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

61 Pages Posted: 9 May 2018

See all articles by Thomas Conlon

Thomas Conlon

University College Dublin

John Cotter

University College Dublin; 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: May 8, 2018

Abstract

Banks adhere to strict rules regarding the quantity of regulatory capital held, but have some flexibility as to its composition. In this paper, we examine bank insolvency risk (distance to default) for listed North American and European banks over the period 2002-2014, focusing on sensitivity to capital other than common equity. Decomposing tier 1 capital into equity and non-core components reveals a heretofore unidentified variation in risk reduction capacity. Greater non-core tier 1 capital is associated with increased insolvency risk for larger and more diversified banks, impairing the risk reducing capacity of aggregate tier 1 capital. Overall tier 2 capital is not linked with insolvency risk, although a conflicting relationship is isolated conditional on the level of total regulatory capital held. Finally, the association between risk and capital is weakened when the latter is 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 (May 8, 2018). 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://www.ucd.ie/bankingfinance/staff/professorjohncotter/

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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