Increasing Profitability Through Contingent Convertible Capital: Empirical Evidence From European Banks

Abstract

This study investigates the consequences of the use of additional tier 1 (AT1) capital instruments on bank profitability. It is motivated by fact that the use of contingent convertible bonds (CoCo-bonds) instead of equity offers a tax-shield and positive risk-taking incentives. I empirically analyse a panel dataset of 231 banks from EEA-countries as well as Switzerland from 2014 to 2018. My analysis shows that the potential tax-shield is a relevant determinant of the use of CoCo-bonds. Subsequently, I find that the use of CoCo-bonds instead of equity as AT1-capital has significant and positive effects on bank profitability.

Keywords: CoCo-Bonds, Contingent Capital, Capital Regulation, Bank Profitability, Capital Structure

JEL Classification: G21, G28, G32