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Beyond Common Equity - The Influence of Secondary Capital on Bank Insolvency Risk

Thomas Conlon, John Cotter () and Philip Molyneux ()
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Thomas Conlon: University College Dublin

No 201806, Working Papers from Geary Institute, University College Dublin

Abstract: Banks adhere to strict rules regarding the quantity of regulatory capital held, but have some flexibility as to its composition. In this paper, we examine bank insolvency risk (distance to default) for listed North American and European banks over the period 2002-2014, focusing on sensitivity to capital other than common equity. Decomposing tier 1 capital into equity and non-core components reveals a heretofore unidentified variation in risk reduction capacity. Greater non-core tier 1 capital is associated with increased insolvency risk for larger and more diversified banks, impairing the risk reducing capacity of aggregate tier 1 capital. Overall tier 2 capital is not linked with insolvency risk, although a conflicting relationship is isolated conditional on the level of total regulatory capital held. Finally, the association between risk and capital is weakened when the latter is defined relative to risk-weighted assets.

Keywords: Regulatory Capital; Bank Risk; Regulatory Capital Arbitrage; Tier 1; Tier 2 (search for similar items in EconPapers)
JEL-codes: G21 G28 G32 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ban, nep-cba, nep-cfn and nep-rmg
Date: 2018-02-19
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http://www.ucd.ie/geary/static/publications/workingpapers/gearywp201806.pdf First version, 2018 (application/pdf)

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Persistent link: https://EconPapers.repec.org/RePEc:ucd:wpaper:201806

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