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Why Do Banks Practice Regulatory Arbitrage? Evidence from Usage of Trust Preferred Securities

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  • Boyson, Nicole M.

    (Northeastern University)

  • Fahlenbrach, Rudiger

    (EPFL Lausanne and Swiss Finance Institute)

  • Stulz, Rene M.

    (OH State University and ECGI, Brussels)

Abstract

We propose a theory of regulatory arbitrage by banks and test it using trust preferred securities (TPS) issuance. We assume that banks have an optimal capital structure that depends on their business model. If a bank's optimal capital structure 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 TPS banks will be riskier than other banks with the same amount of regulatory capital. Our empirical evidence supports these predictions.

Suggested Citation

  • Boyson, Nicole M. & Fahlenbrach, Rudiger & Stulz, Rene M., 2014. "Why Do Banks Practice Regulatory Arbitrage? Evidence from Usage of Trust Preferred Securities," Working Paper Series 2014-01, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
    • Handle: RePEc:ecl:ohidic:2014-01
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    Cited by:

    1. Beltratti, Andrea & Paladino, Giovanna, 2016. "Basel II and regulatory arbitrage. Evidence from financial crises," Journal of Empirical Finance, Elsevier, vol. 39(PB), pages 180-196.
    2. Marco Pagano & ESRB Advisory Scientific Committee, 2014. "Is Europe Overbanked?," mBank - CASE Seminar Proceedings 132, CASE-Center for Social and Economic Research.
    3. Lamont K. Black & Ioannis Floros & Rajdeep Sengupta, 2016. "Raising capital when the going gets tough: U.S. bank equity issuance from 2001 to 2014," Research Working Paper RWP 16-5, Federal Reserve Bank of Kansas City.
    4. Efing, Matthias, 2015. "Arbitraging the Basel securitization framework: Evidence from German ABS investment," Discussion Papers 40/2015, Deutsche Bundesbank.
    5. Sven Bornemann & Susanne Homölle & Carsten Hubensack & Thomas Kick & Andreas Pfingsten, 2014. "Visible Reserves in Banks – Determinants of Initial Creation, Usage and Contribution to Bank Stability," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 41(5-6), pages 507-544, June.

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    More about this item

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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