On book equity: why it matters for monetary policy

Keynote address by Mr Hyun Song Shin, Economic Adviser and Head of Research of the BIS, at the joint workshop by the Basel Committee on Banking Supervision, the Centre for Economic Policy Research and the Journal of Financial Intermediation on "Banking and regulation: the next frontier", Basel, 22 January 2015.

The book value of equity plays a central role in discussions of bank capital adequacy. Yet among researchers in empirical corporate finance, it is common to hear the claim that book equity is a stale and backward-looking measure of the market value of equity, and that researchers should therefore use the market capitalisation of the firm and ignore book equity whenever market capitalisation is available. It is also common for empirical papers to discard financial firms from the dataset at the outset. For both reasons, banks' book equity ends up being neglected by researchers. However, the banks' book equity is the foundation for bank lending, so that adequate book equity plays a central role in the provision of credit to the real economy. For this reason, adequate book equity is essential for the effective transmission of monetary policy. In particular, equity that is sufficient to induce banks to lend could turn out to be considerably higher than equity that ensures solvency.