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Testing for market discipline in the European banking industry: evidence from subordinated debt issues

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Author Info
Andrea Sironi

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Abstract

The question of whether private investors can rationally discriminate between the risk taken by banks is empirically investigated by testing the risk sensitivity of European banks' subordinated notes and debentures (SND) spreads. A unique dataset of issuance spreads, issues and issuers rating, accounting and market measures of bank risk is used for a sample of European banks' SND issued during the 1991-2000:Q1 period. Moody's Bank Financial Strength (MBFS) and FitchIBCA Individual (FII) ratings are used as proxies of banks risk and found to perform better than accounting variables in explaining the cross-sectional variability of spreads. Empirical results support the hypothesis that SND investors are sensitive to bank risk. An exception to this conclusion is represented by SND issued by public banks, i.e. government owned or guaranteed institutions such as the German Landesbank. Results also show that market discipline on European banks has been improving during the nineties, with the risk sensitivity of SND spreads increasing from the first to the second half of the decade.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2000-40.

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Date of creation: 2000
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Handle: RePEc:fip:fedgfe:2000-40

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Related research
Keywords: Banking market - European ; Risk management ; Banks and banking;

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This paper has been announced in the following NEP Reports: References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Robert R. Bliss & Mark J. Flannery, 2000. "Market discipline in the governance of U.S. Bank Holding Companies: monitoring vs. influencing," Working Paper Series WP-00-3, Federal Reserve Bank of Chicago. [Downloadable!]
  2. Richard Cantor & Frank Packer, 1994. "The credit rating industry," Quarterly Review, Federal Reserve Bank of New York, issue Sum, pages 1-26.
  3. Donald P. Morgan & Kevin J. Stiroh, 1999. "Bond market discipline of banks: is the market tough enough?," Staff Reports 95, Federal Reserve Bank of New York. [Downloadable!]
  4. Gorton, Gary & Santomero, Anthony M, 1990. "Market Discipline and Bank Subordinated Debt," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 22(1), pages 119-28, February. [Downloadable!] (restricted)
  5. anonymous, 1999. "Using subordinated debt as an instrument of market discipline," Staff Studies 172, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  6. Merton, Robert C., 1973. "On the pricing of corporate debt: the risk structure of interest rates," Working papers 684-73., Massachusetts Institute of Technology (MIT), Sloan School of Management. [Downloadable!]
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  7. Avery, Robert B & Belton, Terrence M & Goldberg, Michael A, 1988. "Market Discipline in Regulating Bank Risk: New Evidence from the Capital Markets," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 20(4), pages 597-610, November. [Downloadable!] (restricted)
  8. Flannery, Mark J, 1998. "Using Market Information in Prudential Bank Supervision: A Review of the U.S. Empirical Evidence," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 30(3), pages 273-305, August.
  9. Julapa Jagtiani & George Kaufman & Catharine Lemieux, 1999. "Do markets discipline banks and bank holding companies? evidence from debt pricing," Emerging Issues, Federal Reserve Bank of Chicago, issue Jun. [Downloadable!]
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