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Is Banks' Cost of Equity Capital Different Across Countries? Evidence from the G10 Countries Major Banks

by Aurelio Maccario of the UniversitÓ Luiss,
Andrea Sironi of the UniversitÓ Bocconi, and
Cristiano Zazzara of the UniversitÓ Luiss

May 2002

Abstract: One of the major objectives of the 1988 Basel Accord was that of leveling the international playing field. While evaluating the contribution of the Accord remains a very difficult task because of the many factors involved, it is clear that relevant cross-country differences in the cost of equity capital for internationally active banks would significantly undermine the effectiveness of the current, and future evolvement of the Accord in pursuing this goal. This paper investigates this issue by comparing the cost of tier 1 capital of major banks from twelve countries over the 1993-2001 period. A new methodology based on the use of earnings' forecasts rather than historical earnings has been used to estimate banks' cost of equity. Three main results emerge from the empirical analysis. First, the estimated G-10 countries' major banks' average costs of equity have been decreasing during the nine years period from 1993 to 2001. Second, the differences between G-10 countries' average major banks' costs of equity have been steadily decreasing during the five years period from 1996 to 2001. Finally, multivariate regression results show that the individual banks' estimated costs of equity are strongly related to both microeconomic and macroeconomic variables. These results have relevant policy implications as far as the capital adequacy framework, currently undergoing a major reform process, is concerned.

JEL Classification: G15, G21, G28.

Keywords: Bank, cost of capital, bank regulation, capital ratios, earnings estimates.

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