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Target capital ratio and optimal channel(s) of adjustment: A simple model with empirical applications to European banks

Author

Listed:
  • Yann Braouezec

    (IÉSEG School Of Management [Puteaux])

  • Keyvan Kiani

    (IÉSEG School Of Management [Puteaux])

Abstract

Why do banks decide to reach their target capital ratio by selling assets and/or issuing new shares? To answer this question, we offer a simple framework in which each channel of adjustment is costly; underwriting and dilution costs for equity issuance, profit reduction and price impact for asset sale. We make the assumption that the aim of the bank is to minimize the total adjustment cost subject to the target's constraint and we derive its optimal strategy. The solution is formulated in terms of two critical thresholds for which we give an explicit formula. We then compare our model's predictions to the decisions taken by two European systemic banks (Deutsche Bank and UniCredit) to issue new shares in 2017 and for which the target ratio was publicly disclosed. We show that the predictions of the model are consistent with the observed decisions.

Suggested Citation

  • Yann Braouezec & Keyvan Kiani, 2021. "Target capital ratio and optimal channel(s) of adjustment: A simple model with empirical applications to European banks," Post-Print halshs-03341768, HAL.
    • Handle: RePEc:hal:journl:halshs-03341768
    Note: View the original document on HAL open archive server: https://shs.hal.science/halshs-03341768
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    References listed on IDEAS

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    Keywords

    Equity issuance; asset sale; price impact; target capital ratio; systemic banks;
    All these keywords.

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