Research On Structure Design And Pricing Of Bank Contingent Capital With Bail-in Mechanism

Banks in trouble have to rely on government assistance because they are unable to raise new capital in the market.The prevention of systemic financial risk has been highly concerned by the academia and the industry by learning from the experience of the 2008 financial crisis.An important regulatory measure to prevent systemic financial risks is establishing a long-term bail-in mechanism for banks.This regulatory measure can restructure troubled banks on a going concern basis,which aims to enhance the total loss absorbing capacity of banks,reduce the contagion of risk events in the crisis,and avoid the loss of taxpayers’ public funds.Contingent capital has the function of automatically converting into equity or write-down,which can supplement the capital of issuing banks and effectively improve their bail-in ability.At present,different forms of contingent capital have been widely issued in domestic and foreign markets,and many research results have been obtained.However,the contract clauses still need to be more reasonable.At the same time,many unanticipated risk can not be ignored for different contingent capital structure.It needs more theoretical research to support the smooth launch and completion of bank contingent capital supplement.This dissertation learns lessons from the research of bail-in mechanism and bank contingent capital.The contingent capital structure of banks is divided into no contingent capital resupplement and considering contingent capital resupplement according to whether the bail-in capacity of banks is sufficient or not and whether continuous capital supplement is needed.In order to improve the suitability of contract clauses,relieve unexpected risks,optimize bank capital structure and capital supplement strategy,this dissertation provides an optimization design of bank contingent capital structure and the its pricing method under complex path dependence.The main research achievements can be summarized as follows:(1)By adding additional contract clauses,a resetable bail-in mechanism is established to release the unanticipated risk caused by banks which only issue one kind of contingent capital,and the idea of path decomposition is introduced to building pricing model.If the clauses of contingent capital are fixed and it has not been converted for a long time,unanticipated risks such as liquidity pressure caused by high coupon payments may arise.In order to solve this problem,this dissertation designs a resetable bail-in mechanism by adding resetable provision and put provision to the contingent capital contract.Firstly,the path dependence characteristic of bond value is analyzed through the decomposition of possible paths of stock price.Then it calculated put boundary and bond value.Through numerical analysis,we know the value of contingent capital with resetable provision and put provision is less than the value of CoCos with no additional provision under the same parameters.The applicability of its provision has certain advantages compared with the redeemable contingent capital which are prevalent in the current market.Sensitivity analysis results show that it is negatively correlated between the bond value and annual volatility of the stock price,and positively correlated between the bond value and the resetable date.So it is necessary to select an appropriate resetable date based on the prediction of future market risk.(2)This dissertation designs a contingent capital stratified structure with steady operation of banks.Structural pricing models are built to solve the value of every component of bank capital structure.Bank contingent capital stratified structure with CoCos and TLAC bonds is studied based on the supervision requirement of Basel Ⅲ and TLAC rule.It can solve the problem that the total loss absorbing capacity of commercial banks is insufficient and issuing only CoCos will bring unanticipated risk.Firstly,it analysed the basic setting of capital structure and bail-in mechanism with steady operation of banks.And then,it calculated the value of bank asset,various debts and original shareholder’s equity.The numerical analysis shows that the stratified contingent capital structure is stronger than the single contingent capital structure and there is an optimal contingent capital structure in this case.The sensitivity analysis of interest spread indicates that only when the volatility is extremely high,issuing single contingent capital will help the bank to save issuing cost.At any normal volatility level,banks can choose to issue shorter term TLAC bonds to save issuing cost.(3)This dissertation studies the short-term investment risk incentive effect of stratified contingent capital structure with bail-in mechanism.It establishes a short-term structural model and derives the value of every stakeholder by decomposing into sets of exotic options.The elasticity of shareholders’ equity value to the volatility of bank asset value is used to measure the incentive effect of original shareholder’s risk taking.Compared with single contingent capital structure,the bail-in mechanism of stratified contingent capital structure is more complex and its risk effect is more uncertain.Therefore,this dissertation studies how to set the parameters of stratified contingent capital structure with CoCos and TLAC bonds to restain the short-term incentive effect of original shareholders’ risk taking.Firstly,it analyzed the basic setting of capital structure and single period dynamic continuous time model.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 the effect of risk taking can be released by setting the parameters properly.The contrastive analysis of risk incentive effect with different contingent capital structure shows that compared with single contingent capital structure,there is no additional risk incentive with stratified contingent capital structure.In general,stratified contingent capital will have a positive effect on the restain of risk incentive effect.(4)This dissertation constructs a two-stage dynamic continuous time model to study the optimization of bank’s contingent capital dynamic structure and contingent capital supplement strategy in a certain period.Under the new capital adequancy requirement regulation,commercial banks need to enhance their ability to prevent systemic risk with the help of contingent capital buffer.In most cases,it is impossible to supplement the capital gap through a financing strategy.Considering there is a certain capital supplement cost in capital supplement process with contingent capital,and its issuance has great uncertainty on the capital structure and risk-taking of banks,this dissertation designs and optimizes the contingent capital dynamic structure and supplement strategy of banks with bail-in mechanism.Specifically,the bank can carry out an initial capital supplement and a subsequent capital resupplement at any time.Meanwhile,in order to avoid excessive capital supplement,the regulatory authorities will also set capital supplement constraint for the bank.According to the change of bank capital structure in different stages,this dissertation gives a pricing model of the original shareholders’ equity value by using Bayesian conditional probability and exotic option decomposition pricing method.The results of numerical analysis show that in different risk environments,making a reasonable capital supplement strategy is expected to significantly improve the bank’s total loss absorption capacity and reduce unanticipated risk.The main practical value of this dissertation can be summarized as follows:Firstly,it optimizes the contingent capital structure of banks with bail-in mechanism.The analysis results can help banks to improve the total loss absorbing capacity and control the negative effects of unanticipated risk;Secondly,considering the strong path dependence of contingent capital,this dissertation builds pricing models by using a variety of mathematical methods.The accurate pricing model is conducive to stable capital supplement and effective risk management;Thirdly,this dissertation provides a good theoretical basis for the establishment of bank bail-in mechanism and the improvement of the total loss absorbing capacity.It is expected to help the successful implementation of the new regulatory requirements in China.