2.1.2. Equity

There are reasons to believe that a better-capitalized bank should be more profitable because banks with higher capital to assets ratios are considered relatively safer to financial institutions with lower capital ratios. A bank with higher capital will have more flexibility to absorb negative shocks, so this positive impact on bank performance can be because capital acts as a safety net in the case of adverse developments (Athanasoglou et al. 2008; Beltratti and Stulz 2012). Also, a high level of capital can lead to a lower cost of debt, as to finance their assets, banks will not need as many interest-bearing funds. In other words, this relation would help the bank to finance its assets at the more favorable interest rates, increasing expected profitability and o ffsetting the cost of equity, considering the most expensive bank liability in terms of expected return (Garcia and Guerreiro 2016; Tran et al. 2016). García-Herrero et al. (2009) also argue that more capitalized banks have a high value, so they have incentives to remain well-capitalized and to engage in prudent lending. Following these arguments, it seems that banks with higher capital-to-assets ratios usually have a reduced need for external funding, which again has a positive e ffect on their profitability (Kosmidou 2008; Pasiouras and Kosmidou 2007). Thus, the empirical evidence indicates that the best performing banks are those who maintain a high level of equity concerning their assets. Consistent with these influences, a direct association between capital and profitability is expected, and the following hypothesis is established:

**Hypothesis 2.** *There is a positive relationship between the equity ratio of a bank and its performance.*
