Do Strict Capital Requirements Raise the Cost of Capital? Banking Regulation and the Low Risk Anomaly

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.

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Loss portfolio transfer treaties within Solvency II capital system: a reinsurer’s point of view

Insurance Markets and Companies ◽

10.21511/ins.11(1).2020.01 ◽

2020 ◽

Vol 11 (1) ◽

pp. 1-10

Author(s):

Nicolino Ettore D’Ortona ◽

Gabriella Marcarelli ◽

Giuseppe Melisi

Keyword(s):

Cost Of Capital ◽

Solvency Ii ◽

Capital Requirements ◽

Point Of View ◽

Insurance Company ◽

Specific Level ◽

Collective Risk ◽

Risk Appetite ◽

Reinsurance Treaty ◽

The Cost

Loss portfolio transfer (LPT) is a reinsurance treaty in which an insurer cedes the policies that have already incurred losses to a reinsurer. This operation can be carried out by an insurance company in order to reduce reserving risk and consequently reduce its capital requirement calculated, according to Solvency II. From the viewpoint of the reinsurance company, being a very complex operation, importance must be given to the methodology used to determine the price of the treaty.Following the collective risk approach, the paper examines the risk profiles and the reinsurance pricing of LPT treaties, taking into account the insurance capital requirements established by European law. For this purpose, it is essential to calculate the capital need for the risk deriving from the LPT transaction. In the case analyzed, this requirement is calculated under Solvency II legislation, considering the measure of variability determined via simulation. This quantification was also carried out for different levels of the cost of capital rate, providing a range of possible loadings to be applied to the premium. In the case of the Cost of Capital (CoC) approach, the results obtained provide a lower level of premium compared to the percentile-based method with a range between 2.69% and 1.88%. Besides, the CoC approach also provides the advantage of having an explicit parameter, the CoC rate whose specific level can be chosen by the reinsurance company based on the risk appetite.

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Is regulatory capital a legitimate, comparable and objective global standard? Evidence from 51 institutions across 17 countries

South African Journal of Economic and Management Sciences ◽

10.4102/sajems.v17i3.568 ◽

2014 ◽

Vol 17 (3) ◽

pp. 266-283 ◽

Cited By ~ 1

Author(s):

Johann Jacobs ◽

Gary Van Vuuren

Keyword(s):

Financial Institutions ◽

Financial Stability ◽

Financial Regulation ◽

Cost Of Capital ◽

Weighted Average ◽

Capital Requirements ◽

Regulatory Capital ◽

Financial Regulations ◽

The Cost ◽

Playing Fields

Capital as an instrument for financial regulation has come under scrutiny since the financial crisis of 2007 to 2010 highlighted some deficiencies in the ability of capital to absorb unexpected losses and the procyclical nature of capital. This scrutiny arises mainly from the perspective that one of the principal objectives of capital requirements is to promote and contribute to financial stability. However, the literature on the topic is scarce almost to the point of non-existence regarding capital’s validity as tool to level the playing fields between financial institutions. The objective of this article is therefore to investigate financial regulations based on capital requirements from the perspective of its goal of providing equal competitive conditions for financial institutions, the attainment of which is based on the assumption that the cost of capital between institutions (and countries) is the same, which might not necessarily be the case. The cost of capital for 51 financial institutions across 17 countries (three institutions per country) is accordingly calculated in this article using original weighted average cost of capital and capital asset pricing models, as well as modified versions of these to include more country-specific factors. The objective of the article is sought firstly by determining whether the cost of capital is the same among countries and secondly, based on the results, ascertaining whether financial regulations based on capital requirements can therefore realistically achieve this objective of providing equal competitive conditions for financial institutions.

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Quantifying the potential impact of a green supporting factor or brown penalty on European banks and lending

Journal of Financial Regulation and Compliance ◽

10.1108/jfrc-03-2018-0038 ◽

2019 ◽

Vol 27 (3) ◽

pp. 380-394 ◽

Cited By ~ 1

Author(s):

Jakob Thomä ◽

Kyra Gibhardt

Keyword(s):

Cost Of Capital ◽

Capital Requirements ◽

Potential Range ◽

Policy Intervention ◽

Real Economy ◽

Content Type ◽

Reserve Requirements ◽

European Banks ◽

Potential Impact ◽

The Cost

Purpose The European Parliament and Commission are considering introducing a green supporting factor (GSF) or brown penalty (BP) for capital reserve requirements. This paper aims to estimate the potential impact such a policy intervention may have on both capital reserves of European banks and the cost and availability of capital to “green” and “brown” investments. Design/methodology/approach The paper draws on the existing empirical and theoretical literature on the impacts of changes to capital reserve requirements on the real economy. It applies these estimates on the particular policy intervention currently being discussed at EU level to estimate the potential range of impacts on the cost of capital – measured in basis points – and the availability of capital – measured in per cent changes to lending. Findings A GSF would have a limited effect on overall capital requirements of banks compared to a BP – given the larger universe of assets on which such a penalty would be applied. The estimated effect is a reduction in capital requirements associated with a GSF of around €3-4bn based on baseline “green” definitions. In terms of cost of capital, the paper estimates a reduction of 5 to 26 basis points for green projects (with inverse expected effects for a BP). In terms of availability of capital, analysing a BP suggests a potential reduction in lending to brown assets of up to 8 per cent. Originality/value The paper provides direct evidence, with the first quantitative analysis of the potential impact of the current policy proposition discussed at EU-level.

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International Prudential Regulation, Regulatory Risk and Cost of Bank Capital

International Journal of Banking and Finance - Vol. 15, Number 2, 2020 ◽

10.32890/ijbf2008.5.1.8358 ◽

2008 ◽

Author(s):

Phong T. H. Ngo

Keyword(s):

Financial Integration ◽

Cost Of Capital ◽

Capital Requirements ◽

Bank Capital ◽

Basel Accord ◽

Regulatory Standards ◽

Capital Ratios ◽

Regulated Firm ◽

The Cost ◽

Positive Spillovers

We define regulatory risk as regulation that leads to an increase in the cost of capital for a regulated firm. In a general equilibrium setting, scholars have shown that uniform increases in capital requirements lead to an increase in the cost of capital. We extend their model to show that when regulatory standards differ across countries, financial integration leads to positive spillovers that reduce the cost of capital mark up for a given increase in bank capital. Accordingly, regulatory risk may be greater under a regulatory agreement such as the Basel Accord, which imposes international uniformity in capital ratios.

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Using Discounted Cash Flow Analysis in an International Setting: A Survey of Issues in Modeling the Cost of Capital

CFA Digest ◽

10.2469/dig.v29.n3.532 ◽

1999 ◽

Vol 29 (3) ◽

pp. 75-77

Author(s):

Joseph Vu

Keyword(s):

Cash Flow ◽

Cost Of Capital ◽

Flow Analysis ◽

Discounted Cash Flow ◽

International Setting ◽

The Cost

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Islamic Banking Regulations in Light of Basel II

American Journal of Islamic Social Sciences ◽

10.35632/ajiss.v27i1.357 ◽

2010 ◽

Vol 27 (1) ◽

pp. 74-101 ◽

Cited By ~ 3

Author(s):

M. Kabir Hassan ◽

Muhammad Abdul Mannan Chowdhury

Keyword(s):

Financial Institutions ◽

Banking Regulation ◽

Capital Requirements ◽

Basel Ii ◽

Capital Adequacy ◽

Regulatory Agencies ◽

Islamic Banking ◽

Islamic Banks ◽

Minimum Capital ◽

Regulatory Standards

This paper seeks to determine whether the existing regulatory standards and supervisory framework are adequate to ensure the viability, strength, and continued expansion of Islamic financial institutions. The reemergence of Islamic banking and the attention given to it by regulators around the globe as to the implications of a recently issued Basel II banking regulation makes this article timely. The Basel II framework, which is based on minimum capital requirements, a supervisory review process, and the effective use of market discipline, aligns capital adequacy with banking risks and provides an incentive for financial institutions to enhance risk management and their system of internal controls. Like conventional banks, Islamic banks operate under different regulatory regimes. The still diverse views held by the regulatory agencies of different countries on Islamic banking and finance operations make it harder to assess the overall performance of international Islamic banks. In light of the increased financial innovation and diversity of instruments offered in Islamic finance, the need to improve the transparency of bank operations is particularly relevant for Islamic banks. While product diversity is important in maintaining their competitiveness, it also requires increased transparency and disclosure to improve the understanding of markets and regulatory agencies. The governance of Islamic banks is made even more complex by the need for these banks to meet a set of ethical and financial standards defined by the Shari`ah and the nature of the financial contracts banks use to mobilize deposits. Effective transparency in this area will greatly enhance their credibility and reinforce their depositors and investors’ level of confidence.

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