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Subordinated Debt, Market Discipline, and Bank Risk

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  • YEHNING CHEN
  • IFTEKHAR HASAN

Abstract

This paper demonstrates that subordinated debt (subdebt thereafter) regulation can be an effective mechanism for disciplining banks. By reducing the chance that managers of distressed banks can take value‐destroying actions to benefit themselves, subdebt regulation may encourage banks to lower asset risk. Moreover, subdebt regulation and bank capital requirements can be complements for alleviating the banks’ moral hazard problems. To make subdebt regulation effective, regulators may need impose ceilings on the interest rates of subdebt, prohibit collusion between banks and subdebt investors, and require subdebt to convert into the issuing bank's equity when the government provides assistance to the bank.
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Suggested Citation

  • Yehning Chen & Iftekhar Hasan, 2011. "Subordinated Debt, Market Discipline, and Bank Risk," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 43(6), pages 1043-1072, September.
    • Handle: RePEc:mcb:jmoncb:v:43:y:2011:i:6:p:1043-1072
    DOI: j.1538-4616.2011.00417.x
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    Cited by:

    1. Klein, Philipp & Maidl, Christoph & Woyand, Corinna, 2021. "Bank ownership and capital buffers: How internal control is affected by external governance," Journal of Financial Stability, Elsevier, vol. 54(C).
    2. Homma, Yasutake & Suzuki, Katsushi, 2023. "TLAC bonds and bank risk-taking," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 87(C).
    3. Eling, Martin & Jia, Ruo & Schaper, Philipp, 2017. "Get the Balance Right: A Simultaneous Equation Model to Analyze Growth, Profitability, and Safety," Working Papers on Finance 1716, University of St. Gallen, School of Finance.
    4. Paloviita, Maritta & Kinnunen, Helvi, 2011. "Real time analysis of euro area fiscal policies: adjustment to the crisis," Bank of Finland Research Discussion Papers 21/2011, Bank of Finland.
    5. Heller, Yuval & Peleg Lazar, Sharon & Raviv, Alon, 2022. "Banks’ risk taking and creditors’ bargaining power," Journal of Corporate Finance, Elsevier, vol. 74(C).
    6. Lee, Kevin K. & Miller, Scott A., 2020. "Did covenants distort risk signals from bank subordinated debt yields before the financial crisis?," The North American Journal of Economics and Finance, Elsevier, vol. 51(C).
    7. Ryu, Doojin & Yu, Jinyoung, 2021. "Nonlinear effect of subordinated debt changes on bank performance," Finance Research Letters, Elsevier, vol. 38(C).
    8. Hasman, Augusto & Samartín, Margarita, 2022. "Leaving the darkness: The emergence of shadow banks," Journal of Financial Stability, Elsevier, vol. 61(C).
    9. Li, Shanshan & Gong, Di & Lu, Liping, 2024. "Bail-ins and market discipline: Evidence from China," International Review of Economics & Finance, Elsevier, vol. 93(PB), pages 51-68.
    10. Guo, Lin & Prezas, Alexandros P., 2019. "Market monitoring and influence: evidence from deposit pricing and liability composition from 1986 to 2013," Journal of Financial Stability, Elsevier, vol. 43(C), pages 146-166.
    11. Heller, Yuval & Peleg-Lazar, Sharon & Raviv, Alon, 2019. "A closed-form solution to the risk-taking motivation of subordinated debtholders," Economics Letters, Elsevier, vol. 181(C), pages 169-173.
    12. Chen, Yehning, 2016. "Bank capital and credit market competition: Will competitive pressure lead to higher capital levels?," Journal of International Money and Finance, Elsevier, vol. 69(C), pages 247-263.
    13. Bley, Jorg & Saad, Mohsen & Samet, Anis, 2019. "Auditor choice and bank risk taking," International Review of Financial Analysis, Elsevier, vol. 61(C), pages 37-52.
    14. Francis, Bill & Hasan, Iftekhar & Liu, LiuLing & Wang, Haizhi, 2019. "Senior debt and market discipline: Evidence from bank-to-bank loans," Journal of Banking & Finance, Elsevier, vol. 98(C), pages 170-182.
    15. Avino, Davide E. & Conlon, Thomas & Cotter, John, 2019. "Credit default swaps as indicators of bank financial distress," Journal of International Money and Finance, Elsevier, vol. 94(C), pages 132-139.
    16. Conlon, Thomas & Cotter, John & Molyneux, Philip, 2020. "Beyond common equity: The influence of secondary capital on bank insolvency risk," Journal of Financial Stability, Elsevier, vol. 47(C).
    17. Hasman, Augusto & Samartín, Margarita, 2024. "Competition, coinsurance and moral hazard in banking," Journal of Banking & Finance, Elsevier, vol. 164(C).
    18. Yusifzada, Leyla, 2025. "How does subordinated debt affect the cost of capital for banks?," Pacific-Basin Finance Journal, Elsevier, vol. 91(C).
    19. Schürk, Daniel, 2019. "Does Subordinated Debt Discipline Banks? Empirical Evidence of Market Discipline in Europe," Junior Management Science (JUMS), Junior Management Science e. V., vol. 4(2), pages 228-240.
    20. Hogan, Thomas L., 2015. "Capital and risk in commercial banking: A comparison of capital and risk-based capital ratios," The Quarterly Review of Economics and Finance, Elsevier, vol. 57(C), pages 32-45.
    21. Paloviita, Maritta & Kinnunen, Helvi, 2011. "Real time analysis of euro area fiscal policies: adjustment to the crisis," Research Discussion Papers 21/2011, Bank of Finland.
    22. Samet, Anis & Boubakri, Narjess & Boubaker, Sabri, 2018. "Does public–private status affect bank risk taking? Worldwide evidence," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 53(C), pages 287-306.
    23. Tiago F. A. Matos & João C. A. Teixeira & Tiago M. Dutra, 2025. "The role of market discipline and macroprudential policies in achieving bank stability," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 30(3), pages 2085-2107, July.
    24. Thaer Alhalabi & Vítor Castro & Justine Wood, 2023. "Bank dividend payout policy and debt seniority: Evidence from US Banks," Financial Markets, Institutions & Instruments, John Wiley & Sons, vol. 32(5), pages 285-340, December.

    More about this item

    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

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