Impact of additional equity capital on bank funding costs: Australian evidence

The Basel III reform package has sought to address lessons from the financial crisis of 2007-2009, by imposing additional equity capital requirements on banks. We examine the long-run cost implications of the reforms for banks that have transitioned to the new requirements, in an economy with a strong dependence on bank lending and a highly concentrated banking industry. We find evidence that the risk premium on bank equity increases with financial leverage, as predicted by the Modigliani-Miller theorem. This effect is weaker than reported by studies in countries with less concentrated banking industries, including the United Kingdom and Switzerland. However, we also find evidence that the risk premium on bank equity became more responsive to changes in leverage after the financial crisis. We estimate that the reforms have resulted in a modest increase in banks’ overall funding costs (of about 10-17 basis points annually).