Deutsche Bank’s buyback justifies more fair value accounting
Deutsche bank intends to buy back a significant amount of debt, according to the FT.
Interestingly, I wrote about these buybacks in a paper with Annelies Renders of Maastricht university.
These buyback transactions are generally disappointing. The idea is to generate CET1 capital, but this goes at the expense of liquidity and solvency, thus not contributing to financial stability.
The gains on the transaction are limited, because investors want to be compensated for parting from their debt instruments. This is in line with work of Anat Admati, who argues that all of the gains of these transactions accrue to the debt holders.
Given that these buybacks are very costly and inefficient, it would be better to relax the rules on the de-recognition of fair value gains on debt. For example, the current CRR bans these fair value gains: Art 33: 1. says: “Institutions shall not include the following items in any element of own funds: (b) gains or losses on liabilities of the institution that are valued at fair value that result from changes in the own credit standing of the institution;”
As a consequence, banks circumvent this rule and buy back the instruments that trade below par. Accepting the fair value gains on debt would take away the perverse incentive to dodge Art 33.1 (b). It would also keep cash in the bank and not unduly depress capital ratios.
See our paper here.