Financial sector debt bias

Most tax systems create a tax bias toward debt finance. Such debt bias increases firm leverage and may negatively affect financial stability. This paper presents novel evidence on debt bias in the "non- traditional"financial sector—i.e., investment banks and non-bank financial intermediaries such as finance and insurance companies. It also shows how debt bias in the financial sector has been affected by the global financial crisis. The paper finds debt bias to be pervasive, explaining as much as 10 percentage points of bank leverage. These effects are more pronounced before than after the global financial crisis, explained by the post-crisis focus on rebuilding buffers. Going forward, as buffers have largely been re- built, debt bias is once again gaining prominence as a key driver of leverage decisions of financial firms, underscoring the importance of policy reform at this juncture.