Banks to Basics! Why Banking Regulation Should Focus on Equity

34 Pages Posted: 30 Apr 2020

See all articles by Pierre Durand

Pierre Durand

Université Paris Ouest - Nanterre, La Défense - EconomiX

Gaëtan Le Quang

Université Paris Nanterre and EconomiX (UMR7235)

Date Written: April 6, 2020

Abstract

Banking regulation faces multiple challenges that call for rethinking the way it is designed. Not only does it have to tackle the specific risks associated with banking activities, but it is now expected from it to help dealing with climate change. In this paper, we argue that regulators should focus on designing strong equity requirements instead of implementing several complex rules. Such a constraint in equity is however opposed by the banking industry because of its presumed adverse impact on banks' performance. Resorting to Random Forest regressions on a large dataset of banks balance sheet variables, we show that the ratio of equity over total assets has a clear positive effect on banks' performance, as measured by the return on assets. On the contrary, the impact of this ratio on the shareholder value, as measured by the return on equity, is most of the time weakly negative. Strong equity requirements do not therefore impede banks' performance, but do reduce the shareholder value. This may be the reason why the banking industry so fiercely opposes strong equity requirements.

Keywords: Banking regulation, Capital requirements, Basel III, Random Forest regressions

JEL Classification: C44, G21, G28

Suggested Citation

Durand, Pierre and Le Quang, Gaëtan, Banks to Basics! Why Banking Regulation Should Focus on Equity (April 6, 2020). Available at SSRN: https://ssrn.com/abstract=3569504 or http://dx.doi.org/10.2139/ssrn.3569504

Pierre Durand

Université Paris Ouest - Nanterre, La Défense - EconomiX ( email )

200 Avenue de la République
Nanterre cedex, Nanterre Cedex 92000
France

Gaëtan Le Quang (Contact Author)

Université Paris Nanterre and EconomiX (UMR7235) ( email )

92, av. de la République, Nanterre
Room G301, Building G
Paris, Nanterre Cedex 92001
France

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