Bank Capital Structure, Regulatory Capital, and Securities Innovations

Abstract

Although financial instruments that, in effect, permit corporations to treat preferred stock dividends as tax-deductible interest have been used by nonfinancial corporations since late 1993, bank holding companies (BHCs) did not issue these trust-preferred securities (TPS) until 1996, when the Federal Reserve qualified them as Tier-1 capital. We delineate and test hypotheses with 1) analyses of the stock-market reaction to the Fed's ruling and to TPS filings and 2) comparisons of BHCs that issued TPS with those that did not. We conclude that regulatory capital requirements, tax savings, and uninsured sources of funds can have significant positive effects on BHCs' demand for capital; growth and investment opportunities have an inconclusive effect; and transaction costs have a negative effect. Our results are not consistent with the moral-hazard hypothesis.

What Caused the Bank Capital Buildup of the 1990s?

“…However, the large banks' securities issuance suggests that they were trying to limit the impact of share price increases on their market capital ratios. On October 21, 1996, the Federal Reserve Board decided that deeply subordinated debentures issued to a trust financed by preferred stock ("trust preferred shares") would count as up to 25 percent of Tier 1 regulatory capital (Benston et al 2003). The bars in Figure 8 plot the net issuance of three security types by the top 100 BHCs, for each year of our sample period.…”

Trust‐Preferred Securities and Insurer Financing Decisions

“…The first debt–equity hybrid security was issued on October 27, 1993 by Texaco (Benston et al, ). By the end of 1999, almost 300 corporations, including insurance and securities firms, had issued at least $65 billion of these securities (Sachs, ).…”

“…Most pertinent to the present study, though, Benston et al () and Harvey, Collins, and Wansley () analyze BHC abnormal returns after the 1996 Fed's ruling that permitted TPS and related issues. In an analysis of TPS issuers and nonissuers, Benston et al find that larger and more financially levered banks were more likely to issue TPS.…”

“…Engel, Erickson, and Maydew () study the general impact of hybrid securities and Benston et al () study their effect in the banking industry. The present study is the first to extend the inquiry to the insurance industry.…”

The Future of Banking Regulation in Developed Countries: Lessons from and for Europe

“…The issuing BHC compared to BHCs that did not issue TPSs tended to be larger, have a greater proportion of foreign and other uninsured deposits, greater growth potential, and lower regulatory capital. See Benston, et al . (2003) for a more complete description and analysis, from which these data were taken.…”