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Subordinated debt as instrument of market discipline: Risk sensitivity of sub-debt yield spreads in UK banking

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  • Zhang, Zhichao
  • Song, Wei
  • Sun, Xin
  • Shi, Nan

Abstract

This paper empirically examines whether yield spreads of subordinated debt issued by UK banks are sensitive to bank risks, with a dataset that includes spreads, ratings, accounting measures of bank risks and market condition indexes in the sample period between 1997 and 2009. The results show that Moody's and S&P traditional ratings have significant and negative impacts on spreads, and investors have exercised sensible discrimination between different risk profiles of UK financial institutions. However, accounting measures show an absence of the explanatory power of the spreads. Market condition indicators, particularly those related to European markets, also have significant influence on credit yield spreads. The findings indicate that, in the UK, sub-debt spreads do reflect the issuing banks’ risk-taking, hence satisfying a critical precondition for sub-debts to be an instrument of market discipline in banking.

Suggested Citation

  • Zhang, Zhichao & Song, Wei & Sun, Xin & Shi, Nan, 2014. "Subordinated debt as instrument of market discipline: Risk sensitivity of sub-debt yield spreads in UK banking," Journal of Economics and Business, Elsevier, vol. 73(C), pages 1-21.
    • Handle: RePEc:eee:jebusi:v:73:y:2014:i:c:p:1-21
    DOI: 10.1016/j.jeconbus.2013.11.002
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    More about this item

    Keywords

    UK banking industry; Market discipline; Subordinated debt; Yield spreads;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation

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