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Why do banks choose to finance with equity?

Nonna Y. Sorokina, John Thornton and Ajay Patel

Journal of Financial Stability, 2017, vol. 30, issue C, 36-52

Abstract: A majority of U.S. banks between 1973 and 2012 held equity capital significantly beyond the required minimum. We study the risk-return tradeoff in connection with a bank’s capital structure, and identify several new significant market factors that drive the level of equity capital in banks. During normal growth periods, bank leverage is negatively related to a level of competition and loan portfolio diversification, while high bank leverage is associated with low past liquidity. During recessions and expansions, the roles of those factors change following distortions in risk-return tradeoff. In distress, when banks approach regulatory capital requirements, market determinants of book leverage lose their significance; however, leverage does not decrease until a bank is within 1% of the minimal capital threshold.

Keywords: Capital structure; Leverage; Bank; Competition; Diversification; Liquidity; Capital requirements; Economic cycle (search for similar items in EconPapers)
JEL-codes: G21 G28 G32 (search for similar items in EconPapers)
Date: 2017
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DOI: 10.1016/j.jfs.2017.04.002

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