A new TCH research note shows that most of the decline in price-to-tangible book value of equity in the post-crisis period is driven by the fall in banks’ profitability as measured by the return on tangible common equity (ROTCE). The TCH note also shows that both the decline in P/TBV and ROTCE is particularly pronounced for banks above $10bn in total consolidated assets. The note then explores possible explanations for this finding, including the role of major changes in regulatory policies.
Understanding the sources of the decline in the market value of banks’ equity is important for an assessment of the efficacy of post-crisis regulatory reforms. New regulations have required banks to hold substantially more capital and made their balance sheets substantially more liquid, thereby making banks more resilient to adverse economic and financial shocks. However, if changes in regulation have also caused the market value of bank equity to decline, then its benefits are substantially reduced as banks are unable to benefit via reduced costs of raising capital. Moreover, bank equity risk increases markedly with market leverage (measured as the quasi-book value of assets to the market value of equity), thus a decrease in the market value of bank equity leads to an increase in bank equity risk. This outcome has led some researchers to suggest that banks’ have become riskier, challenging the efficacy of post-crisis reforms.