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Are banks’ below-par own debt repurchases a cause for prudential concern?

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  • Lubberink, Martien

Abstract

In the lead-up to the implementation of Basel III, European banks bought back debt securities that traded at a discount. Banks engaged in these Liability Management Exercises (LMEs) to realize a fair value gain that the accounting and prudential rules exclude from regulatory capital calculations, this to safeguard the safety and soundness of the banking system. For a sample of 720 European LMEs conducted from April 2009 to December 2013, I show that banks lost about 9.3 billion euros in premiums to compensate investors for parting from their debt securities. This amount would have been recognized as Core Tier 1 regulatory capital, if regulation would accept the recognition of fair value gains on debt. The premiums paid are particularly high for the most loss absorbing capital securities. More importantly, the premiums increase with leverage and in times of stress, right when conserving cash is paramount to preserve the safety and soundness of the banking system. These results weaken the case of the exclusion from regulatory capital of unrealized gains that originate from a weakened own credit standing.

Suggested Citation

  • Lubberink, Martien, 2014. "Are banks’ below-par own debt repurchases a cause for prudential concern?," MPRA Paper 59475, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:59475
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    Keywords

    Banking; repurchases; subordinated debt.;

    JEL classification:

    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G35 - Financial Economics - - Corporate Finance and Governance - - - Payout Policy
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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