The Interaction of Bank Regulation and Taxation

49 Pages Posted: 5 Dec 2013 Last revised: 4 Nov 2018

Date Written: November 3, 2018

Abstract

The tax benefit of interest deductibility encourages debt financing, but regulatory and market constraints create dependency between bank leverage and asset risk. Using a large international sample of banks in this paper I find that banks located in high-tax countries have higher leverage and lower average asset risk-weights. This trade-off is stronger when regulation is more stringent or when capital constraints are tighter. Non-financial firms' leverage and asset risk are positively related to tax rates, as further evidence of the regulatory induced adjustment of portfolio risk. While the estimated overall effect of taxation on bank risk is modest, it induces significant portfolio reallocation toward less lending. These results suggest that any elimination of the tax bias towards debt may not bring the expected benefits for bank stability.

Keywords: Bank leverage, Bank regulation, Bank risk, Corporate taxation, Debt-bias

JEL Classification: G21, G28, G32, H25

Suggested Citation

Horváth, Bálint L., The Interaction of Bank Regulation and Taxation (November 3, 2018). Available at SSRN: https://ssrn.com/abstract=2363451 or http://dx.doi.org/10.2139/ssrn.2363451

Bálint L. Horváth (Contact Author)

University of Bristol ( email )

University of Bristol,
Senate House, Tyndall Avenue
Bristol, BS8 ITH
United Kingdom

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