Banks Risk Taking and Creditors Bargaining Power

Abstract

We study the influence of unsecured debt (subdebt) and of bail-in debt on banks' risk-taking in a contingent claim model, while considering the bargaining between stockholders and debtholders. We show that replacing stock with subdebt: (1) leads to fewer risk-shifting events, but generates a higher level of risk when stockholders have strong bargaining power, and (2) does not affect asset risk when side-payments are possible. Further, severe regulatory corrective measures might have adverse effects on risk-shifting. Finally, in a bank with bail-inable debt, an increase in debt write-down increases the magnitude, yet decreases the likelihood, of risk-shifting events.

A closed-form solution to the risk-taking motivation of subordinated debtholders

“…3 The question whether and to what extent subdebtholders can affect the choice of asset risk is a separate question that is beyond the scope of this paper. In Heller, Peleg Lazar, and Raviv (2019) we apply a game-theoretic bargaining analysis to study the equilibrium risk induced by joint control of the bank by shareholders and subdebtholders. loan's face value is F S and its market value is B S and the junior debt's face value is F J and its market value is B J .…”

A closed-form solution to the risk-taking motivation of subordinated debtholders

“…However, the focus of those papers is on the sensitivity of the bank's stock to asset risk when bank assets are a risky debt claim.3 The question whether and to what extent subdebtholders can affect the choice of asset risk is a separate question that is beyond the scope of this paper. InHeller, Peleg Lazar, and Raviv (2019) we apply a game-theoretic bargaining analysis to study the equilibrium risk induced by joint control of the bank by shareholders and subdebtholders.…”