Systemic Banks, Capital Composition and Coco Issuance: The Effects on Bank Risk

Abstract

This paper shows that systemic banks are prone to increase their capital ratio through a decline in risk-weighted assets density and an intense use of lower level capital. The market access of systemic firms, and the fact that they were singled out for higher capital requirements. seem to have biased them towards lower level capital, consistent with the theory that asymmetric information drives capital decisions. These effects are particularly strong for firms that were rather under-capitalized at the start of the period. More transparency in the pricing of lower capital level would reduce the incentives to use it, while strict capital composition requirements for firms with lower buffers would be an improvement.

Keywords: Contingent capital, banking regulation, risk-taking incentives, asset substitution, systemic risk

JEL Classification: G12, G21, G28