Are Banks' Below Par Own Debt Repurchases a Cause for Prudential Concern?

Martien Lubberink*, Annelies Renders

*Corresponding author for this work

Research output: Contribution to journalArticleAcademicpeer-review

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Abstract

In the lead-up to the implementation of Basel III, European banks repurchased debt securities that traded below par. Banks engaged in these Liability Management Exercises (LMEs) to realize a fair value gain that prudential rules exclude from regulatory capital calculations. The LMEs enabled banks to augment Core Tier 1 capital, given that alternative methods to increase capital ratios were not feasible in practice. Using data of 720 European LMEs conducted between April 2009 and December 2013, we show that poorly capitalized banks repurchased securities and lost about euro9.1bn in premiums to compensate their holders. Banks also repurchased the most loss-absorbing securities, for which they paid the highest premiums. These premiums increase with leverage and in times of stress. Hence debt repurchases are a cause for prudential concern.
Original languageEnglish
Pages (from-to)501-529
Number of pages29
JournalJournal of Accounting, Auditing & Finance
Volume35
Issue number3
DOIs
Publication statusPublished - Jul 2020

Keywords

  • banking
  • liability management
  • prudential filters
  • fair value option
  • subordinated debt

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