Tax Effects on Bank Liability Structure

Using supervisory data, we test the tax effects on the liability structure (the composition of deposits and other forms of debt) of the credit cooperative banks (BCC) by exploiting exogenous variations in the rates of tax on productive activities (IRAP) across Italian regions and over time. The testable predictions are derived from a model of bank liability structure that incorporates regulatory closure, endogenous default, and deposit insurance. We show that banks endogenously respond to tax cuts mainly by reducing non-deposit debt ratios, instead of deposit ratios, when lowering leverage. The overall liability structure adjustment substantially reduces non-equity funding costs.