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.
Dick-Nielsen, Jens ; Gyntelberg, Jacob ; Thimsen, Christoffer. / The Cost of Capital for Banks. Paper presented at The 80th Annual Meeting of American Finance Association. AFA 2020, San Diego, United States.67 p.
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Dick-Nielsen, J, Gyntelberg, J & Thimsen, C 2020, 'The Cost of Capital for Banks' Paper presented at, San Diego, United States, 03/01/2020 - 05/01/2020, .

The Cost of Capital for Banks. / Dick-Nielsen, Jens; Gyntelberg, Jacob; Thimsen, Christoffer.

2020. Paper presented at The 80th Annual Meeting of American Finance Association. AFA 2020, San Diego, United States.

Research output: Contribution to conferencePaperResearchpeer-review

TY - CONF

T1 - The Cost of Capital for Banks

AU - Dick-Nielsen, Jens

AU - Gyntelberg, Jacob

AU - Thimsen, Christoffer

PY - 2020

Y1 - 2020

N2 - 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.

AB - 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.

KW - Bank funding

KW - Cost of equity

KW - Total cost of capital

KW - Leverage effect

KW - Capital buffers

KW - Bank funding

KW - Cost of equity

KW - Total cost of capital

KW - Leverage effect

KW - Capital buffers

M3 - Paper

ER -

Dick-Nielsen J, Gyntelberg J, Thimsen C. The Cost of Capital for Banks. 2020. Paper presented at The 80th Annual Meeting of American Finance Association. AFA 2020, San Diego, United States.