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

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.

The inverted-u-shaped impact of fintech development on bank risk: A study of liability structure and economic uncertainty

“…It is observed that finte ch indirectly augments banks' liability expenses, leading to a heightened dependence on interbank liabilities as a countermeasure . Lin and Xuezhi (2021) came up with a new liability structure based on Basel III and the Total Loss-Absorbing Capacity (TLAC) Term Sheet. This structure focused on layered contingent capital and the possible effects of fintech on banking vulnerabilities.…”

“…Secondly, the use of the mediating role of the liability structure. Wang and Qin (2021) proposed a ne w type of bank liability structure. However, our Equation 2 directly addresses the mediating role of liabilit y structure in the relationship between fintech and commercial bank risk, which was not the core focus of their research.…”