The Value Relevance of Regulatory Capital Components
We measure the relevance of regulatory capital and regulatory adjustments of U.S. banks for shareholders. We use parsimonious log-linear regression models that mitigate shortcomings of conventional research designs. Results for the years 2001-2020 show that banks’ share price sensitivity to various measures of bank capital, e.g. book equity, Tier 1, Total Capital, converges to one when market uncertainty is low and when banks’ Tier 1 ratios reaches 12~percent of RWAs. Share prices are particularly sensitive to changes in capital of highly geared banks during times of elevated market uncertainty. We attribute the excess sensitivity to adjustments that increase regulatory capital. In all, we show that shareholders positively respond to increases in non-equity bank capital when it matters most.
Link to paper, click here.
Max Headroom: Discretionary Capital Buffers and Bank Risk
Abstract: The paper examines the association between discretionary bank capital buffers, capital requirements, and risk for European banks. The discretionary buffers are banks’ own buffers, or headroom, and undisclosed buffers agreed in the supervisory review process (SREP). I exploit information of discretionary buffers that banks started to disclose after the release of an EBA opinion in 2015. Results from SREP and Pillar 2 data from the largest 99 European banks over 2013-2019 show that lower discretionary buffers increase bank risk. An additional examination of banks’ responses to EBA stress test results reveals a positive association between discretionary buffers and stress test results for SSM banks, a result that runs against supervisory requirements.
Link to paper: click here.
See also: this SSRN Regulation of Financial Institutions eJournal
Are Banks’ Below-Par Own Debt Repurchases a Cause for Prudential Concern?
Abstract: Leading up to the implementation of Basel III, European banks needed to substantially increase their capital ratios. To do this, banks made use of Liability Management Exercises (LMEs) in which they repurchased below-par debt securities. Banks are subject to a prudential filter that excludes from the calculation of capital ratios unrealized gains on debt securities arising from a deterioration in banks’ own credit standing. By repurchasing below-par debt securities, banks can circumvent the prudential filter as unrealized gains become realized and increase Core Tier 1 capital. We examine the determinants and consequences of these LMEs and provide evidence that these debt repurchases are a cause for prudential concern.
Here is the full paper: Are Banks’ Below-Par Own Debt Repurchases a Cause For Prudential Concern?
A primer on regulatory bank capital adjustments
Winner of best paper award afaanz in finance stream.
Abstract: This paper empirically examines regulatory adjustments, adjustments that banks have to apply to book equity in order to calculate Tier 1 regulatory capital. These adjustments affect the level and structure of the regulatory capital of banks. For a large sample of US bank holding companies over the years 2001–2013, this paper documents a decreasing relation between regulatory adjustments and bank solvency. Low solvency banks benefit from regulatory adjustments: they report values of Tier 1 regulatory capital that exceed book equity. These banks rely on regulatory adjustments to inflate important regulatory solvency ratios, such as the Tier 1 leverage ratio and the Tier 1 risk-based capital ratio. In contrast, highly solvent banks report Tier 1 capital that is lower than book equity. These banks are required to adjust their solvency ratios downward for prudential reasons, despite their resilient solvency levels. These results weaken the case for regulatory adjustments.
Here is the full paper: A primer on regulatory bank capital adjustments.
More robust Dutch bank capital and transparent regulation
Abstract: The recently established European rules on bank capital are the end result of a transparent process to which many parties have contributed shortly after the onset of the financial crisis. As a result of this process, Europe has the last word on bank capital – no longer The Hague. However, Dutch control over bank capital is not lost. Important fora, including the Basel Committee, the European Commission, and the European Banking Authority are transparent and thereby provide opportunities to influence policy. The openness has contributed to financial stability. Banks used this openness in a timely fashion to improve their solvency. In addition, the openness influenced the government’s vision on bank capital, albeit late and possibly without effect.
For the full paper, in Dutch, click here.
Google scholar: click here.
SSRN author page: click here.