Reevaluating Bank Price-to-Book Ratios: An In-Depth Analysis of Equity Components Across Economic Cycles

This study explores the evolution of price-to-book (P/B) ratios among European banks from 2005 to 2020, period where the majority of banks in different countries had a P/B ratio below 1. By dissecting banks' accounting equity into investor contributions and earnings-derived components, the research aims to evaluate how each component of equity affects these ratios and investigates whether their dynamics shifted during the period. We address a gap in prior research that has not extensively examined how individual equity components affect the overall P/B ratio. This aspect is crucial, especially in scenarios where the increase of specific components compensates for declines in others, thereby stabilizing total equity values. Our methodology involves regression analyses using a panel data model with random effects. The findings reveal that earnings-related equity components significantly influence P/B ratios. In contrast, investor contributions; which strengthen the solvency of the entity, appear to have a minimal impact. Additionally, our analysis highlights a significant quadratic relationship between the P/B ratios and both the profit or loss reported on Income Statements and distributed dividends.