ECB published a working paper that studies the impact of the introduction and implementation of the new bail-in regulations on the subordinated bond yield spreads against senior unsecured bonds. The study links the bond yield developments with the characteristics of issuing entities and the economic and financial environment. The results show that the tier 1 capital ratio makes subordinated debt safer and, therefore, less costly. The ratio of subordinated debt over total capital funds (in the balance sheet of banks) is positively correlated with the subordinated-senior bond spreads, which indicates that markets price the higher risk of banks with less stable sources of funding in their liability or capital structures. As expected, market conditions and economic environment variables also play a key role in explaining the bond spreads.
The study shows that new Bank Recovery and Resolution Directive (BRRD) regime might have reduced the perception of risk of senior bondholders by providing early intervention tools and a framework that protects senior bonds relatively well against losses in case of failure. Other factors not necessarily attributable to the bail-in regime, such as the effects of the expansionary monetary policy measures or the Basel III implementation (enforcing the build-up of capital and de-risking processes), may have led to a general decline in both yields while keeping the spreads relatively constant.
The results also highlight that the characteristics of the institutions and the different reactions of each kind of bond should be taken into account when analyzing the changes or the implementation of the regulation. In this regard, the regressions show that after the introduction of the new bail-in regulation, there is a convergence between the bond yields of the global systemically important institutions (G-SIBs) and the non-G-SIBs, which could point out to a reduction in the perception of the so called “too big to fail” public implicit guarantee. Nonetheless, this convergence is largely driven by a decline in the bond yields of non-G-SIBs mainly from the second quarter of 2017 onward, and not by significant increases in the yields of bonds issued by G-SIBs.
Unlike other studies, this work emphasizes the difference in the reactions of bond yields depending on their seniority after the entry into force and the implementation of the new bail-in regulation. This paper contributes to fill this analytical gap, but additional work on the implications of the new bail-in regulation is required. Funding costs and capital, among other factors, determine the financial strength of the banks and they are interconnected. Bond yields provide market information that should be considered when facing the withdrawal of monetary stimuli or possible changes in the economic and financial environment.
Related Link: Working Paper (PDF)
Keywords: Europe, EU, Banking, Securities, Bail-in Regime, Basel III, G-SIBs, Too Big to Fail, Systemic Risk, Regulatory Capital, BRRD, ECB
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