The Cost of Capital for Banks

Jens Dick-Nielsen, Jacob Gyntelberg, Christoffer Thimsen

Research output: Contribution to conferencePaperResearchpeer-review

Abstract

Expected returns based on analyst earnings forecasts show that when the tier 1 ratio increases the cost of equity and debt capital for banks decreases whereas total cost of capital remains unchanged. These findings are consistent with the conservation of risk principle (Modigliani and Miller, 1958). Empirically, the disadvantages of equity funding are small; a 10 pp increase in the tier 1 ratio preserves total risk but causes a 2.3% loss of firm value due to the lower tax shield. The loss is equivalent to a 2-8 bps increase in borrowing rates. These findings have important implications for the cost of substantially heightened capital requirements.
Original languageEnglish
Publication date2020
Number of pages67
Publication statusPublished - 2020
EventThe 80th Annual Meeting of American Finance Association. AFA 2020 - San Diego, United States
Duration: 3 Jan 20205 Jan 2020
Conference number: 80
https://afajof.org/annual-meeting/

Conference

ConferenceThe 80th Annual Meeting of American Finance Association. AFA 2020
Number80
CountryUnited States
CitySan Diego
Period03/01/202005/01/2020
Internet address

Keywords

  • Bank funding
  • Cost of equity
  • Total cost of capital
  • Leverage effect
  • Capital buffers

Cite this

Dick-Nielsen, J., Gyntelberg, J., & Thimsen, C. (2020). The Cost of Capital for Banks. Paper presented at The 80th Annual Meeting of American Finance Association. AFA 2020, San Diego, United States. https://editorialexpress.com/cgi-bin/conference/download.cgi?db_name=AFA2020&paper_id=1321