How Sensitive are Bank Market Values to Regulatory Adjustments of Capital?

Abstract

We measure the sensitivity of bank market values to capital and regulatory adjustments applied to bank capital. Using a novel approach to measure value relevance for U.S. bank holding companies over the years 2001-2022, we show that the sensitivity of banks’ market values to measures of bank capital e.g. book equity, Tier 1, and Total Capital, converges to a one-to-one relationship when market uncertainty is low and when banks’ Tier 1 ratios reach 12 percent of RWAs. Market values are more sensitive to changes in capital of highly geared banks when market uncertainty is high; with shareholders responding positively in particular to increases in Tier 1 and Total Capital. Market values are largely insensitive to prudential filters, such as the one on unrealized gains and losses on available for sale securities. The methods we adopt show, with some precision, which adjustments proposed by regulators have positive effects and which adjustments have negative effects on market valuations of banks.

Keywords: Banking, Capital structure, log-log regression models, Prudential filters

JEL Classification: G21, G32, M41