Nothing special about an allowance for corporate equity: Evidence from Italian banks

Dennis Dreusch, Felix Noth and Peter Reichling

Journal of International Money and Finance, 2025, vol. 150, issue C

Abstract: This paper analyzes the impact of reduced tax incentives for equity financing on banks' regulatory capital ratios under the Basel III regime. We are particularly interested in a recent interest rate cut in the Italian corporate equity allowance, which reduces the relative tax advantage of equity financing. The results show that banks respond to this increased tax disparity by significantly reducing their regulatory capital while at the same time reducing their risk-taking. The decline in capital is more pronounced for small banks and outweighs the initial capital gains from the introduction of this tax instrument. Our results challenge the use of equity allowances, in that financial stability gains persist only as long as costly tax subsidies remain intact and diminish as the size of the subsidy is reduced.

Keywords: Bank capital structure; Debt bias; Taxes; Regulation (search for similar items in EconPapers)
JEL-codes: G21 G28 G32 H25 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:150:y:2025:i:c:s0261560624002067

DOI: 10.1016/j.jimonfin.2024.103219

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