Friday , January 24 2020
Home / Bank of International Settlement / Believing in bail-in? Market discipline and the pricing of bail-in bonds

Believing in bail-in? Market discipline and the pricing of bail-in bonds

Summary:
BIS Working Papers  |  No 831  |  17 December 2019 by  Ulf Lewrick, José María Serena Garralda and Grant Turner PDF full text (421kb)  |  36 pages Focus Shareholders and unsecured creditors should bear the losses if a firm fails. During past crises, this simple principle did not hold for banks considered "too big to fail". Bail-in regulation seeks to address this problem by earmarking some debt instruments as "bail-inable". If bail-in regulation functions well, the investors in these instruments should expect to bear losses in the course of

Topics:
International Settlement considers the following as important:

This could be interesting, too:

International Settlement writes Bad bank resolutions and bank lending

Bank of Japan writes Minutes of the Monetary Policy Meeting on December 18 and 19, 2019

International Settlement writes Impending arrival – a sequel to the survey on central bank digital currency

FRED Blog writes Do government dollars drive recovery? : The conventional wisdom and data behind government spending during recessions

BIS Working Papers  |  No 831  | 
17 December 2019
PDF full text
 (421kb)
 |  36 pages

Focus

Shareholders and unsecured creditors should bear the losses if a firm fails. During past crises, this simple principle did not hold for banks considered "too big to fail". Bail-in regulation seeks to address this problem by earmarking some debt instruments as "bail-inable". If bail-in regulation functions well, the investors in these instruments should expect to bear losses in the course of resolution. Accordingly, they should monitor banks and exert discipline on their risk-taking. This paper studies whether this is indeed the case.

Contribution

We explore the global market for bail-inable bank debt, focussing on the largest market segment: senior unsecured bonds. We identify the bail-in risk premium by carefully matching these bonds with comparable senior bonds that are not subject to bail-in risk. We identify the main drivers of the bail-in risk premium for global systemically important banks (G-SIBs) and other major banks.

Findings

Investors exert market discipline on G-SIBs by demanding a bail-in risk premium. We find that this premium averages 20 basis points (2016-18), with riskier banks having to pay even more. Yet the bail-in premium varies pro-cyclically: when market-wide credit risk declines, the premium falls, and it does so most strongly for the riskier issuers. Banks take advantage of this pattern and time their bail-in bond issuance accordingly. The flipside of compressed premia during good times is that, during periods of market stress, riskier issuers could be exposed to material increases in the cost of bail-in debt. This reinforces the value of a conservatively calibrated bail-in regime alongside stringent supervision to ensure that banks build up their resilience during good times.


Abstract

Bail-in regulation is a centrepiece of the post-crisis overhaul of bank resolution. It requires major banks to maintain a sufficient amount of "bail-in debt" that can absorb losses during resolution. If resolution regimes are credible, investors in bail-in debt should have a strong incentive to monitor banks and price bail-in risk. We study the pricing of senior bail-in bonds to evaluate whether this is the case. We identify the bail-in risk premium by matching these bonds with comparable senior bonds that are issued by the same banking group but are not subject to bail-in risk. The premium is higher for riskier issuers, consistent with the notion that bond investors exert market discipline on banks. Yet the premium varies pro-cyclically: a decline in marketwide credit risk lowers the bail-in risk premium for all banks, with the compression much stronger for riskier issuers. Banks, in turn, time their bail-in bond issuance to take advantage of periods of low premia.

JEL codes: E44, E61, G28

Keywords: too big to fail, banking regulation, TLAC, financial stability

International Settlement
The Bank for International Settlements (BIS) is an international company limited by shares owned by central banks which "fosters international monetary and financial cooperation and serves as a bank for central banks". The BIS carries out its work through subcommittees, the secretariats it hosts and through an annual general meeting of all member banks. It also provides banking services, but only to central banks and other international organizations. It is based in Basel, Switzerland, with representative offices in Hong Kong and Mexico City.

Leave a Reply

Your email address will not be published. Required fields are marked *