The Relationship between Capital and Earnings in Banking

Posted: 16 Sep 1999

See all articles by Allen N. Berger

Allen N. Berger

University of South Carolina - Darla Moore School of Business; Wharton Financial Institutions Center; European Banking Center

Date Written: February 1994

Abstract

Contrary to conventional wisdom, bank capital-asset ratios are positively related to returns on equity in the 1980s. We find that higher capital Granger-causes higher earnings and vice versa using data on U.S. banks, 1983-1989. The Granger-causation from earnings to capital suggests that banks often retain marginal increases in earnings, which is not surprising. The positive Granger-causation from capital to earnings, which is surprising, occurs primarily through lower interest rates paid on uninsured purchased funds. This is consistent with the hypothesis that expected bankruptcy costs for banks increased substantially in the 1980s, raising optimal capital ratios.

JEL Classification: G21

Suggested Citation

Berger, Allen N., The Relationship between Capital and Earnings in Banking (February 1994). Available at SSRN: https://ssrn.com/abstract=5601

Allen N. Berger (Contact Author)

University of South Carolina - Darla Moore School of Business ( email )

1705 College St
Francis M. Hipp Building
Columbia, SC 29208
United States
803-576-8440 (Phone)
803-777-6876 (Fax)

Wharton Financial Institutions Center

Philadelphia, PA 19104-6367
United States

European Banking Center

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

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