The impact of the yield curve on bank equity returns: Evidence from Canada

We examine the reaction of Canadian banks' equity returns to changes in yield curve spreads. We find that Canadian banks equity returns are positively impacted by contemporaneous (and lagged) yield curve spreads. Our results suggest that Canadian banks have become more sensitive to changes in the slope of the yield curve in the post 2007–2009 financial crisis. We also find an asymmetric impact of the slope of the yield curve on Canadian bank equity returns. For equity investors, the yield curve’s relevance varies with spread-maturities. Our findings have important implications for the estimations of banks’ cost of capital and implicitly suggest regulatory incentives in favor of macro-prudential policy to evaluate bank risk. Swings in yield curve spreads could induce shifts in banks’ profit-seeking behavior towards non-interest income sources.