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Sub-debt yield spreads as bank risk measures

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Author Info
Douglas D. Evanoff
Larry D. Wall

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Abstract

Several recent studies have recommended greater reliance on subordinated debt as a tool to discipline bank risk taking. Some of these proposals recommend using sub-debt yield spreads as triggers for supervisory discipline under prompt corrective action (PCA). Currently such action is prompted by capital adequacy measures. This paper provides the first empirical analysis of the relative accuracy of various capital ratios and sub-debt spreads in predicting bank condition, measured as subsequent CAMEL or BOPEC ratings. The results suggest that some of the capital ratios, including the summary measure used to trigger PCA, have almost no predictive power. Sub-debt yield spreads performed slightly better than the best capital measure, the Tier-1 leverage ratio, albeit the difference is not significant. The performance of sub-debt yields satisfies an important prerequisite for using sub-debt as a PCA trigger. However, the prediction errors are relatively high and further work to refine the measures would be desirable.

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Paper provided by Federal Reserve Bank of Atlanta in its series Working Paper with number 2001-11.

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Date of creation: 2001
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Publication status: Published in Journal of Financial Services Research, Oct–Dec 2001and Journal of Banking and Finance, May 2002
Handle: RePEc:fip:fedawp:2001-11

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Related research
Keywords: Risk ; Debt ; Bank supervision ; Bank capital;

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  2. Rebel Cole & Jeffery Gunther, 1998. "Predicting Bank Failures: A Comparison of On- and Off-Site Monitoring Systems," Journal of Financial Services Research, Springer, vol. 13(2), pages 103-117, April. [Downloadable!] (restricted)
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  10. Diana Hancock & Myron Kwast, 2001. "Using Subordinated Debt to Monitor Bank Holding Companies: Is it Feasible?," Journal of Financial Services Research, Springer, vol. 20(2), pages 147-187, October. [Downloadable!] (restricted)
  11. Douglas D. Evanoff & Larry D. Wall, 2000. "The role of subordinated debt in bank safety and soundness regulation," Proceedings, Federal Reserve Bank of Chicago, issue May, pages 480-493.
  12. Diana Hancock & Myron L. Kwast, 2001. "Using subordinated debt to monitor bank holding companies: is it feasible?," Finance and Economics Discussion Series 2001-22, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  15. Jeffrey W. Allen & John J. McConnell, 1998. "Equity Carve-Outs and Managerial Discretion," Journal of Finance, American Finance Association, vol. 53(1), pages 163-186, 02. [Downloadable!] (restricted)
  16. Douglas D. Evanoff & Larry D. Wall, 2000. "Subordinated debt and bank capital reform," Working Paper Series WP-00-7, Federal Reserve Bank of Chicago. [Downloadable!]
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  17. Jeffery W. Gunther & Robert R. Moore, 2000. "Early warning models in real time," Financial Industry Studies Working Paper 00-01, Federal Reserve Bank of Dallas. [Downloadable!]
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  20. D'Souza, Julia & Jacob, John, 2000. "Why firms issue targeted stock," Journal of Financial Economics, Elsevier, vol. 56(3), pages 459-483, June. [Downloadable!] (restricted)
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