The Optimal Capital Structure of Banks: Balancing Deposit Insurance, Capital Requirements and Tax-Advantaged Debt

The capital structure and regulation of financial intermediaries is an important topic for practitioners, regulators and academic researchers. In general, theory predicts that firms choose their capital structures by balancing the benefits of debt (e.g., tax and agency benefits) against its costs (e.g., bankruptcy costs). However, when traditional corporate finance models have been applied to insured financial institutions, the results have generally predicted corner solutions (all equity or all debt) to the capital structure problem. This paper studies the impact and interaction of deposit insurance, capital requirements and tax benefits on a bankÇs choice of optimal capital structure. Using a contingent claims model to value the firm and its associated claims, we find that there exists an interior optimal capital ratio in the presence of deposit insurance, taxes and a minimum fixed capital standard. Banks voluntarily choose to maintain capital in excess of the minimum required in order to balance the risks of insolvency (especially the loss of future tax benefits) against the benefits of additional debt. Because we derive a closed- form solution, our model provides useful insights on several current policy debates including revisions to the regulatory framework for GSEs, tax policy in general and the tax exemption for credit unions.

The effect of the shift from HMO to PPO plans on the prevalence of hospital bad debt in the insured population: A case study in two Houston-area hospitals

In spite of the dramatic increase and general concern with U.S. hospital bad debt expense (AMNews, January 12, 2004; Philadelphia Business Journal, April 30, 2004; WSJ, July 23, 2004), there appears to be little available analysis of the precise sources and causes of its growth. This is particularly true in terms of the potential contribution of insured patients to bad debt expense in light of the recent shift in managed care from health maintenance organization (HMO) plans to preferred provider organization (PPO) plans (Kaiser Annual Survey Report, 2003). This study examines and attempts to explain the recent dramatic growth in bad debt expense by focusing on and analyzing data from two Houston-area hospital providers within one healthcare system. In contrast to prior studies in which self-pay was found to be the primary source of hospital bad debt expense (Saywell, R. M., et al., 1989; Zollinger, T. W., 1991; Weissman, Joel S., et al., 1999), this study hypothesizes that the growing hospital bad debt expense is mainly due to the shifting trend away from HMOs to PPOs as a conscious decision by employers to share costs with employees. Compared to HMO plans, the structure of PPOs includes higher co-pays, coinsurance, and deductibles for the patient-pay portion of medical bills, creating the potential for an increase in bad debt for hospital providers (from a case study). This bad debt expense has a greater impact in the community hospital than in the Texas Medical Center hospital. ^

A Cost-Benefit analysis model for technical debt management considering uncertainty and time

In the last few years, technical debt has been used as a useful means for making the intrinsic cost of the internal software quality weaknesses visible. This visibility is made possible by quantifying this cost. Specifically, technical debt is expressed in terms of two main concepts: principal and interest. The principal is the cost of eliminating or reducing the impact of a, so called, technical debt item in a software system; whereas the interest is the recurring cost, over a time period, of not eliminating a technical debt item. Previous works about technical debt are mainly focused on estimating principal and interest, and on performing a cost-benefit analysis. This cost-benefit analysis allows one to determine if to remove technical debt is profitable and to prioritize which items incurring in technical debt should be fixed first. Nevertheless, for these previous works technical debt is flat along the time. However the introduction of new factors to estimate technical debt may produce non flat models that allow us to produce more accurate predictions. These factors should be used to estimate principal and interest, and to perform cost-benefit analysis related to technical debt. In this paper, we take a step forward introducing the uncertainty about the interest, and the time frame factors so that it becomes possible to depict a number of possible future scenarios. Estimations obtained without considering the possible evolution of the interest over time may be less accurate as they consider simplistic scenarios without changes.

Opinions in cases of debt, 1748-1749

Opinions rendered in cases brought against Thomas Barker, executor of the estate of Robert Forstor, by James and Roger Barlow (executors of the estate of Thomas Forster), Sibylla Price, and Richard Foster. The attorney for all plaintiffs was Samuel Swann.

[ Warrant for the arrest of Samuel Gray for debt], 1769

A warrant for the arrest and sale of all assets of Gray who was found to owe another merchant Alexander Hill in a recent trial. Also includes appraisal of property by Fairfield and Salter and statement by Sheriff Cudworth.

[Receipt for certificates of funded debt], 1791 January 28

Printed Commissioner's Office receipt form acknowledging three certificates of funded debt received by Caleb Gannett from Nathaniel Appleton, Commissioner of Loans in the State of Massachusetts. The receipt, No. 712, is signed by Gannett and dated January 28, 1791.

Banking Union with a Sovereign Virus. The self-serving regulatory treatment of sovereign debt in the euro area. CEPS Policy Brief No. 289, 27 March 2013

In many eurozone countries, domestic banks often hold more than 20% of domestic public debt, which is an unsatisfactory situation given that banks are highly leveraged and that sovereign debt is inherently subject to default risk within the euro area. This paper by Daniel Gros finds, however, that the relative concentration of public debt on bank balance sheets is not just a result of the euro crisis, for there are strong additional incentives for banks in some countries to increase their sovereign. His contribution discusses a number of these regulatory incentives – the most important of which is specific to the euro area – and explores ways in which euro area banks can be weaned from massive investments in government bonds.

Household debt and the European crisis. ECRI Research Report No. 13, June 2013

The fall in economic output all over Europe since 2008 has had important consequences for household liabilities. Major growth in demand and supply for household credit products has generated an increase in household debt, which contributed to growth rates during the pre-crisis period but – in some countries – became household-debt overhangs and helped inflate asset bubbles. In the run-up to the crisis, long-term economic lessons and theories were often overlooked and signs that the economic situation could worsen were ignored. Although not at the core of the crisis, household debt had important consequences for macroeconomic stability, robustness of growth and the depth of recessions. The last ten years in Europe have demonstrated the typical final stage of a household debt cycle: rapid increase and abrupt retrenchment. Widely varying outcomes across Europe enable us to consider the causes of the rapid growth in household debt and draw theoretical lessons that can help policy-makers and academics devise a coherent regulatory response to avoid extremes of the debt cycle in future.

Sovereign debt and its restructuring framework in the Euro area. Bruegel Working Paper 2013/05, August 2013

To compensate for the inflexibility of fixed exchange rates, the euro area needs flexibility through a system of orderly debt restructuring. With virtually no room for macroeconomic manoeuvring since the crisis onset, fiscal austerity has been the main instrument for achieving reductions in public debt levels; but because austerity also weakens growth, public debt ratios have barely budged. Austerity has also implied continued high private debt ratios. And these debt burdens have perpetuated economic stasis. Economic theory,history, and the recent experience all call for a principled debt restructuring mechanism as an integral element of the euro area’s design. Sovereign debt should be recognised as equity (a residual claim on the sovereign), operationalised by the automatic lowering of the debt burden upon the breach of contractually-specified thresholds. Making debt more equity-like is also the way forward for speedy private deleveraging. This debt-equity swap principle is a needed shock absorber for the future but will also serve as the principle to deal with the overhang of ‘legacy’ debt.

The euro area's tightrope walk: debt and competitiveness in Italy and Spain. Bruegel Policy Contribution 2013/11, September 2013

Competitiveness adjustment in struggling southern euro-area members requires persistently lower inflation than in major trading partners, but low inflation worsens public debt sustainability. When average euro-area inflation undershoots the two percent target, the conflict between intra-euro relative price adjustment and debt sustainability is more severe. In our baseline scenario, the projected public debt ratio reduction in Italy and Spain is too slow and does not meet the European fiscal rule. Debt projections are very sensitive to underlying assumptions and even small negative deviations from GDP growth, inflation and budget surplus assumptions can easily result in a runaway debt trajectory. The case for a greater than five percent of GDP primary budget surplus is very weak. Beyond vitally important structural reforms, the top priority is to ensure that euro area inflation does not undershoot the two percent target, which requires national policy actions and more accommodative monetary policy. The latter would weaken the euro exchange rate, thereby facilitating further intra-euro adjustment. More effective policies are needed to foster growth. But if all else fails, the European Central Bank’s Outright Monetary Transactions could reduce borrowing costs.