Why Do Banks Practice Regulatory Arbitrage? Evidence from Usage of Trust Preferred Securities

Nicole Boyson, Ruediger Fahlenbrach and René Stulz

No 19984, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We propose a theory of regulatory arbitrage by banks and test it using trust preferred securities (TPS) issuance. From 1996 to 2007, U.S. banks in the aggregate increased their regulatory capital through issuance of TPS while their net issuance of common stock was negative due to repurchases. We assume that, in the absence of capital requirements, a bank has an optimal capital structure that depends on its business model. Capital requirements can impose constraints on bank decisions. If a bank's optimal capital structure also meets regulatory capital requirements with a sufficient buffer, the bank is unconstrained by these requirements. We expect that unconstrained banks will not issue TPS, that constrained banks will issue TPS and engage in other forms of regulatory arbitrage, and that banks with TPS will be riskier than other banks with the same amount of regulatory capital, and therefore, more adversely affected by the credit crisis. Our empirical evidence supports these predictions.

JEL-codes: G01 G21 (search for similar items in EconPapers)
Date: 2014-03
New Economics Papers: this item is included in nep-ban and nep-cba
Note: AP CF
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Citations: View citations in EconPapers (4)

Published as Nicole M. Boyson, Rüdiger Fahlenbrach, René M. Stulz; Why Don't All Banks Practice Regulatory Arbitrage? Evidence from Usage of Trust-Preferred Securities, The Review of Financial Studies, Volume 29, Issue 7, 1 July 2016, Pages 1821–1859, https://doi.org/10.1093/rfs/hhw007

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Working Paper: Why Do Banks Practice Regulatory Arbitrage? Evidence from Usage of Trust Preferred Securities (2014)
Working Paper: Why Do Banks Practice Regulatory Arbitrage? Evidence from Usage of Trust Preferred Securities (2014)
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