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Capital headroom and bank cost of equity: Evidence from the Euro Area

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  • Behn, Markus
  • Cappiello, Lorenzo
  • Reghezza, Alessio

Abstract

Does capital headroom – i.e. the difference between capital ratios and capital requirements – affect banks’ cost of equity? Using quarterly data on listed euro area banks from Q4 2014 to Q1 2025, we document a robust negative relationship: a one percentage point increase in capital headroom reduces the cost of equity by 10–12 basis points. This effect is driven by capitalisation rather than requirements and is also non-linear: the reduction in the cost of equity is strongest for banks with low headroom and weakens as headroom increases. Maintaining adequate headroom above minimum requirements lowers equity costs by enhancing resilience which is valued by investors.

Suggested Citation

  • Behn, Markus & Cappiello, Lorenzo & Reghezza, Alessio, 2026. "Capital headroom and bank cost of equity: Evidence from the Euro Area," Economics Letters, Elsevier, vol. 265(C).
    • Handle: RePEc:eee:ecolet:v:265:y:2026:i:c:s0165176526001989
    DOI: 10.1016/j.econlet.2026.113004
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    JEL classification:

    • G2 - Financial Economics - - Financial Institutions and Services
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • F51 - International Economics - - International Relations, National Security, and International Political Economy - - - International Conflicts; Negotiations; Sanctions

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