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Are banks’ below-par own debt repurchases a cause for prudential concern?

Lubberink, Martien and Renders, Annelies (2017): Are banks’ below-par own debt repurchases a cause for prudential concern?

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Abstract

Leading up to the implementation of Basel III, European banks repurchased debt securities that traded below par. Banks are subjected to a prudential filter that excludes unrealized gains on liabili- ties from changes in own credit standing from the calculation of capital ratios. By repurchasing debt securities below par, unrealized gains become realized and increase Core Tier 1 capital. Using data of 720 European Liability Management Exercises (LMEs) conducted between April 2009 and De- cember 2013, we show that poorly capitalized banks repurchased securities and lost about 9.1bn euro in premiums to compensate debt 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.

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