Working Paper: NBER ID: w19984
Authors: Nicole M. Boyson; Rüdiger Fahlenbrach; Ren M. Stulz
Abstract: We propose a theory of regulatory arbitrage by banks and test it using trust preferred securities (TPS) issuance. From 1996 to 2007, U.S. banks in the aggregate increased their regulatory capital through issuance of TPS while their net issuance of common stock was negative due to repurchases. We assume that, in the absence of capital requirements, a bank has an optimal capital structure that depends on its business model. Capital requirements can impose constraints on bank decisions. If a bank's optimal capital structure also meets regulatory capital requirements with a sufficient buffer, the bank is unconstrained by these requirements. We expect that unconstrained banks will not issue TPS, that constrained banks will issue TPS and engage in other forms of regulatory arbitrage, and that banks with TPS will be riskier than other banks with the same amount of regulatory capital, and therefore, more adversely affected by the credit crisis. Our empirical evidence supports these predictions.
Keywords: regulatory arbitrage; trust preferred securities; bank capital; financial crisis
JEL Codes: G01; G21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| capital constraints (D24) | TPS issuance (H87) |
| capital constraints (D24) | bank risk (G21) |
| TPS issuance (H87) | bank risk (G21) |
| TPS usage (C87) | government assistance (H53) |
| TPS issuance (H87) | distance to default (Y20) |
| TPS and other regulatory arbitrage (F38) | risk exposure (G22) |