In this work, we estimate the Cost of Equity (CoE) for a comprehensive set of European banks. In particular, we analyze the cross-country differences among euro area banks’ CoE and explore the determinants of the observed heterogeneity.
We find that Italian banks pay larger returns than their European peers. We investigate whether this reflects the perceived risk to invest in Italy compared to other countries or bank-specific factors. To do this, we examine the determinants of the CoE with panel data regressions.
Our findings suggest that a large fraction of CoE is explained by a common set of euro area macro variables, but most of the gap among banks in different countries is explained by asset quality and profitability indicators.
In addition, the estimates show that the CoE of Italian banks is somewhat overvalued. Our analysis implies that banks can reduce the cost of capital by speeding up the disposal of non-performing loans as well as improving profitability.