The Structure of Bank Debt Covenants

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Abstract
This paper identifies the sources of conflicts between debtholders and stockholders in commercial banks, considering the potential influence of bank deposit insurance and regulations restricting bank capital ratios, merger activities, and dividend payments. We address the means by which debt covenants are used to reduce these costly conflicts by examining a period when change in capital regulations occurred. We advance a general Substitute Regulations Hypothesis: regulations that reduce the expected costs of bondholder-stockholder conflicts substitute for costly covenants. Our results support this hypothesis. We document variation in the choice of debt covenants, and hence debt structure, and relate that variation to bank regulations.