A credit risk analysis of the Norwegian bank bond market : Effects of MREL implementiation in the Norwegian bank bond market

Abstract

If recovery and resolution directives are credible, investors owning bail-in debt will have an incentive to monitor the risk of a bank. In this thesis we have analyzed the effects of the new EU resolution framework, with a special focus on the minimum requirement for own funds and eligible liabilities (MREL). We have studied how the Norwegian bond market, mainly focused on Tier 2, senior and senior non-preferred (SNP) debt, have shifted the risks within the mentioned debt classes. The new debt class SNP is introduced as a consequence of the MREL regulation. We have constructed our own credit model to price the credit risk inspired by the Merton model. The results from our model are then compared with market data collected from Nordic Bond Pricing (NBP). We find the pricing of these debt classes to be in line with their position in the credit hierarchy. The relative risks within our credit model are also comparable to the market data. However, within the SNP class we observe two securities where a call option seems to be mispriced. A SNP bond with an embedded call option traded at levels equal to an equivalent bond without the option, with equal credit risk, are most likely mispriced and thereby being an arbitrage opportunity. This breaks the premise that an option has a strictly positive value. As the implementation of the SNP class is an ongoing process, we believe the differences between credit risk from NBP data and our own estimates will settle over time. As the MREL regulations are not fully implemented in Norway yet, there can be new changes concerning the volume of SNP expected to be issued by the market. The total volume of SNP issuances can change even without regulatory changes, because the requirement of each bank depends on how their assets are distributed. In our analysis we find the volume and pricing of SNP debt to be positively correlated with the MREL set for banks. A higher MREL requires more SNP debt to be issued.