Taxation Effects on Bank Capital Structure and Stability

Tax policy exerts a profound influence on the way banks fund themselves and on the resilience of the financial system. By altering the relative cost of debt and equity, corporate income taxes and targeted levies can create a pronounced debt bias, encouraging institutions to increase leverage. Conversely, the introduction of bank-specific taxes on liabilities or assets aims to rebalance incentives, prompting higher equity ratios and dampening excessive risk-taking. The interaction of tax instruments with regulatory regimes such as Basel III shapes capital adequacy and liquidity buffers, with implications for risk weights, loss-absorbing capacity and contagion dynamics. Empirical evidence demonstrates that liability taxes and levies can reduce interbank exposures, strengthen capital cushions and lower the probability and cost of crises. At the same time, tax-driven profit-shifting strategies and differential tax allowances for equity financing may distort funding choices and affect small and large banks differently. Understanding these effects is critical for policymakers seeking to bolster stability without unduly constraining credit provision or creating unintended compliance burdens.

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Taxation Effects on Bank Capital Structure and Stability publication trend

The graph below shows the total number of articles in taxation effects on bank capital structure and stability across all publications each year (not limited to Nature Index journals).

Technical terms

Capital structure: The mix of debt and equity financing that a bank employs to fund its assets.

Leverage: The ratio of a bank’s debt to its equity, indicating its reliance on borrowed funds.

Liability tax: A specific tax levied on the value of a bank’s liabilities to discourage excessive debt.

Bank levy: A targeted charge on banks’ balance-sheet items, often liabilities or assets, to internalise crisis costs.

Tax shield: The reduction in taxable income resulting from the deductibility of interest payments.

Risk weight: A factor assigned to bank assets under capital rules, determining how much capital must be held against potential losses.

References

1. Liability taxes, risk, and the cost of banking crises. Journal of Corporate Finance (2023).
2. Interactions between bank levies and corporate taxes: How is bank leverage affected?. Journal of Banking & Finance (2020).
3. Capital Regulation, Liquidity Requirements and Taxation in a Dynamic Model of Banking. IMF Working Papers (2012).
4. Taxes, Leverage, and Profit Shifting in Banks. Economies (2024).
5. Taxing banks leverage and syndicated lending: A cross-country comparison. International Review of Law and Economics (2023).