Beyond Common Equity: The Influence of Secondary Capital on Bank Insolvency Risk

60 Pages Posted: 9 May 2018 Last revised: 10 Feb 2020

See all articles by Thomas Conlon

Thomas Conlon

University College Dublin

John Cotter

University College Dublin; University of California, Los Angeles (UCLA) - Anderson School of Management

Philip Molyneux

University of Sharjah - College of Business Administration

Multiple version iconThere are 2 versions of this paper

Date Written: February 10, 2020

Abstract

Banks must adhere to strict rules regarding the quantity of regulatory capital held but have some flexibility as to its composition. In this paper, we examine if bank insolvency (distance to default) is sensitive to capital other than common equity for a sample of listed North American and European banks. Decomposing tier 1 capital into tangible equity and non-core components reveals a series of heretofore unidentified non-linear links with insolvency risk. We assess the influence of binding capital requirements, finding that low regulatory capital buffers are associated with increased insolvency risk for banks holding greater quantities of non-core tier 1 and tier 2 capital. The links between insolvency and capital, evident when the latter is denominated relative to tangible assets or total regulatory capital, are found to be expunged when defined relative to risk-weighted assets.

Keywords: Regulatory Capital, Bank Risk, Regulatory Capital Arbitrage, Tier 1, Tier 2

JEL Classification: G21, G28, G32

Suggested Citation

Conlon, Thomas and Cotter, John and Molyneux, Philip, Beyond Common Equity: The Influence of Secondary Capital on Bank Insolvency Risk (February 10, 2020). Michael J. Brennan Irish Finance Working Paper Series Research Paper No. 18-4, Available at SSRN: https://ssrn.com/abstract=3175598 or http://dx.doi.org/10.2139/ssrn.3175598

Thomas Conlon (Contact Author)

University College Dublin ( email )

Smurfit Graduate Business School
Blackrock
Co. Dublin, n/a
Ireland

HOME PAGE: http://www.ucd.ie/bankingfinance/staff/drthomasconlon/

John Cotter

University College Dublin ( email )

School of Business, Carysfort Avenue
Blackrock, Co. Dublin
Ireland
353 1 716 8900 (Phone)
353 1 283 5482 (Fax)

HOME PAGE: http://https://johncotter.org/

University of California, Los Angeles (UCLA) - Anderson School of Management ( email )

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States

Philip Molyneux

University of Sharjah - College of Business Administration ( email )

University City Road
Sharjah, 27272
United Arab Emirates

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