Valuing guaranteed bank debt: The roles of the strength and size of the bank and the guarantor

Estrellaa, Arturo; Schichb, Sebastian

doi:10.18533/jefs.v3i05.165

Cited by 4 publications

(3 citation statements)

References 16 publications

(14 reference statements)

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“…Earlier OECD discussions on the topic concluded that in some countries part of the decline in the estimated value of implicit bank debt guarantees reflected a deterioration of the strength of the sovereign seen as providing the guarantee. This interpretation is consistent with recent theoretical work that explains how the value of a bank debt guarantee depends on the strength and size of both the bank and the guarantor (Estrella and Schich, 2015).…”

Section: Notessupporting

confidence: 92%

Estimating the size and incidence of bank resolution costs for selected banks in OECD countries

Grimaldi¹,

Hofmeister²,

Schich³

et al. 2016

OECD Journal: Financial Market Trends

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This report provides estimates of the costs associated with bank resolution both in terms of the expected costs that might arise should a bank fail (i.e. as "ex-post" costs), as well as the cost associated with the likelihood that a solvent bank might fail (i.e. as "ex-ante" costs) over the next year. It finds that expected resolution costs (ex-post costs) have dropped recently due to higher average capital ratios and a lower level of bank liabilities as a percentage of GDP. The annualised value of these expected resolution costs (ex-ante costs), which increased sharply after 2008, has since subsided, but remains well above its 2008 level. Overall, the estimates produced in this report support the notion that recent financial sector reforms have had an impact on reducing the costs associated with bank failure, including the expected costs to taxpayers. However, estimates are in most cases yet to return to pre-crisis levels.

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Section: Notessupporting

confidence: 92%

Estimating the size and incidence of bank resolution costs for selected banks in OECD countries

Grimaldi¹,

Hofmeister²,

Schich³

et al. 2016

OECD Journal: Financial Market Trends

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“…1 TBTF reforms, implicit guarantees and TBTF reform evaluation Note: Stylised representation of the role of the concept of implicit guarantees as part of TBTF policy reforms. For simplicity, the stylised description abstracts from the role and strength of the perceived guarantor [12]. This observation has received special attention in Europe, where the presence of implicit bank debt guarantees supposedly being provided by domestic sovereigns has tended to reinforce the close and adverse interrelationships between the values of domestic sovereign and banking sector debt.…”

Section: Estimation Challengesmentioning

confidence: 99%

Limiting too-big-to-fail: market reactions to policy announcements and actions

2021

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Banks considered too-big-to-fail (TBTF) tend to benefit from funding cost advantages as their debt is considered implicitly guaranteed by public authorities, even if the latter have undertaken substantial effort to limit TBTF. This paper focuses on the changes in related market perceptions in response to bank regulatory and resolution reform announcements as well as actual failure resolution actions. It analyses how premia on risky bank debt have reacted to such events, using data for senior and subordinated debt CDS quotes for 45 European banks from January 2007 to May 2020. The empirical results are consistent with progress being made in reducing the value of implicit bank debt guarantees, especially on subordinated bank liabilities. Some earlier bank failure resolution actions appeared to significantly raise risk premia, although more recent failure resolution cases either had no effect on risk premia or moved them in the opposite direction. Several of these events consisted of no-action, that is, in particular, they did not entail any bail-in. As opposed to resolution actions, the reactions of risk premia to policy and regulatory announcements are more difficult to explain and no clear pattern seems to be emerging, confirming the view that action speaks louder than words.

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“…Merton () uses an option pricing approach to show that the value of a guarantee increases with the risk of the debtor. Estrella and Schich () derive predictions regarding the value of implicit guarantees from a sovereign for bank debt on the basis of a contingent claims model in which, however, not only the bank but also the sovereign is risky. The value of the guarantee is higher the weaker and larger the debtor and the stronger and larger the guarantor, although the credit strength of the bank and the sovereign strength are economically more important for the value of implicit bank debt guarantees than the size of bank and sovereign.…”

Section: What Factors Influence the Value Of The Perceived Guarantee?mentioning

confidence: 99%

Implicit Bank Debt Guarantees: Costs, Benefits and Risks

Schich

2018

Journal of Economic Surveys

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The expectation by market participants that public authorities might bailout the creditors of banks that are considered too important for financial system stability or another reason to be allowed to fail, is commonly referred to as an implicit guarantee. Public authorities do not have any explicit commitment to intervene; they may even honestly state that they not want to do so ex ante, but may feel compelled to do so ex post. A declared policy aim is to limit the value of implicit guarantees by making banks stronger, more easily resolvable in case of distress, as well as by imposing extra charges that rise as banks become more systemically important. As part of the latter approach, globally systemically important banks are identified and subjected to more costly and intrusive regulation. There is little evidence that specific approach has been successful so far. There is some evidence that the introduction of new resolution frameworks has been helpful, while the use of newly available resolution tools and the involvement of bank creditors in the burden sharing associated with bank failure resolution has significantly reduced the value of implicit bank debt guarantees, where it occurred. In that sense, actions speak louder than words.

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Valuing guaranteed bank debt: The roles of the strength and size of the bank and the guarantor

Cited by 4 publications

References 16 publications

Estimating the size and incidence of bank resolution costs for selected banks in OECD countries

Estimating the size and incidence of bank resolution costs for selected banks in OECD countries

Limiting too-big-to-fail: market reactions to policy announcements and actions

Implicit Bank Debt Guarantees: Costs, Benefits and Risks

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