Modigliani-Miller Doesn't Hold in a 'Bailinable' World: A New Capital Structure to Reduce the Banks' Funding Cost

UNIVERSITÀ CATTOLICA DEL SACRO CUORE, Dipartimento di Economia e Finanza, Working Paper n. 52, November 2016

21 Pages Posted: 28 Nov 2016

See all articles by Angelo S. Baglioni

Angelo S. Baglioni

Catholic University of the Sacred Heart of Milan

Marcello Esposito

Università Carlo Cattaneo (LIUC)

Date Written: November 25, 2016

Abstract

To protect retail investors from the bail-in rule, we propose that banks should issue subordinated "contractual bail-in instruments", as defined in the BRRD, for an amount (together with Tier1 capital) at least equal to 8% of their liabilities. We support our argument by means of a theoretical model, where retail investors are uncertainty averse, due to their lack of information about the new "bailinable" regime. To the contrary, institutional investors are better informed. Within this framework, a bank is able to reduce the cost of debt by splitting it into a junior and a senior tranche, sold to institutional and retail investors respectively. This result is a deviation from the Modigliani-Miller theorem. We also provide some estimates of the amounts of contractual bail-in instruments that European banks should issue in order to reach the 8% target level. Such amounts are considerable, implying that the solution proposed here should be implemented gradually over a transition period.

Keywords: banks, capital structure, bail-in, resolution, regulation, MREL

JEL Classification: G21, G28

Suggested Citation

Baglioni, Angelo and Esposito, Marcello, Modigliani-Miller Doesn't Hold in a 'Bailinable' World: A New Capital Structure to Reduce the Banks' Funding Cost (November 25, 2016). UNIVERSITÀ CATTOLICA DEL SACRO CUORE, Dipartimento di Economia e Finanza, Working Paper n. 52, November 2016, Available at SSRN: https://ssrn.com/abstract=2875880 or http://dx.doi.org/10.2139/ssrn.2875880

Angelo Baglioni (Contact Author)

Catholic University of the Sacred Heart of Milan ( email )

Largo Gemelli, n.1
Milano, 20123
Italy
390272344024 (Phone)
390272342781 (Fax)

Marcello Esposito

Università Carlo Cattaneo (LIUC) ( email )

Corso Matteotti, 22
21053 Castellanza (VA)
Italy

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