The Design of Stratified Contingent Bank Liability Structure to Release Risk Incentive Effects

Wang Lin; Qin Xuezhi

doi:doi:10.11648/j.jfa.20210902.14

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The Design of Stratified Contingent Bank Liability Structure to Release Risk Incentive Effects

Wang Lin, Qin Xuezhi

Published in Journal of Finance and Accounting (Volume 9, Issue 2)

Received: 19 March 2021 Accepted: Published: 8 May 2021

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Abstract

This paper proposes a new type of bank liability structure with stratified contingent capital based on the suggestions of Basel III and TLAC Term Sheet. It try to solve the problem that the total loss absorbing capacity of global systemically important banks is insufficient and the single contingent capital-CoCos will bring extra risk to the bank in recent years. Compared with single contingent capital, the bail-in mechanism of stratified contingent capital is more complex and its risk effects will be more uncertain. Therefore, this paper studies how to design the parameters setting of stratified contingent liability structure to release the incentive effect of original shareholders’ risk taking. Firstly, it analyzed the basic setting of bank capital structure and bail-in mechanism. And then, it calculated the value of CoCos, TLAC bonds, and original shareholders’ equity by replicating payoffs using sets of exotic options. Finally, it calculated the elasticity of the original shareholders’ equity value to the volatility of asset value. The elasticity is used to analyze the incentive effect of original shareholders’ risk taking. The numerical analysis shows that risk incentive effect is more sensitive to the parameters setting of CoCos. In any case, conversion rate has a more important impact than the trigger threshold. In particular, the effect of risk taking can be eliminated by setting the parameters properly.

Published in	Journal of Finance and Accounting (Volume 9, Issue 2)
DOI	10.11648/j.jfa.20210902.14
Page(s)	53-59
Creative Commons	This is an Open Access article, distributed under the terms of the Creative Commons Attribution 4.0 International License (http://creativecommons.org/licenses/by/4.0/), which permits unrestricted use, distribution and reproduction in any medium or format, provided the original work is properly cited.
Copyright	Copyright © The Author(s), 2024. Published by Science Publishing Group

Keywords

Contingent Capital, Debt Structure, Risk Incentive

References

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[2]	Financial Stability Board (FSB). Principles on Loss-absorbing and Recapitalisation Capacity of G-SIBs in Resolution: Total Loss-absorbing Capacity (TLAC) Term Sheet, 2015.
[3]	N. Martynova and E. Perotti. Convertible bonds and bank risk-taking, vol 35, Journal of Financial Intermediation, 2018, pp. 61-80.
[4]	C. W. Calomiris and R. J. Herring. How to Design a Contingent Convertible Debt Requirement That Helps Solve Our Too-Big-to-Fail Problem, vol. 2. Journal of Applied Corporate Finance, 2013, pp. 39-62.
[5]	E. Barucci and L. D. Viva. Countercyclical Contingent Capital, vol. 6. Journal of Banking &Finance, 2012, pp. 1688-1709.
[6]	F. Fiordelisi, G. Pennacchi and O. Ricci. Are contingent convertibles going-concern capital, vol. 43. Journal of Financial Intermediation, 2020, pp. 1-19.
[7]	T. Berg and C. Kaserer. Does contingent capital induce excessive risk-taking, vol. 3. Journal of Financial Intermediation, 2015, pp. 356-385.
[8]	F. Mahmoud and M. Ayowande. Shareholder risk-taking incentives in the presence of contingent capital, Bank of England, Staff Working Paper, 2019.
[9]	S. Chan and S. V. Wijnbergen. Coco Design, Risk Shifting Incentives and Financial Fragility, ECMI Working Paper, 2017.
[10]	L. Gai, F. Ielasi and M. Mainini. The Impact of Bail-in Risk on Bank Bondholders, International Journal of Business and Management, vol. 15. 2020, pp. 105-121.
[11]	C. Koziol and J. Lawrenz. Contingent Convertibles. Solving or Seeding the Next Banking Crisis? vol. 1. Journal of Banking & Finance, 2012, pp. 90-104.
[12]	S. Sundaresan and Z. Wang. On the design of contingent capital with a market trigger, vol. 2. The Journal of Finance, 2015, pp. 881-920.
[13]	G. Pennacchi A Structural Model of Contingent Bank Capital, FRB of Cleveland Working Paper, 2011.
[14]	J. Hilscher and A. Raviv. Bank Stability and Market Discipline: The Effect of Contingent Capital on Risk Taking and Default Probability, vol. 29. Journal of Corporate Finance, 2014, pp. 542-560.
[15]	S. P. Himmelberg and S. Tsyplakov. Optimal terms of contingent capital, incentive effects, and capital structure dynamics, vol. 64. Journal of Corporate Finance, 2020, pp. 1-21.
[16]	P. G. Zhang, Exotic Options, 2nd ed., World Scientific Publishing, 1998.

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APA Style

Wang Lin, Qin Xuezhi. (2021). The Design of Stratified Contingent Bank Liability Structure to Release Risk Incentive Effects. Journal of Finance and Accounting, 9(2), 53-59. https://doi.org/10.11648/j.jfa.20210902.14

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ACS Style

Wang Lin; Qin Xuezhi. The Design of Stratified Contingent Bank Liability Structure to Release Risk Incentive Effects. J. Finance Account. 2021, 9(2), 53-59. doi: 10.11648/j.jfa.20210902.14

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AMA Style

Wang Lin, Qin Xuezhi. The Design of Stratified Contingent Bank Liability Structure to Release Risk Incentive Effects. J Finance Account. 2021;9(2):53-59. doi: 10.11648/j.jfa.20210902.14

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@article{10.11648/j.jfa.20210902.14,
  author = {Wang Lin and Qin Xuezhi},
  title = {The Design of Stratified Contingent Bank Liability Structure to Release Risk Incentive Effects},
  journal = {Journal of Finance and Accounting},
  volume = {9},
  number = {2},
  pages = {53-59},
  doi = {10.11648/j.jfa.20210902.14},
  url = {https://doi.org/10.11648/j.jfa.20210902.14},
  eprint = {https://article.sciencepublishinggroup.com/pdf/10.11648.j.jfa.20210902.14},
  abstract = {This paper proposes a new type of bank liability structure with stratified contingent capital based on the suggestions of Basel III and TLAC Term Sheet. It try to solve the problem that the total loss absorbing capacity of global systemically important banks is insufficient and the single contingent capital-CoCos will bring extra risk to the bank in recent years. Compared with single contingent capital, the bail-in mechanism of stratified contingent capital is more complex and its risk effects will be more uncertain. Therefore, this paper studies how to design the parameters setting of stratified contingent liability structure to release the incentive effect of original shareholders’ risk taking. Firstly, it analyzed the basic setting of bank capital structure and bail-in mechanism. And then, it calculated the value of CoCos, TLAC bonds, and original shareholders’ equity by replicating payoffs using sets of exotic options. Finally, it calculated the elasticity of the original shareholders’ equity value to the volatility of asset value. The elasticity is used to analyze the incentive effect of original shareholders’ risk taking. The numerical analysis shows that risk incentive effect is more sensitive to the parameters setting of CoCos. In any case, conversion rate has a more important impact than the trigger threshold. In particular, the effect of risk taking can be eliminated by setting the parameters properly.},
 year = {2021}
}

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TY - JOUR
T1 - The Design of Stratified Contingent Bank Liability Structure to Release Risk Incentive Effects
AU - Wang Lin
AU - Qin Xuezhi
Y1 - 2021/05/08
PY - 2021
N1 - https://doi.org/10.11648/j.jfa.20210902.14
DO - 10.11648/j.jfa.20210902.14
T2 - Journal of Finance and Accounting
JF - Journal of Finance and Accounting
JO - Journal of Finance and Accounting
SP - 53
EP - 59
PB - Science Publishing Group
SN - 2330-7323
UR - https://doi.org/10.11648/j.jfa.20210902.14
AB - This paper proposes a new type of bank liability structure with stratified contingent capital based on the suggestions of Basel III and TLAC Term Sheet. It try to solve the problem that the total loss absorbing capacity of global systemically important banks is insufficient and the single contingent capital-CoCos will bring extra risk to the bank in recent years. Compared with single contingent capital, the bail-in mechanism of stratified contingent capital is more complex and its risk effects will be more uncertain. Therefore, this paper studies how to design the parameters setting of stratified contingent liability structure to release the incentive effect of original shareholders’ risk taking. Firstly, it analyzed the basic setting of bank capital structure and bail-in mechanism. And then, it calculated the value of CoCos, TLAC bonds, and original shareholders’ equity by replicating payoffs using sets of exotic options. Finally, it calculated the elasticity of the original shareholders’ equity value to the volatility of asset value. The elasticity is used to analyze the incentive effect of original shareholders’ risk taking. The numerical analysis shows that risk incentive effect is more sensitive to the parameters setting of CoCos. In any case, conversion rate has a more important impact than the trigger threshold. In particular, the effect of risk taking can be eliminated by setting the parameters properly.
VL - 9
IS - 2
ER -

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Author Information

Wang Lin

School of Economics and Management, Dalian University of Technology, Dalian, China
Qin Xuezhi

School of Economics and Management, Dalian University of Technology, Dalian, China

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APA Style

Wang Lin, Qin Xuezhi. (2021). The Design of Stratified Contingent Bank Liability Structure to Release Risk Incentive Effects. Journal of Finance and Accounting, 9(2), 53-59. https://doi.org/10.11648/j.jfa.20210902.14

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ACS Style

Wang Lin; Qin Xuezhi. The Design of Stratified Contingent Bank Liability Structure to Release Risk Incentive Effects. J. Finance Account. 2021, 9(2), 53-59. doi: 10.11648/j.jfa.20210902.14

Copy | Download

AMA Style

Wang Lin, Qin Xuezhi. The Design of Stratified Contingent Bank Liability Structure to Release Risk Incentive Effects. J Finance Account. 2021;9(2):53-59. doi: 10.11648/j.jfa.20210902.14

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@article{10.11648/j.jfa.20210902.14,
  author = {Wang Lin and Qin Xuezhi},
  title = {The Design of Stratified Contingent Bank Liability Structure to Release Risk Incentive Effects},
  journal = {Journal of Finance and Accounting},
  volume = {9},
  number = {2},
  pages = {53-59},
  doi = {10.11648/j.jfa.20210902.14},
  url = {https://doi.org/10.11648/j.jfa.20210902.14},
  eprint = {https://article.sciencepublishinggroup.com/pdf/10.11648.j.jfa.20210902.14},
  abstract = {This paper proposes a new type of bank liability structure with stratified contingent capital based on the suggestions of Basel III and TLAC Term Sheet. It try to solve the problem that the total loss absorbing capacity of global systemically important banks is insufficient and the single contingent capital-CoCos will bring extra risk to the bank in recent years. Compared with single contingent capital, the bail-in mechanism of stratified contingent capital is more complex and its risk effects will be more uncertain. Therefore, this paper studies how to design the parameters setting of stratified contingent liability structure to release the incentive effect of original shareholders’ risk taking. Firstly, it analyzed the basic setting of bank capital structure and bail-in mechanism. And then, it calculated the value of CoCos, TLAC bonds, and original shareholders’ equity by replicating payoffs using sets of exotic options. Finally, it calculated the elasticity of the original shareholders’ equity value to the volatility of asset value. The elasticity is used to analyze the incentive effect of original shareholders’ risk taking. The numerical analysis shows that risk incentive effect is more sensitive to the parameters setting of CoCos. In any case, conversion rate has a more important impact than the trigger threshold. In particular, the effect of risk taking can be eliminated by setting the parameters properly.},
 year = {2021}
}

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