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Working Paper

Optimal Financial Structure and Bank Capital Requirements: An Empirical Investigation

This paper presents an empirical analysis of the determinants of the leverage ratios (the book value of liabilities divided by the total of the book value of liabilities’ and the market value of equity) for 232 bank holding companies for December 1986, June 1987, and December 1987. Many theoretical models of bank behavior assume that bank capital requirements will be binding, and empirical research has generally shown that almost all- banks will meet capital guidelines. However, if the optimal leverage ratios differ among banks, then banks’ responses to changes in capital requirements or to changes in factors that influence their optimal leverage ratio may vary in a cross section. The theoretical framework is a variant of the one developed in Bradley, Jarrell, and Kim (1984). The optimal leverage ratio balances the tax advantage of debt with the costs of bankruptcy. In addition to considering nondebt tax shields and tax rates as determinants of the optimal ratio, we analyze the simultaneity between leverage and investment in municipal securities (munis). Previous research indicates that banks utilize munis to' minimize tax liabilities.

Suggested Citation

Osterberg, William P., and James B. Thomson. 1990. “Optimal Financial Structure and Bank Capital Requirements: An Empirical Investigation.” Federal Reserve Bank of Cleveland, Working Paper No. 90-07.