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Title:The long-term relationship between capital and earnings in banking PDF Logo
Authors:Hortlund, Per
Issue Date:2005
Series/Report no.:SSE/EFI Working Paper Series in Economics and Finance 611
Abstract:Contrary to received wisdom, some recent studies report a negative relationship between leverage and profitability in banking in the 1980s and early 1990s. This study presents new data on the leverage and profitability of Swedish commercial banks in 1870-2001, and explores the sign of the relationship in the long term. In the studied period, the capital-asset ratio decreased by a factor four, while return-on-equity more than doubled. The leverage formula postulates a positive linear relationship between return-on-equity and the debt-equity ratio. A strong positive linear relationship was found over the period 1871-1980, but not in 1980-2001. Thus, while supporting the results of the previous studies, a long-term normal positive relationship between leverage and profitability is also reaffirmed.
Subjects:Return-on-equity
Leverage
Bank capital
JEL:G21
N23
N24
Document Type:Working Paper
Appears in Collections:SSE/EFI Working Paper Series in Economics and Finance, EFI - The Economic Research Institute, Stockholm School of Economics

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