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


  • Nicole Boyson
  • Rüdiger Fahlenbrach
  • René M. Stulz


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.

Suggested Citation

  • Nicole Boyson & Rüdiger Fahlenbrach & René M. Stulz, 2014. "Why Do Banks Practice Regulatory Arbitrage? Evidence from Usage of Trust Preferred Securities," NBER Working Papers 19984, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:19984
    Note: AP CF

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    References listed on IDEAS

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    Cited by:

    1. Sengupta, Rajdeep & Black, Lamont K. & Floros , Ioannis, 2016. "Raising capital when the going gets tough: U.S. bank equity issuance from 2001 to 2014," Research Working Paper RWP 16-5, Federal Reserve Bank of Kansas City.
    2. Sven Bornemann & Susanne Homölle & Carsten Hubensack & Thomas Kick & Andreas Pfingsten, 2014. "Visible Reserves in Banks – Determinants of Initial Creation, Usage and Contribution to Bank Stability," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 41(5-6), pages 507-544, June.
    3. Beltratti, Andrea & Paladino, Giovanna, 2016. "Basel II and regulatory arbitrage. Evidence from financial crises," Journal of Empirical Finance, Elsevier, vol. 39(PB), pages 180-196.

    More about this item

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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