Are Banks' Below-Par Own Debt Repurchases a Cause for Prudential Concern?

45 Pages Posted: 19 Aug 2014 Last revised: 20 Dec 2016

See all articles by Martien Jan Peter Lubberink

Martien Jan Peter Lubberink

Victoria University of Wellington - School of Accounting and Commercial Law

Date Written: October 20, 2014

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 Euro 9.3B 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.

Keywords: Banking, repurchases, subordinated debt, Basel III

JEL Classification: E58, G21, G28, G32, G35, M41

Suggested Citation

Lubberink, Martien Jan Peter, Are Banks' Below-Par Own Debt Repurchases a Cause for Prudential Concern? (October 20, 2014). 27th Australasian Finance and Banking Conference 2014 Paper. Available at SSRN: https://ssrn.com/abstract=2482834 or http://dx.doi.org/10.2139/ssrn.2482834

Martien Jan Peter Lubberink (Contact Author)

Victoria University of Wellington - School of Accounting and Commercial Law ( email )

New Zealand
+64 4 463 5968 (Phone)

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