David Lando's webpage

Bank Equity Risk  

Abstract:
Bank leverage has fallen since the Global Financial Crisis and market-to-book ratios have improved, yet equity risk has not declined. We show that both effects have been offset by a shrinking distance between capital ratios and the buffer requirement below which payouts are restricted. A two-factor model with buffer and resolution boundaries explains the trade-off. As the model predicts, banks closer to the buffer have higher equity volatility, beta and implied cost of equity, controlling for leverage and market-to-book. Our results show capital regulation can make bank debt safer but is no guarantee for reduced equity risk.