, and the borrowing and lending rates. These analyses led to the fifth and last analysis, the scenario analysis, which sought to analyse to what extent the banks’ values would increase or decrease, due to a hypothetical increase in the Tier 1 ratio. This was answered using the price-earnings and market-to-book valuation models. It was concluded that the banks’ values would increase, to a low but significant extent, when the Tier 1 ratio was increased.