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Are banks using leverage to target return on equity? Evidence from the US and the EU

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  • Spyros Pagratis
  • Eleni Karakatsani
  • Helen Louri

Abstract

We find evidence that banks actively use leverage to attain RoE targets and that leverage adjustments are primarily driven by capital distributions to shareholders. Using a large group of publicly-traded commercial banks from the US and the EU for the period 2001–2013, we demonstrate that this effect particularly holds for large banks before the crisis. Such behaviour may have led banks to enter the crisis with insufficient capital buffers to absorb losses, requiring unprecedented support by the public sector to maintain their solvency. Therefore, recent policies restricting the use of RoE as a metric in remuneration schemes and introducing constraints to capital distributions unless banks maintain certain buffers above the regulatory minimum, are in the right direction.

Suggested Citation

  • Spyros Pagratis & Eleni Karakatsani & Helen Louri, 2020. "Are banks using leverage to target return on equity? Evidence from the US and the EU," Oxford Economic Papers, Oxford University Press, vol. 72(3), pages 863-892.
    • Handle: RePEc:oup:oxecpp:v:72:y:2020:i:3:p:863-892.
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    File URL: http://hdl.handle.net/10.1093/oep/gpz049
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    More about this item

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation

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