Abstract
This paper assesses the effect of banking regulation on bond yields. The costs for banks associated with capital requirements for holding bonds may lead to the demand for a higher compensatory yield. As government debt in particular is treated preferentially, capital costs may determine part of the spread between corporate and government bonds. We introduce a new measure for approximating the part of the spread that is induced by regulatory capital costs. Using German bond price data, we find that the costs associated with capital requirements explain a substantial fraction of the credit spread. Our findings contribute to the debate on whether to abolish the preferential treatment of government bonds in banking regulation and are of relevance for policymakers, banks and investors.
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