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Nonna Sorokina

AIMI fellow’s research finds positive connection between bank capital and firm leverage

Posted on June 13, 2025

SCRANTON, Pa. — Banks face many risks every day including not having enough money to make payments to depositors and suffering losses if loans they issued are not being paid on time. In a paper published in Financial Management Association, Nonna Sorokina, assistant professor of business at Penn State Scranton, finds a positive relationship between levels of bank equity capital and leverage of non-financial firms. 

Non-financial firms are those that use banking services but are not banks, according to Sorokina. 

“This is a big topic of conversation in finance,” Sorokina said. “Where do you get your capital? Do you issue stocks (equity)? Do you borrow? Firms borrow an average of 40% of their capital. Some, however, refuse to borrow, which is not necessarily efficient. Most firms are levered at least to some extent.” 

In this paper, Sorokina collaborates with Lindsay Baran, associate professor in Kent State University’s Ambassador College of Business and Entrepreneurship in Ohio; and Ajay Patel, professor and Thomas S. Goho Chair in Finance at Wake Forest University in North Carolina, to study the effects of bank capital decisions on capital decisions of non-financial firms, as well as their growth and risk. 

“We looked at how bank capital may be connected to non-financial firms’ capital decisions,” she said. “We were looking to see if there’s a connection between how much banks borrow and if that will influence the firms that borrow from banks.” 

Sorokina noted that there’s a positive connection between bank capital and firm leverage. 

“This means that when banks make decisions to hold more capital under the pressure of market factors or regulators – government organizations that set rules and monitor banks for compliance – who want to make banks safer, there is more skin in the game. There’s more equity and less borrowing,” Sorokina said. “This does affect firm leverage.” 

There’s still a question left unanswered, though. 

When regulators establish new capital requirements to hold more capital, does it make our overall system more efficient or productive? Does it become safer as a result? 

“What we find is that when banks are better capitalized, they allow non-financial firms to borrow more; those firms become riskier and grow slower. We always look for effects in the non-financial industry, because when regulations change, it could influence how firms grow,” Sorokina said. 

Choice of borrowers also makes a difference. According to Sorokina, when banks have more equity and feel solid, they may choose to lend to riskier borrowers who may not pay on time. 

Too much debt, however, poses risks. 

“When things don’t go right, people may not be able to pay, and similarly, firms may not be able to pay,” Sorokina said. “Banks, by nature, finance almost 90% of their capital with debt because they take deposits, which are also considered to be debt. The bank is borrowing from us as we deposit money into our accounts.” 

Though some deposits are insured by the Federal Deposit Insurance Corporation, there’s still a dilemma when people assume that the government may have to step in to cover financial obligations, Sorokina said. 

“That’s called the moral hazard of deposit insurance,” she said. “I was working on my doctorate leveraging my experience in financial industry during the time of financial crisis in 2007-09. I have seen it all from the inside. When banks don’t handle their capital correctly, it causes a lot of issues.” 

This paper is the third and final in a series. 

Sorokina also worked with Praneeth Sunkavalli and Jainil Kakka, Penn State Great Valley graduate students in data analytics who graduated in December 2024, on data collection, cleaning up and merging already-existing datasets, and validating all calculations from their observations. 

The team used Penn State Institute for Computational and Data Sciences (ICDS) Roar for this project. 

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