Are Banks’ Below-Par Own Debt Repurchases a Cause for Prudential Concern?
With Annelies Renders, Maastricht University.
In the lead-up to the implementation of Basel III, European banks repurchased debt securities that traded below par. Banks engaged in these Liability Management Exercises (LMEs) to realize a fair value gain that prudential rules exclude from regulatory capital calculations. Many banks executed LMEs to augment Core Tier 1 capital, given that alternative methods were not feasible in practice. Using data of 720 European LMEs conducted between April 2009 and December 2013, we show that poorly capitalized banks in particular engaged in LMEs and lost about 9.1bn Euro in premiums to compensate fixed-income investors for parting with their securities. This amount would largely be recognized as Core Tier 1 regulatory capital if regulation accepted the recognition of fair value gains on debt. Banks used their discretion to buy back the most loss-absorbing capital securities, for which they paid the highest premiums. More importantly, the premiums increase with leverage and in times of stress, when conserving cash is paramount to preserve the safety and soundness of the banking system. Our results weaken the case of the exclusion from regulatory capital of unrealized fair value gains that originate from a poor own credit standing.
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.
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