Changes in the Cost of Bank Equity and the Supply of Bank Credit

This paper shows that both bank balance sheet composition and credit supply significantly respond to a decrease in the relative cost of bank equity. To do so, we exploit the staggered introduction of tax reforms in Europe from 2000 to 2012 as exogenous sources of changes in the cost of equity. We investigate the effect on credit supply using loan level data in a country where firms are not affected by these reforms, and where foreign banks affected by the reforms are lending actively: Germany. We find that the relative decrease in the cost of equity leads banks to rely more on equity financing and to increase lending to firms, while decreasing security and interbank asset holdings. Overall, our paper shows that taxation can be an effective tool to monitor bank leverage and credit supply