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An Analysis of Subordinated Debt in Banking: The Case of Costly Bankruptcy

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  • Nivorozhkin, Eugene

    (Department of Economics, School of Economics and Commercial Law, Göteborg University)

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    Abstract

    The paper analyzes the mandatory subordinated debt proposals in banking. It theoretically investigates the role of subordinated debt as a buffer against losses for the deposit insurer, and its role in providing direct and indirect market discipline. The incorporation of bankruptcy cost in the framework of the analysis provides some new evidence to the potential role of subordinated debt. The extent of market discipline of subordinated debt critically depends on its relative magnitude to senior debt and the bankruptcy costs. Under specified conditions, the subordinated debt prices are found to provide additional information about the value of bank assets relative to equity prices. The issues of the credibility of the proposed subordinated debt schemes are also discussed. The results indicate the critical role of regulator’s judgment in interpreting and acting upon the information from the subordinated debt prices.

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    Bibliographic Info

    Paper provided by University of Gothenburg, Department of Economics in its series Working Papers in Economics with number 44.

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    Length: 48 pages
    Date of creation: 23 May 2001
    Date of revision: 15 Oct 2001
    Handle: RePEc:hhs:gunwpe:0044

    Contact details of provider:
    Postal: Department of Economics, School of Business, Economics and Law, University of Gothenburg, Box 640, SE 405 30 GÖTEBORG, Sweden
    Phone: 031-773 10 00
    Web page: http://www.handels.gu.se/econ/
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    Related research

    Keywords: bank; subordinated debt; market discipline; bankruptcy costs; deposit insurance;

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    References

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    1. Anderson, Ronald W & Sundaresan, Suresh, 1996. "Design and Valuation of Debt Contracts," Review of Financial Studies, Society for Financial Studies, vol. 9(1), pages 37-68.
    2. Douglas D. Evanoff & Larry D. Wall, 2000. "Subordinated debt as bank capital: a proposal for regulatory reform," Economic Perspectives, Federal Reserve Bank of Chicago, issue Q II, pages 40-53.
    3. Black, Fischer & Cox, John C, 1976. "Valuing Corporate Securities: Some Effects of Bond Indenture Provisions," Journal of Finance, American Finance Association, vol. 31(2), pages 351-67, May.
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    Cited by:
    1. Adrian POP, 2005. "La Politique de Dette Subordonnée comme alternative au IIIè Pilier de Bâle II : est-elle faisable?," Discussion Papers (REL - Recherches Economiques de Louvain) 2005023, Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES).

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