Bank stock returns, leverage and the business cycle

The returns on bank stocks rise and fall with the business cycle, making bank equity financing cheaper in the boom and dearer during a recession. This provides support for prudential tools that give incentives for banks to build capital buffers at times when the cost of equity is lower. In addition, banks with higher leverage face a higher cost of equity, which suggests that higher capital ratios are associated with lower funding costs.

JEL classification: G3, G21, G28.