IDEAS home Printed from https://ideas.repec.org/p/hal/journl/halshs-03341768.html
   My bibliography  Save this paper

Target capital ratio and optimal channel(s) of adjustment: A simple model with empirical applications to European banks

Author

Listed:
  • Yann Braouezec

    (IÉSEG School Of Management [Puteaux])

  • Keyvan Kiani

    (IÉSEG School Of Management [Puteaux])

Abstract

Why do banks decide to reach their target capital ratio by selling assets and/or issuing new shares? To answer this question, we offer a simple framework in which each channel of adjustment is costly; underwriting and dilution costs for equity issuance, profit reduction and price impact for asset sale. We make the assumption that the aim of the bank is to minimize the total adjustment cost subject to the target's constraint and we derive its optimal strategy. The solution is formulated in terms of two critical thresholds for which we give an explicit formula. We then compare our model's predictions to the decisions taken by two European systemic banks (Deutsche Bank and UniCredit) to issue new shares in 2017 and for which the target ratio was publicly disclosed. We show that the predictions of the model are consistent with the observed decisions.

Suggested Citation

  • Yann Braouezec & Keyvan Kiani, 2021. "Target capital ratio and optimal channel(s) of adjustment: A simple model with empirical applications to European banks," Post-Print halshs-03341768, HAL.
    • Handle: RePEc:hal:journl:halshs-03341768
    Note: View the original document on HAL open archive server: https://shs.hal.science/halshs-03341768
    as

    Download full text from publisher

    File URL: https://shs.hal.science/halshs-03341768/document
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Christoffer Kok & Glenn Schepens, 2013. "Bank reactions after capital shortfalls," Working Paper Research 250, National Bank of Belgium.
    2. Reint Gropp & Thomas Mosk & Steven Ongena & Carlo Wix, 2019. "Banks Response to Higher Capital Requirements: Evidence from a Quasi-Natural Experiment," The Review of Financial Studies, Society for Financial Studies, vol. 32(1), pages 266-299.
    3. Yann Braouezec & Lakshithe Wagalath, 2016. "Risk-based capital requirements and optimal liquidation in a stress scenario," Working Papers 2016-ACF-01, IESEG School of Management.
    4. Douglas W. Diamond & Raghuram G. Rajan, 2011. "Fear of Fire Sales, Illiquidity Seeking, and Credit Freezes," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 126(2), pages 557-591.
    5. Yann Braouezec & Lakshithe Wagalath, 2018. "Risk-Based Capital Requirements and Optimal Liquidation in a Stress Scenario," Post-Print hal-02505173, HAL.
    6. Cohen, Benjamin H. & Scatigna, Michela, 2016. "Banks and capital requirements: Channels of adjustment," Journal of Banking & Finance, Elsevier, vol. 69(S1), pages 56-69.
    7. Markus K. Brunnermeier, 2009. "Deciphering the Liquidity and Credit Crunch 2007-2008," Journal of Economic Perspectives, American Economic Association, vol. 23(1), pages 77-100, Winter.
    8. Jean‐Paul Décamps & Thomas Mariotti & Jean‐Charles Rochet & Stéphane Villeneuve, 2011. "Free Cash Flow, Issuance Costs, and Stock Prices," Journal of Finance, American Finance Association, vol. 66(5), pages 1501-1544, October.
    9. De Jonghe, Olivier & Öztekin, Özde, 2015. "Bank capital management: International evidence," Journal of Financial Intermediation, Elsevier, vol. 24(2), pages 154-177.
    10. Bakkar, Yassine & De Jonghe, Olivier & Tarazi, Amine, 2023. "Does banks’ systemic importance affect their capital structure and balance sheet adjustment processes?," Journal of Banking & Finance, Elsevier, vol. 151(C).
    11. Shimizu, Katsutoshi, 2015. "Adjusting denominators of capital ratios: Evidence from Japanese banks," Journal of Financial Stability, Elsevier, vol. 19(C), pages 60-68.
    12. Harris, Milton & Raviv, Artur, 1991. "The Theory of Capital Structure," Journal of Finance, American Finance Association, vol. 46(1), pages 297-355, March.
    13. Ivica Klinac & Roberto Ercegovac, 2018. "Banking System Adjustment to Regulatory Capital Requirements," Croatian Economic Survey, The Institute of Economics, Zagreb, vol. 20(2), pages 69-96, December.
    14. Fernando Duarte & Thomas M. Eisenbach, 2021. "Fire‐Sale Spillovers and Systemic Risk," Journal of Finance, American Finance Association, vol. 76(3), pages 1251-1294, June.
    15. Stewart C. Myers, 2001. "Capital Structure," Journal of Economic Perspectives, American Economic Association, vol. 15(2), pages 81-102, Spring.
    16. Rodrigo Cifuentes & Hyun Song Shin & Gianluigi Ferrucci, 2005. "Liquidity Risk and Contagion," Journal of the European Economic Association, MIT Press, vol. 3(2-3), pages 556-566, 04/05.
    17. Joao F. Gomes, 2001. "Financing Investment," American Economic Review, American Economic Association, vol. 91(5), pages 1263-1285, December.
    18. Nicole M. Boyson & Rüdiger Fahlenbrach & René M. Stulz, 2016. "Why Don't All Banks Practice Regulatory Arbitrage? Evidence from Usage of Trust-Preferred Securities," The Review of Financial Studies, Society for Financial Studies, vol. 29(7), pages 1821-1859.
    19. Kapan, Tümer & Minoiu, Camelia, 2018. "Balance sheet strength and bank lending: Evidence from the global financial crisis," Journal of Banking & Finance, Elsevier, vol. 92(C), pages 35-50.
    20. Allen Berger & Robert DeYoung & Mark Flannery & David Lee & Özde Öztekin, 2008. "How Do Large Banking Organizations Manage Their Capital Ratios?," Journal of Financial Services Research, Springer;Western Finance Association, vol. 34(2), pages 123-149, December.
    21. Juelsrud, Ragnar E. & Wold, Ella Getz, 2020. "Risk-weighted capital requirements and portfolio rebalancing," Journal of Financial Intermediation, Elsevier, vol. 41(C).
    22. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
    23. Öztekin, Özde & Flannery, Mark J., 2012. "Institutional determinants of capital structure adjustment speeds," Journal of Financial Economics, Elsevier, vol. 103(1), pages 88-112.
    24. Flannery, Mark J. & Rangan, Kasturi P., 2006. "Partial adjustment toward target capital structures," Journal of Financial Economics, Elsevier, vol. 79(3), pages 469-506, March.
    25. Y. Braouezec, 2010. "Modigliani-Miller Theorem," Post-Print hal-00836276, HAL.
    26. Altinkilic, Oya & Hansen, Robert S, 2000. "Are There Economies of Scale in Underwriting Fees? Evidence of Rising External Financing Costs," The Review of Financial Studies, Society for Financial Studies, vol. 13(1), pages 191-218.
    27. Memmel, Christoph & Raupach, Peter, 2010. "How do banks adjust their capital ratios?," Journal of Financial Intermediation, Elsevier, vol. 19(4), pages 509-528, October.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Bakkar, Yassine & De Jonghe, Olivier & Tarazi, Amine, 2023. "Does banks’ systemic importance affect their capital structure and balance sheet adjustment processes?," Journal of Banking & Finance, Elsevier, vol. 151(C).
    2. Quang Thi Thieu Nguyen & Christopher Gan & Zhaohua Li, 2020. "Capital regulation and bank balance sheet adjustments: a simultaneous approach," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 60(2), pages 1563-1599, June.
    3. Yassine Bakkar & Olivier de Jonghe & Amine Tarazi, 2017. "Does banks' systemic importance affect their capital structure adjustment process?," Working Papers hal-01546995, HAL.
    4. Baik, Hyeoncheol & Han, Sumin & Joo, Sunghoon & Lee, Kangbok, 2022. "A bank's optimal capital ratio: A time-varying parameter model to the partial adjustment framework," Journal of Banking & Finance, Elsevier, vol. 142(C).
    5. Laetitia Lepetit & Amine Tarazi & Nadia Zedek, 2012. "Ultimate Ownership Structure and Bank Regulatory Capital Adjustment: Evidence from European Commercial Banks," Working Papers hal-00918579, HAL.
    6. İbrahim Yarba & Z. Nuray Güner, 2020. "Leverage dynamics: Do financial development and government leverage matter? Evidence from a major developing economy," Empirical Economics, Springer, vol. 59(5), pages 2473-2507, November.
    7. Nicolas Griesshaber, 2017. "Towards a more comprehensive understanding of corporate leverage ratios," IFC Bulletins chapters, in: Bank for International Settlements (ed.), Uses of central balance sheet data offices' information, volume 45, Bank for International Settlements.
    8. de-Ramon, Sebastian J.A. & Francis, William B. & Harris, Qun, 2022. "Bank-specific capital requirements and capital management from 1989-2013: Further evidence from the UK," Journal of Banking & Finance, Elsevier, vol. 138(C).
    9. Ebrahim, M. Shahid & Girma, Sourafel & Shah, M. Eskandar & Williams, Jonathan, 2014. "Dynamic capital structure and political patronage: The case of Malaysia," International Review of Financial Analysis, Elsevier, vol. 31(C), pages 117-128.
    10. Jiang, Chunxia & Liu, Hong & Molyneux, Philip, 2019. "Do different forms of government ownership matter for bank capital behavior? Evidence from China," Journal of Financial Stability, Elsevier, vol. 40(C), pages 38-49.
    11. Gilani, Usman & Keasey, Kevin & Vallascas, Francesco, 2021. "Board financial expertise and the capital decisions of US banks," Journal of Corporate Finance, Elsevier, vol. 71(C).
    12. Iván Arribas & Emili Tortosa-Ausina & TingTing Zhu, 2021. "Optimal capital structure, model uncertainty, and European SMEs," Working Papers 2021/11, Economics Department, Universitat Jaume I, Castellón (Spain).
    13. Braouezec, Yann & Wagalath, Lakshithe, 2019. "Strategic fire-sales and price-mediated contagion in the banking system," European Journal of Operational Research, Elsevier, vol. 274(3), pages 1180-1197.
    14. Bakkar, Yassine, 2023. "Climate Risk and Bank Capital Structure," QBS Working Paper Series 2023/04, Queen's University Belfast, Queen's Business School.
    15. Couaillier, Cyril, 2021. "What are banks’ actual capital targets?," Working Paper Series 2618, European Central Bank.
    16. Lepetit, Laetitia & Saghi-Zedek, Nadia & Tarazi, Amine, 2015. "Excess control rights, bank capital structure adjustments, and lending," Journal of Financial Economics, Elsevier, vol. 115(3), pages 574-591.
    17. Jokipii, Terhi & Milne, Alistair, 2011. "Bank capital buffer and risk adjustment decisions," Journal of Financial Stability, Elsevier, vol. 7(3), pages 165-178, August.
    18. Thomas Hemmelgarn & Daniel Teichmann, 2014. "Tax reforms and the capital structure of banks," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 21(4), pages 645-693, August.
    19. Mário Santos & António Moreira & Elisabete Vieira, 2014. "Ownership concentration, contestability, family firms, and capital structure," Journal of Management & Governance, Springer;Accademia Italiana di Economia Aziendale (AIDEA), vol. 18(4), pages 1063-1107, November.
    20. Spiros Bougheas & Adam Hal Spencer, 2022. "Fire sales and ex ante valuation of systemic risk: A financial equilibrium networks approach," Discussion Papers 2022/04, University of Nottingham, Centre for Finance, Credit and Macroeconomics (CFCM).

    More about this item

    Keywords

    Equity issuance; asset sale; price impact; target capital ratio; systemic banks;
    All these keywords.

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:hal:journl:halshs-03341768. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: CCSD (email available below). General contact details of provider: https://hal.archives-ouvertes.fr/ .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.