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Capital Ratios and the Weighted Average Cost of Capital: Evidence from Chilean Banks

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  • Rodrigo Cifuentes
  • Tomás Gómez
  • Alejandro Jara

Abstract

In this paper, we find that one additional percentage point of common equity Tier 1 to risk-weighted assets ratio is associated with an increase in the Weighted Average Cost of Capital (WACC) of Chilean banks by a maximum of only 11.7 basis points. This result is found by assessing the impact of capital ratios on the return of capital and the return of debt, following alternative empirical strategies, which consider both market data and banks’ balance sheet information. We find that higher capital ratios decrease the return on banks’ capital—partially because more capital makes banks less risky—in magnitudes similar to those found in the literature for other countries. Secondly, we study the role of capital on the return of banks’ debt. We find a strong impact of capital ratios on the return of subordinated debt, and no effect on senior debt.

Suggested Citation

  • Rodrigo Cifuentes & Tomás Gómez & Alejandro Jara, 2022. "Capital Ratios and the Weighted Average Cost of Capital: Evidence from Chilean Banks," Working Papers Central Bank of Chile 960, Central Bank of Chile.
    • Handle: RePEc:chb:bcchwp:960
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    File URL: https://www.bcentral.cl/documents/33528/133326/DTBC_960.pdf
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    References listed on IDEAS

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