Banks to basics! Why banking regulation should focus on equity

Pierre Durand and Gaëtan Le Quang

No 2020-2, EconomiX Working Papers from University of Paris Nanterre, EconomiX

Abstract: Banking regulation faces multiple challenges that call for rethinking the way it is designed in order to tackle the specific risks associated with banking activities. In this paper, we argue that regulators should focus on designing strong equity requirements instead of implementing several complex rules. Such a constraint in equity is however opposed by the banking industry because of its presumed adverse impact on banks' performance. Resorting to Random Forest regressions on a large dataset of banks balance sheet variables, we show that the ratio of equity over total assets has a clear positive effect on banks' performance, as measured by the return on assets. On the contrary, the impact of this ratio on the shareholder value, as measured by the return on equity, is most of the time weakly negative. Strong equity requirements do not, therefore, impede banks' performance but do reduce the shareholder value. This may be the reason why the banking industry so fiercely opposes strong equity requirements.

Keywords: Banking regulation; Capital requirements; Basel III; Random Forest Regression (search for similar items in EconPapers)
JEL-codes: C44 G21 G28 (search for similar items in EconPapers)
Pages: 33 pages
Date: 2020
New Economics Papers: this item is included in nep-ban, nep-cba, nep-cmp and nep-rmg
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Working Paper: Banks to basics! Why banking regulation should focus on equity (2021)
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