Optimal Bank Capital

57 Pages Posted: 18 Apr 2011

See all articles by Gilberto Marcheggiano

Gilberto Marcheggiano

Goldman Sachs Group, Inc. - Goldman Sachs Asset Management

David Miles

Imperial College Business School; The Bank of England; Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute)

Jing Yang

Bank of England

Multiple version iconThere are 2 versions of this paper

Date Written: April 2011

Abstract

This paper reports estimates of the long-run costs and benefits of banks funding more of their assets with loss-absorbing capital, or equity. Measuring those costs requires careful consideration of a wide range of issues about how shifts in funding affect required rates of return and on how costs are influenced by the tax system; it also requires a clear distinction to be drawn between costs to individual institutions (private costs) and overall economic (or social) costs. Without a calculation of the benefits from having banks use more equity no estimate of costs - however accurate - can tell us what the optimal level of bank capital is. We use empirical evidence on UK banks to assess costs; we use data from shocks to incomes from a wide range of countries over a long period to assess risks to banks and how equity funding (or capital) protects against those risks. We find that the amount of equity capital that is likely to be desirable for banks to use is very much larger than banks have used in recent years and also higher than targets agreed under the Basel III framework.

Keywords: banks, capital regulation, capital structure, cost of equity, leverage, Modigliani-Miller

JEL Classification: G21, G28

Suggested Citation

Marcheggiano, Gilberto and Miles, David Kenneth and Yang, Jing, Optimal Bank Capital (April 2011). CEPR Discussion Paper No. DP8333. Available at SSRN: https://ssrn.com/abstract=1810296

Gilberto Marcheggiano (Contact Author)

Goldman Sachs Group, Inc. - Goldman Sachs Asset Management ( email )

200 West Street
New York, NY 10282
United States

David Kenneth Miles

Imperial College Business School ( email )

South Kensington Campus
Exhibition Road
London SW7 2AZ, SW7 2AZ
United Kingdom

The Bank of England ( email )

Threadneedle Street
London EC2R 8AH
United Kingdom

Centre for Economic Policy Research (CEPR)

London
United Kingdom

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Jing Yang

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

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