The Cost of Capital for Banks

67 Pages Posted: 16 Apr 2019

See all articles by Jens Dick-Nielsen

Jens Dick-Nielsen

Copenhagen Business School - Department of Finance

Jacob Gyntelberg

Nordea Group; University of Copenhagen - Department of Economics

Christoffer Thimsen

Aarhus University - CREATES

Date Written: March 15, 2019

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.

Keywords: Bank funding, Cost of equity, Total cost of capital, Leverage effect, Capital buffers

JEL Classification: D92, G21, G28, L51

Suggested Citation

Dick-Nielsen, Jens and Gyntelberg, Jacob and Thimsen, Christoffer, The Cost of Capital for Banks (March 15, 2019). Available at SSRN: https://ssrn.com/abstract=3360923

Jens Dick-Nielsen (Contact Author)

Copenhagen Business School - Department of Finance ( email )

Solbjerg Plads 3
Frederiksberg, DK-2000
Denmark

Jacob Gyntelberg

Nordea Group ( email )

Grønjordsvej 10
Copenhagen, DK - 2300
Denmark

University of Copenhagen - Department of Economics ( email )

Øster Farimagsgade 5, Bygn 26
Copenhagen, 1353
Denmark

Christoffer Thimsen

Aarhus University - CREATES ( email )

Nordre Ringgade 1
Aarhus, 8000
Denmark

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