Are Banks' Below-Par Own Debt Repurchases a Cause For Prudential Concern?
Posted: 1 Feb 2016 Last revised: 29 Aug 2017
Date Written: October 21, 2016
Leading up to the implementation of Basel III, European banks needed to substantially increase their capital ratios. To do this, banks made use of Liability Management Exercises (LMEs) in which they repurchased below-par debt securities. Banks are subject to a prudential filter that excludes from the calculation of capital ratios unrealized gains on debt securities arising from a deterioration in banks’ own credit standing. By repurchasing below-par debt securities, banks can circumvent the prudential filter as unrealized gains become realized and increase Core Tier 1 capital. We examine the determinants and consequences of these LMEs and provide evidence that these debt repurchases are a cause for prudential concern.
Keywords: banking, fair values, repurchases, subordinated debt
JEL Classification: E58, G21, G32, G35, M41
Suggested Citation: Suggested Citation