Research

Working papers:

Multiple buffer CoCos and their impact on financial stability Tinbergen Institute WP Jan 2020 

In this paper we develop a theoretical model to investigate the effect on a bank's financial stability of having multiple contingent convertible bonds buffers (CoCos) on the same bank balance sheet, using cash-in-the-market pricing and global games methodologies. Contingent convertible bonds are meant to act as a bail-in mechanism for banks, where CoCo debt converts into equity when a bank needs it the most. We find that having CoCo buffers which trigger at different capitalisation levels can be detrimental for the CoCo bail-in capacity. Market-based triggers lead to premature conversion and fire-sales of equity. In contrast with existing literature, we show that book-based trigger CoCos yield an optimal outcome, as long as they incorporate expected credit losses.

Risk-Taking, Competition and Uncertainty. Do CoCo Bonds Increase the Risk Appetite of Banks?  – Bank of England Staff WP Aug 2021 (joint with Mahmoud Fatouh, Bank of England, and Sweder van Wijnbergen, UvA)

We assess the impact of contingent convertible (CoCo) bonds and the wealth transfers they imply conditional on conversion on the risk-taking behaviour of the issuing bank. We also test for regulatory arbitrage: do banks try to maintain risk-taking incentives by issuing CoCo bonds, when regulators reduce them through higher capitalization ratios? While we test for, and reject sample selection bias, we show that CoCo bonds issuance has a strong positive effect on risk-taking behaviour, and so do conversion parameters that reduce dilution of existing shareholders upon conversion. Higher economic volatility amplifies the impact of CoCo bonds on risk-taking.

Presented at: Royal Economic Society Symposium 2021, IFABS 2021, Money Macro and Finance Society Annual Conference 2021

Capital Allocation, Leverage Ratio Requirement and Banks’ Risk-Taking -forthcoming Dec 2021  (joint with Quynh- Anh Vo, Bank of England)

This paper examines how the level (i.e. group or business unit level) at which regulatory requirements are applied affects banks' asset risk. We develop a theoretical model and calibrate it to UK banks. Our main finding is that the impact differs depending on which regulatory constraint is binding at the group consolidated level. If that is the leverage ratio requirement, then the allocation of regulatory constraints to business units either maintains or decreases the riskiness of banks' investment portfolios. However, if the risk-weighted requirement is the binding constraint at the group level, applying regulatory requirements at the business unit level can lead to banks selecting riskier asset portfolios as optimal. We also find that the impact on banks' asset risk differs across bank business models.

Presented at: EFMA 2021, IFABS 2021, 37th Symposium on Money Banking and Finance BdF 2021, WinE EEA 2021, 20th Annual FDCI/JFSR Bank Research Conference 2021

Work in progress:

Bank ring-fencing reforms and their risk-taking implications (2021) (joint with John Thanassoulis and Irem Erten, Warwick Business School)

The Financial Services Act of 2013 in the UK required large banks to ring-fence their retail banking from their investment and international banking operations. This research studies if the ring-fencing reforms altered the risk-appetite or the risk perception of the ring-fenced bank, or of the non-ring-fenced bank. We hypothesise that the reform has severed a negative feedback channel from the wider banking group and so reduced the RFB risk perception. We also study the responsiveness of banks subject to ring-fencing to the coronavirus shock. We perform our analysis using confidential and regulatory repo and interest rate swap data.

Home versus host? Pass-through of capital changes in OTC markets (2021) (joint with Ahmed MA Ahmed, University of Chicago)

We study how financial institutions adjust their trading behavior in the interest rate market against pension funds and insurance companies in face of CVA (credit valuation adjustment) capital requirements. To answer this question, we use unique and confidential trade repository data from the Bank of England at transaction and identity levels. CVA is calculated at counterparty level and reflects the exposure of mark-to-market losses due to changes in the credit quality of the counterparty for non-cleared derivatives. It was introduced in 2010 with few temporary exemptions that were applied by the EU CRR in 2014 to pension funds among others. Since CVA is only calculated on non-cleared derivatives and is most material when maturities are long, insurance companies and pension funds are among the most impacted counterparties from these capital requirements due to their long-term hedging needs. Additionally, we exploit the exogenous variation of the CVA exemptions applying only to certain jurisdictions to test whether the booking or headquarters location of the financial institution matters most for the pass-through of capital charges to end-users.

(Updated: 5 Dec 2021)