Why do banks choose to finance with equity? |
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| Institution: | 1. The College of New Jersey, United States;2. Kent State University, United States;3. Wake Forest University, United States;1. Goethe University Frankfurt, Germany;2. Goethe University Frankfurt, CEPR and CFS, Theodor-W. Adorno Platz 3, 60323 Frankfurt am Main, Germany;1. School of Economics and Business Administration, University of Navarra, Edificio Amigos, 31009 Pamplona, Spain;2. BBVA Research, Paseo Castellana 81, 7th Floor, 28046 Madrid, Spain;1. Industrial Engineering and Operations Research Department, Columbia University, 500 W. 120th St., Mudd 510, New York, NY 10027, United States;2. Federal Reserve Bank of Cleveland, 1455 E 6th Street, Cleveland, OH 44114, United States;3. Weatherhead School of Management, Case Western Reserve University, 11119 Bellflower Road, Cleveland, OH 44106, United States;1. International Monetary Fund, 700 19th Street, N.W., Washington, D.C., 20431, USA;2. National Bank of Serbia, Kralja Petra 12, Belgrade, 11000, Serbia;3. FEFA, Metropolitan University, Belgrade, Serbia;4. CESifo, Munich, Germany |
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| Abstract: | A majority of U.S. banks between 1973 and 2012 held equity capital significantly beyond the required minimum. We study the risk-return tradeoff in connection with a bank’s capital structure, and identify several new significant market factors that drive the level of equity capital in banks. During normal growth periods, bank leverage is negatively related to a level of competition and loan portfolio diversification, while high bank leverage is associated with low past liquidity. During recessions and expansions, the roles of those factors change following distortions in risk-return tradeoff. In distress, when banks approach regulatory capital requirements, market determinants of book leverage lose their significance; however, leverage does not decrease until a bank is within 1% of the minimal capital threshold. |
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| Keywords: | Capital structure Leverage Bank Competition Diversification Liquidity Capital requirements Economic cycle |
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