Report

Government Guarantees and the Valuation of American Banks


Abstract: Banks' ratio of the market value to book value of their equity was close to 1 until the 1990s, then more than doubled during the 1996-2007 period, and fell again to values close to 1 after the 2008 financial crisis. Sarin and Summers (2016) and Chousakos and Gorton (2017) argue that the drop in banks' market-to-book ratio since the crisis is due to a loss in bank franchise value or profitability. In this paper we argue that banks' market-to-book ratio is the sum of two components: franchise value and the value of government guarantees. We empirically decompose the ratio between these two components and find that a large portion of the variation in this ratio over time is due to changes in the value of government guarantees.

Keywords: Banking; Bank valuation; Bank leverage; Risk shifting; Bank regulation; Bank financial soundness;

JEL Classification: H12; G38; G21; E44; G32; G28;

https://doi.org/10.21034/sr.567

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Provider: Federal Reserve Bank of Minneapolis

Part of Series: Staff Report

Publication Date: 2018-06-19

Pages: 84 pages

Order Number: 567