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Banks are not happy when regulators force them to raise the ratio of capital to total assets: they argue that this reduces their potential profits When a bank borrows more in order to purchase more

Banks are not happy when regulators force them to raise the ratio of capital to total assets: they argue that this reduces their potential profits. When a bank borrows more in order to purchase more risky assets, however, the interest rate it must pay on the borrowing should be high enough to compensate the lenders for the risk that the bank cannot repay in full-and the higher interest rate reduces bank profits. In light of this observation, is it obvious to you that it is more profitable for the bank to finance its asset purchase by borrowing, rather than by issuing additional shares of stock (and thereby increasing rather than reducing its ratio of capital to total assets)?

Jun 16 2020 View more View Less

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