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On bank disclosure and subordinated debt

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  • Rafael Hortala-Vallve
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    Abstract

    Following Pillar 3 of the new Basel Capital Adequacy Proposals (Basel II), we analyse the effects of disclosure in the banking sector in a stylised setting of delegated portfolio management. We first consider the interaction between the shareholder and the manager of a bank - the manager has to exert risk monitoring effort in order to decrease the bank's probability of default. Disclosure is captured through a signal about the manager's effort and it is shown that the shareholder desires full disclosure (a perfect signal) so as to implement the first best level of effort. We then introduce a third stakeholder that has fixed claims on the bank, the debt-holder. This agent introduces a counteracting effect: the shareholder may not desire full disclosure anymore given that a lower level of disclosure allows the bank to improve its perceived probability of default, which in turn decreases its financing costs. This implies that subordinated debt itself may not increase the soundness of the banking sector unless it is accompanied by measures of compulsory disclosure.

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    File URL: http://eprints.lse.ac.uk/28650/
    File Function: Open access version.
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    Bibliographic Info

    Paper provided by London School of Economics and Political Science, LSE Library in its series LSE Research Online Documents on Economics with number 28650.

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    Date of creation: 2005
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    Publication status: Published in Cuadernos de Economía, 2005, 28(77-78), pp. 45-80. ISSN: 0210-0266
    Handle: RePEc:ehl:lserod:28650

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    Postal: LSE Library Portugal Street London, WC2A 2HD, U.K.
    Phone: +44 (020) 7405 7686
    Web page: http://www.lse.ac.uk/
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    Related research

    Keywords: bank disclosure; subordinated debt; delegated portfolio management;

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    References

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    1. Diamond, Douglas W, 1985. " Optimal Release of Information by Firms," Journal of Finance, American Finance Association, vol. 40(4), pages 1071-94, September.
    2. Xavier Freixas, 1999. "Optimal bail out policy, conditionality and constructive ambiguity," Economics Working Papers 400, Department of Economics and Business, Universitat Pompeu Fabra.
    3. Stephen Morris & Hyun Song Shin, 2001. "The CNBC Effect: Welfare Effects of Public Information," Cowles Foundation Discussion Papers 1312, Cowles Foundation for Research in Economics, Yale University.
    4. Palomino, Frederic & Prat, Andrea, 2003. " Risk Taking and Optimal Contracts for Money Managers," RAND Journal of Economics, The RAND Corporation, vol. 34(1), pages 113-37, Spring.
    5. Carl Ackermann & Richard McEnally & David Ravenscraft, 1999. "The Performance of Hedge Funds: Risk, Return, and Incentives," Journal of Finance, American Finance Association, vol. 54(3), pages 833-874, 06.
    6. Con Keating & Hyun Song Shin & Charles Goodhart & Jon Danielsson, 2001. "An Academic Response to Basel II," FMG Special Papers sp130, Financial Markets Group.
    7. Diamond, Douglas W & Verrecchia, Robert E, 1991. " Disclosure, Liquidity, and the Cost of Capital," Journal of Finance, American Finance Association, vol. 46(4), pages 1325-59, September.
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