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Bank Debt Regulations Implications for Bank Capital and Bond Risk

Stig Helberg and Snorre Lindset

Working Paper Series from Department of Economics, Norwegian University of Science and Technology

Abstract: We use a structural model of default risk to study how optimal bank capital and bond risk are influenced by deposit insurance, implicit guarantees, depositor preference, asset encumbrance, and bail-in resolution frameworks. We find that these features of bank financing, in addition to having an immediate impact on bond debt risk, also change optimal bank capital, countering the first-order effect on bond debt risk. Bondholders' risk is thereby not materially affected, but shareholder value and public sector value are. A gap between optimal capital and required capital represents a cost to shareholders, and increases the risk of regulatory arbitrage. Enhancing capital requirements, and at the same time adopting bank debt regulations that reduce the optimal capital, is to gain some and lose some in terms of financial stability. Based on a small sample of European banks, we find support for the central model predictions.

Keywords: Bank debt regulations; optimal bank capital; bond risk. (search for similar items in EconPapers)
JEL-codes: G21 G28 G32 (search for similar items in EconPapers)
Pages: 42 pages
Date: 2013-06-13
New Economics Papers: this item is included in nep-ban, nep-cba and nep-rmg
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Persistent link: https://EconPapers.repec.org/RePEc:nst:samfok:14813

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