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The relationship between capital and earnings in banking

  • Allen N. Berger

Contrary to conventional wisdom, bank capital ratios are positively related to returns on equity in the 1980s. Higher capital Granger-caused higher earnings and vice versa for U.S. banks, 1983-89. The surprising positive Granger-causation from capital to earnings occurred primarily through lower interest rates paid on uninsured purchased funds. The data support the hypothesis that expected bankruptcy costs for banks increased substantially in the 1980s, raising optimal capital ratios. The causation from capital to earnings became negative in the early 1990s, when aggregate risk, regulation, and earnings changed, but the findings still support the expected bankruptcy costs hypothesis. Copyright 1995 by Ohio State University Press.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 94-2.

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Date of creation: 1994
Date of revision:
Handle: RePEc:fip:fedgfe:94-2
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