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
Date Written: November 25, 2016
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: Suggested Citation