Risk Management and Value Creation in ... - Arabictrader.com

Capital Structure in Banks 139
TABLE 5.1
Bank Book Capital Ratios
Asset Size Bucket
1996 (in $bn) 0.5–1 1–2 2–5 5–10 10–30 > 30
Number of Banks 203 112 65 33 32 29
Tier-1 Capital/Average
Assets (in %) 8.58 8.57 7.80 8.46 7.50 7.14
Total Capital (Tier-1 +
Tier-2) / Risk-Weighted
Assets (in %) 14.47 14.23 13.46 13.75 13.25 12.80
Source: Adapted from Davis and Lee (1997), p. 37. Tier-1 and Tier-2 capital are
defined in the “Available Capital” section later in this chapter. Used with permission.
mum where the marginal effects equal out. 7 Typically, the reduced form of
such models tries to find the optimal capital structure where the marginal
tax benefits equal the marginal increase in bankruptcy costs. 8 As we saw in
Chapter 3, in such models, it can be easily shown that risk management can
contribute to value creation, because it allows the firm to increase its leverage
while keeping the probability of bankruptcy low.
These simple models do not cover banking reality, because manifold other
departures from the frictionless M&M world could explain the economically
driven leverage of banks. For instance, the capital requirement is:
■ Reduced by tax benefits
■ Increased in response to a rise in the expected costs of financial
distress 9
■ Ambiguous with regard to other transaction and agency costs 10
■ Reduced by regulation 11
7 See, for example, Johnson (1998), pp. 47–48, who refers to an extensive list of
references to the literature.
8 See, for example, Opler et al. (1997).
9 See Berger et al. (1995b), pp. 396 and 399.
10 Some of the agency problems between shareholders and debt holders are reduced
by an increase in leverage, whereas some other conflicts between shareholders and
managers are reduced when leverage is increased. Given that the corporate finance
literature has made little progress in quantifying this trade-off, the net impact of
economically induced capital requirements can be best described as ambiguous. See
Berger et al. (1995b), p. 399.
11 The introduction of the safety net and the subsequent effects on the capital ratios
(as discussed in regard to Figure 5.1) basically insulates banks from market discipline.
See Berger et al. (1995b), p. 400.