Macro-prudential financial regulation of banks after the crisis of 2008

PhD ThesisAfter the global financial crisis of 2008 policy makers around the world initiated a paradigm shift towards macro-prudential financial regulation of banks. As a consequence the regulatory authorities are tasked with the objective of “maintaining financial stability”. This PhD analyses the potential of this paradigm shift and identifies some of the issues of its objective. If maintaining financial stability is not fulfilled, systemic risk can again lead to damages to the financial and real economy in the form of a credit crunch as seen in the early stages of the crisis of 2008. From a practical perspective, the findings of this thesis provide useful support for policy makers by identifying the key challenges in times of distress: Manipulating the incentives of banks towards the objective of promoting financial stability, and identifying the biggest sources for systemic risk in the banking sector and preventing its propagation. Within an academic context, this thesis contributes to the nascent field of qualitative and quantitative research on systemic risk and contingent convertible bonds (CoCos) for the recovery and resolution of struggling banks. The conditional Value-at-Risk (CoVaR) methodology is a new approach to quantifying the systemic risk stemming from one particular bank. The empirical results of this thesis show that a bank’s systemic risk is dependent on the state of the financial environment. So, this methodology can help the new macro-prudential regulatory agencies in their supervisory review of a bank. However, the results can alter substantially, depending on the sample period. CoCos automatically decrease the leverage of a bank upon a specific trigger event. The bank’s capital ratio is reinforced instantaneously, making it more loss-absorbent. This thesis proposes a design that circumvents most of the issues identified in the nascent body of research that could limit CoCos. Specifically, and contrary to most proposals, it reinforces the natural order of shareholders and other creditors. With this, the moral hazard of banks is reduced and financial stability promoted