Working Paper: CEPR ID: DP8801
Authors: Viral V. Acharya; Irvind Gujral; Nirupama Kulkarni; Hyun Song Shin
Abstract: The headline numbers appear to show that even as banks and financial intermediaries suffered large credit losses in the financial crisis of 2007-09, they raised substantial amounts of new capital, both from private investors and through government-funded capital injections. However, on closer inspection the composition of bank capital shifted radically from one based on common equity to that based on debt-like hybrid claims such as preferred equity and subordinated debt. The erosion of common equity was exacerbated by large scale payments of dividends, in spite of widely anticipated credit losses. Dividend payments represent a transfer from creditors (and potentially taxpayers) to equity holders in violation of the priority of debt over equity. The dwindling pool of common equity in the banking system may have been one reason for the continued reluctance by banks to lend over this period. We draw conclusions on how capital regulation may be reformed in light of our findings.
Keywords: asset substitution; crisis; regulatory capital; risk-shifting
JEL Codes: G21; G28; G32; G35; G38
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Dividend payments (G35) | erosion of common equity (G32) |
| erosion of common equity (G32) | reluctance to lend (F34) |
| Dividend payments (G35) | reluctance to lend (F34) |
| High leverage of banks (G21) | reluctance to lend (F34) |
| erosion of common equity (G32) | high leverage of banks (G21) |
| Dividend payments (G35) | high leverage of banks (G21) |