Search

Working Paper No. 63. The Long-Term Relationship between Capital and Earnings in Banking: Sweden 1870–2001

PublicationWorking paper
Företagandets villkor, Leverage, Per Hortlund
Working Paper No. 63.
Download

Abstract

Contrary to received wisdom, two recent studies report a negative relationship between leverage and profitability in banking in the 1980s and early 1990s. This study presents new data on the leverage and profitability of Swedish commercial banks in 1870–2001, and explore the sign of the relation-ship in the long term. In the studied period, the capital-asset ratio decreased by a factor four, while return-on-equity more than doubled. The Leverage Formula postulates a positive linear relation between return-on-equity and the debt-equity ratio. A strong positive linear relationship was found over the period 1871–1980, but not in 1980–2001. Thus, while supporting the re-sults of the previous studies, a long-term “normal” positive relationship be-tween leverage and profitability is also reaffirmed.

Hortlund, P. (2005). The Long-Term Relationship between Capital and Earnings in Banking: Sweden 1870–2001. Ratio Working Paper No. 63.

Based on content

Working Paper No. 67. Clearing vs. Leakage: Does Note Monopoly Increase Money and Credit Cycles?
Working paperPublication
Hortlund, P.
Publication year

2005

Published in

Ratio Working Paper

Abstract

The effects of note monopolisation on the amplitude of money and credit cycles are studied. Note monopolisation trades clearing for leakage. If the central bank’s reserve ratio is larger than that of the commercial banks, and if the currency-deposit ratio is sufficiently large, the leakage effect could domi-nate the loss-of-clearing effect (base expansion), such that the credit capacity of the banking system decreases. This was the case when the Bank of Sweden gained a note monopoly in 1904. Money and credit cycles should therefore have become smaller. Swedish bank data for 1871–1938 reveal that money cycles became smaller, but credit cycles larger. The latter is attributed to an increasing time-demand deposit ratio, which increases the credit capacity of the banking system.

Working Paper No. 67. Clearing vs. Leakage: Does Note Monopoly Increase Money and Credit Cycles?
Working paperPublication
Hortlund, P.
Publication year

2005

Published in

Ratio Working Paper

Abstract

The effects of note monopolisation on the amplitude of money and credit cycles are studied. Note monopolisation trades clearing for leakage. If the central bank’s reserve ratio is larger than that of the commercial banks, and if the currency-deposit ratio is sufficiently large, the leakage effect could domi-nate the loss-of-clearing effect (base expansion), such that the credit capacity of the banking system decreases. This was the case when the Bank of Sweden gained a note monopoly in 1904. Money and credit cycles should therefore have become smaller. Swedish bank data for 1871–1938 reveal that money cycles became smaller, but credit cycles larger. The latter is attributed to an increasing time-demand deposit ratio, which increases the credit capacity of the banking system.

Working Paper No. 63. The Long-Term Relationship between Capital and Earnings in Banking: Sweden 1870–2001
Working paperPublication
Hortlund, P.
Publication year

2005

Published in

Ratio Working Paper

Abstract

Contrary to received wisdom, two recent studies report a negative relationship between leverage and profitability in banking in the 1980s and early 1990s. This study presents new data on the leverage and profitability of Swedish commercial banks in 1870–2001, and explore the sign of the relation-ship in the long term. In the studied period, the capital-asset ratio decreased by a factor four, while return-on-equity more than doubled. The Leverage Formula postulates a positive linear relation between return-on-equity and the debt-equity ratio. A strong positive linear relationship was found over the period 1871–1980, but not in 1980–2001. Thus, while supporting the re-sults of the previous studies, a long-term “normal” positive relationship be-tween leverage and profitability is also reaffirmed.

Show more