Capital costs of banks

We apply the Wicksell-Tobin investment model, augmented by the capital asset pricing theory, to the task of deriving the cost of capital for banks. In contrast to the literature we recognise that banks vicariously acquire capital when they grant commercial loans. These insights yield two important implications. First, if applied uncritically, the capital asset pricing model may be rendered a mere tautology. Second, as Wicksell-Tobin stress the dual nature of capital valuations, namely market value and replacement cost, marking to market turns out to be only one version of economic value accounting. Marking to replacement cost becomes the preferred option because it prevents banks during periods of asset inflation from granting loans on the basis of exaggerated market values of investment projects. Its adoption would inject greater stability into the banking industry.