Do Strict Capital Requirements Raise the Cost of Capital? Bank Regulation, Capital Structure, and the Low Risk Anomaly

10 Pages Posted: 15 Mar 2015

See all articles by Malcolm P. Baker

Malcolm P. Baker

Harvard Business School; National Bureau of Economic Research (NBER)

Jeffrey Wurgler

NYU Stern School of Business; National Bureau of Economic Research (NBER)

Multiple version iconThere are 5 versions of this paper

Date Written: March 13, 2015

Abstract

Traditional capital structure theory predicts that reducing banks’ leverage reduces the risk and cost of equity but does not change the weighted average cost of capital, and thus the rates for borrowers. We confirm that the equity of better-capitalized banks has lower beta and idiosyncratic risk. However, over the last 40 years, lower risk banks have not had lower costs of equity (lower stock returns), consistent with a stock market anomaly previously documented in other samples. A calibration suggests that a binding ten percentage-point increase in Tier 1 capital to risk-weighted assets could double banks’ risk premia over Treasury bills.

Keywords: Bank, Banks, Banking, Regulation, Capital, Requirements, Leverage, Tier 1, Capitalization, Anomaly, Risk

JEL Classification: G2, G21, G28, G32, G38

Suggested Citation

Baker, Malcolm P. and Wurgler, Jeffrey A., Do Strict Capital Requirements Raise the Cost of Capital? Bank Regulation, Capital Structure, and the Low Risk Anomaly (March 13, 2015). American Economic Review, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2577963

Malcolm P. Baker

Harvard Business School ( email )

Boston, MA 02163
United States
617-495-6566 (Phone)

HOME PAGE: http://www.people.hbs.edu/mbaker

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Jeffrey A. Wurgler (Contact Author)

NYU Stern School of Business ( email )

Stern School of Business
44 West 4th Street, Suite 9-190
New York, NY 10012-1126
United States
212-998-0367 (Phone)
212-995-4233 (Fax)

HOME PAGE: http://www.stern.nyu.edu/~jwurgler/

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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