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The Long-Term Relationship between Capital and Earnings in Banking: Sweden 1870–2001

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    Contrary to received wisdom, two recent studies report a negative relation-ship between leverage and profitability in banking in the 1980s and early 1990s. This study presents new data on the leverage and profitability of Swedish commercial banks in 1870–2001, and explore the sign of the relation-ship in the long term. In the studied period, the capital-asset ratio decreased by a factor four, while return-on-equity more than doubled. The Leverage Formula postulates a positive linear relation between return-on-equity and the debt-equity ratio. A strong positive linear relationship was found over the period 1871–1980, but not in 1980–2001. Thus, while supporting the re-sults of the previous studies, a long-term “normal” positive relationship be-tween leverage and profitability is also reaffirmed.

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    File URL: http://www.ratio.se/pdf/wp/ph_relationship.pdf
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    Paper provided by The Ratio Institute in its series Ratio Working Papers with number 63.

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    Length: 18 pages
    Date of creation: 03 Jan 2005
    Date of revision:
    Handle: RePEc:hhs:ratioi:0063
    Contact details of provider: Postal: The Ratio Institute, P.O. Box 5095, SE-102 42 Stockholm, Sweden
    Phone: 08-441 59 00
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    1. Demirguc-Kunt, Asli & Huizinga, Harry, 1998. "Determinants of commercial bank interest margins and profitability : some international evidence," Policy Research Working Paper Series 1900, The World Bank.
    2. Berger, Allen N. & Herring, Richard J. & Szego, Giorgio P., 1995. "The role of capital in financial institutions," Journal of Banking & Finance, Elsevier, vol. 19(3-4), pages 393-430, June.
    3. Capie, Forrest & Billings, Mark, 2001. "Profitability in English banking in the twentieth century," European Review of Economic History, Cambridge University Press, vol. 5(03), pages 367-401, December.
    4. Allen N. Berger, 1994. "The relationship between capital and earnings in banking," Finance and Economics Discussion Series 94-2, Board of Governors of the Federal Reserve System (U.S.).
    5. Englund, Peter, 1999. "The Swedish Banking Crisis: Roots and Consequences," Oxford Review of Economic Policy, Oxford University Press, vol. 15(3), pages 80-97, Autumn.
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