Mapping Capital Ratios to Bank Lending Spreads: The Role of Efficiency and Asymmetry in Performance Indices

Ali Golbabaei Pasandi, Mahmoud Botshekan, Abol Jalilvand (), Mohammad Ali Rastegar and Mojtaba Rostami Noroozabad
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Ali Golbabaei Pasandi: Department of Management, Faculty of Administrative Sciences and Economics, University of Isfahan, Isfahan 8174673441, Iran
Mahmoud Botshekan: Department of Management, Faculty of Administrative Sciences and Economics, University of Isfahan, Isfahan 8174673441, Iran
Abol Jalilvand: Department of Finance, Quinlan School of Business, Loyola University Chicago, Chicago, IL 60611, USA
Mohammad Ali Rastegar: Faculty of Industrial and Systems Engineering, Tarbiat Modares University, Tehran 1411713116, Iran
Mojtaba Rostami Noroozabad: Department of Financial Management, Faculty of Management, Islamic Azad University, Tehran 1477893855, Iran

JRFM, 2024, vol. 17, issue 7, 1-20

Abstract: Beyond the 2007–2008 financial crisis, the collapse of the Silicon Valley Bank and the acquisition of Credit Suisse by the Swiss investment bank UBS Group AG in 2023 have brought fresh attention to the need for new regulatory capital, liquidity risk management, and leverage requirements. To meet tightened capital requirements, banks have to increase their capital ratios either by increasing equity or by decreasing risk-weighted assets. Both options lead to banks’ performance deterioration. One remedy for banks to recover is raising their lending spread. A critical question is how much the lending spread should be increased to offset the drop in the bank’s financial performance level. In this study, we focus on the asymmetries and efficiency consequences of performance indices such as economic value added ( EVA ) and the more commonly used return on equity (ROE) in determining the loan spread. Using data on the largest U.S. banks over the period 2018–2022, our results show that the ROE rule significantly overestimates the magnitude of the lending spreads required to offset the negative financial consequences of increases in capital ratios. The EVA approach, on the other hand, prescribes on average a significantly lower lending spread of 0.4505 basis points against a lending spread of 21.0441 basis points associated with the use of the ROE approach. The efficiency and the level of lending spreads should enable banks to maintain their competitive advantages in the loan markets impacting overall economic productivity and growth.

Keywords: capital ratio; economic value-added; lending spreads; performance measure asymmetry (search for similar items in EconPapers)
JEL-codes: C E F2 F3 G (search for similar items in EconPapers)
Date: 2024
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