Economics and Business
Quarterly Reviews
ISSN 2775-9237 (Online)
Published: 20 November 2023
The Impact of Regulatory Changes on the Effectiveness to Earn Positive Margin for their Investors
Sanja Petrinić Turković
Croatian National Bank
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10.31014/aior.1992.06.04.543
Pages: 128-139
Keywords: Banking Regulation, Cost of Capital, Return on Capital
Abstract
It is often forgotten that banks are private companies and that shareholders and investors expect certain return on their investments. Banks are also highly leveraged companies increasingly dependent on the investors especially in long-term debt. On the other hand, during the period of "low-for-long" interest rates, we have witnessed that Return on Capital for major listed European banks was constantly falling. Average use to stand on 2.28% in 2002 and has fallen by 2021 to 1.87% . In majority of listed European banks that was much lower than their Cost of Capital (4.4% in 2002 fallen to 2.8% in 2021) which is usually taken as the benchmark for investors' minimum expectations in terms of return on their investment. In line with the Modigliani–Miller theorem that has in recent research proven to be valid for the banks , this research had ignored the capital structure and used as key variables Cost of Capital and Return on Capital, both not sensitive to the capital structure of an entity. Every new regulatory requirement although strengthening the resilience also increases cost of compliance and possibly further reduces the positive margins banks are earning to their shareholders and investors. It is therefore a legitimate question will the shareholders and investors keep investing in banks capital if the Return on Capital will not cover Cost of the same Capital. Especially now that new investment opportunities arise and competition on the market for non-core banking services like payment services, digital services, etc. further intensifies. The research presented in this paper analysed the data for 53 European listed banks and based on the fixed effect model applied to the panel data concluded that regulatory changes do effect banks effectiveness to earn that positive margin for their investors and shareholders. It has also been concluded that traditional banks which are dominantly financed through deposits and oriented to extending loans are more resilient to regulatory changes. This paper contributes to the literature on factors influencing the Cost of Capital and Return on Capital for banks, but does so by analysing the influence of different regulatory changes and key business model variables on the differential of Return on Capital and Cost of Capital. In a brother sense, this paper is also consistent with the conclusions of the literature on "low risk anomaly" proving that "traditional" less risky banks, from their business model perspective, tend to outperform their counterparts.
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