The Impact of Capital and Liquidity Regulation: Evidence from European Banks

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YEREVAN, Armenia – On November 12, Armen Arakelyan, faculty member at the American University of Armenia (AUA) College of Business and Economics discussed a study he conducted titled, “The Impact of Capital and Liquidity Regulation: Evidence from European Banks.” The event was part of CBE’s Research Seminar Series (Seminar #4).

Professor Arakelyan is adjunct assistant professor of finance at AUA. He holds a PhD in finance from Carlos III University in Madrid, Spain. His current area of research is banking supervision, and more specifically, the impact of heightened capital and liquidity requirements of the Basel regulation on bank cost of capital. In addition, his research interests include credit derivatives valuation and liquidity. In this regard, his studies deal with the importance of liquidity and the size of liquidity compensation in Credit Defaults Swap (CDS) markets.

Under the assumption of efficient and perfect capital markets, lower leverage leads to lower equity risk and, hence, lower required return on it, leaving weighted average cost of capital unchanged. Arakelyan tested this question, using data from listed European banks and found that lower leverage (as well as higher liquidity) decrease equity risk. However, low risk banks offer higher or the same risk-adjusted stock returns in excess of risk-free rate. Under the assumption of riskless debt, calibration results show that a 10 percentage point increase in capital requirements brings about a 40 basis point increase in the weighted average cost of capital.

Founded in 1991, the American University of Armenia (AUA) is a private, independent university located in Yerevan, Armenia and affiliated with the University of California. AUA provides a global education in Armenia and the region, offering high-quality, graduate and undergraduate studies, encouraging civic engagement, and promoting public service and democratic values.