How does equity capital cost affect bank performance during a financial crisis?

Jeng-Yan Tsai and Shi Chen

Applied Economics, 2015, vol. 47, issue 42, 4459-4474

Abstract: This article theoretically examines how equity capital cost affects return performance and safety of a bank and how this effect varies across a financial crisis comparing to a normal time when the bank manager's performance reveals the like of higher equity return and the dislike of higher equity risk. We derive two main results. First, an increase in the bank's equity capital cost from an increase of the interest rate of the Federal funds results in a reduced loan risk-taking at an increased optimal bank interest margin, implying better bank performance. Second, by ignoring the dislike, we find that the better performance is reinforced during a financial crisis but is reduced during a normal time. Financial crises and the dislike preference as such contribute a relatively low return and the stability of banking activities.

Date: 2015
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DOI: 10.1080/00036846.2015.1030569

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