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Subordinated debt and prompt corrective regulatory action

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  • Douglas D. Evanoff
  • Larry D. Wall

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 subordinated debt yield spreads as additional triggers for supervisory discipline under prompt corrective action (PCA), action that is currently prompted by capital adequacy measures. This paper provides a theoretical model describing how use of a second market-measure of bank risk, in addition to the supervisors’ own internalized information, could improve bank discipline. The authors then empirically evaluate the implications of the model. The evidence suggests that subordinated debt spreads dominate the current capital measures used to trigger PCA and consideration should be given to using spreads to complement supervisory discipline. The evidence also suggests that spreads over corporate bonds may be preferred to using spreads over U.S. Treasuries.

Suggested Citation

  • Douglas D. Evanoff & Larry D. Wall, 2002. "Subordinated debt and prompt corrective regulatory action," FRB Atlanta Working Paper 2002-18, Federal Reserve Bank of Atlanta.
  • Handle: RePEc:fip:fedawp:2002-18
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    References listed on IDEAS

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    1. Diana Hancock & Myron Kwast, 2001. "Using Subordinated Debt to Monitor Bank Holding Companies: Is it Feasible?," Journal of Financial Services Research, Springer;Western Finance Association, vol. 20(2), pages 147-187, October.
    2. Douglas D. Evanoff & Larry D. Wall, 2000. "Subordinated debt and bank capital reform," Working Paper Series WP-00-7, Federal Reserve Bank of Chicago.
    3. Andrea Sironi, 2001. "An Analysis of European Banks' SND Issues and its Implications for the Design of a Mandatory Subordinated Debt Policy," Journal of Financial Services Research, Springer;Western Finance Association, vol. 20(2), pages 233-266, October.
    4. Mark Flannery, 2001. "The Faces of “Market Discipline”," Journal of Financial Services Research, Springer;Western Finance Association, vol. 20(2), pages 107-119, October.
    5. Rebel A. Cole & Jeffery W. Gunther, 1995. "FIMS: a new monitoring system for banking institutions," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Jan, pages 1-15.
    6. Jeffery W. Gunther & Mark E. Levonian & Robert R. Moore, 2001. "Can the stock market tell bank supervisors anything they don't already know?," Economic and Financial Policy Review, Federal Reserve Bank of Dallas, issue Q II, pages 2-9.
    7. Harald Benink & Clas Wihlborg, 2002. "The New Basel Capital Accord: Making it Effective with Stronger Market Discipline," European Financial Management, European Financial Management Association, vol. 8(1), pages 103-115.
    8. R. Alton Gilbert & Andrew P. Meyer & Mark D. Vaughan, 2000. "The role of a CAMEL downgrade model in bank surveillance," Working Papers 2000-021, Federal Reserve Bank of St. Louis.
    9. Evanoff, Douglas D. & Wall, Larry D., 2002. "Measures of the riskiness of banking organizations: Subordinated debt yields, risk-based capital, and examination ratings," Journal of Banking & Finance, Elsevier, vol. 26(5), pages 989-1009, May.
    10. 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.
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    Citations

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    Cited by:

    1. Robert N. Collender, 2008. "Enterprise Credit Default Swaps and Market Discipline – Preliminary Analysis," FHFA Staff Working Papers 08-02, Federal Housing Finance Agency.
    2. Jean-Charles Rochet, 2003. "Réglementation prudentielle et discipline de marché," Revue d'Économie Financière, Programme National Persée, vol. 73(4), pages 201-212.
    3. Decamps, Jean-Paul & Rochet, Jean-Charles & Roger, Benoit, 2004. "The three pillars of Basel II: optimizing the mix," Journal of Financial Intermediation, Elsevier, vol. 13(2), pages 132-155, April.
    4. Mayes, David G. & Nieto, María J. & Wall, Larry, 2008. "Multiple safety net regulators and agency problems in the EU: Is Prompt Corrective Action partly the solution?," Journal of Financial Stability, Elsevier, vol. 4(3), pages 232-257, September.
    5. Mayes, David G., 2004. "An approach to bank insolvency in transition and emerging economies," Research Discussion Papers 4/2004, Bank of Finland.
    6. Mamiza Haq & Amine Tarazi & Necmi Avkiran & Ana Rosa Fonceca, 2013. "Market Discipline and Bank Charter Value: The Case of Two Safe Banking Industries," Working Papers hal-00955135, HAL.
    7. Mayes, David G., 2004. "Who pays for bank insolvency?," Journal of International Money and Finance, Elsevier, vol. 23(3), pages 515-551, April.
    8. David G. Mayes, 2011. "Early Intervention and Prompt Corrective Action in Europe," Chapters,in: The Financial Crisis and the Regulation of Finance, chapter 10 Edward Elgar Publishing.
    9. James B. Bullard & Christopher J. Neely & David C. Wheelock, 2009. "Systemic risk and the financial crisis: a primer," Review, Federal Reserve Bank of St. Louis, issue Sep, pages 403-418.
    10. Mayes, David G., 2005. "Who pays for bank insolvency in transition and emerging economies?," Journal of Banking & Finance, Elsevier, vol. 29(1), pages 161-181, January.
    11. Mayes, David G. & Nieto, María J. & Wall, Larry, 2007. "Multiple safety net regulators and agency problems in the EU : is Prompt Corrective Action a partial solution," Research Discussion Papers 7/2007, Bank of Finland.
    12. Frederick T. Furlong & Robard Williams, 2006. "Financial market signals and banking supervision: are current practices consistent with research findings?," Economic Review, Federal Reserve Bank of San Francisco, pages 17-29.

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    Keywords

    Bank supervision ; Debt;

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