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Using subordinated debt to monitor bank holding companies: is it feasible?

  • Diana Hancock
  • Myron L. Kwast
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    Much research is needed to implement a supervisory surveillance system for banking organizations that relies on subordinated debt and other market data. This paper is germane to that task. We find subordinated debt spreads are most consistent across data sources for the most liquid bonds (i.e., those of relatively large issuance size, relatively young age, issued by relatively large firms) traded in a relatively robust overall bond market. We also find there is a high degree of concordance in rankings of firms by their minimum spreads across bonds with especially strong agreement about which large firms are in the tails of the spread distribution at each point in time. Our time-series results support and provide guidance for the use of subordinated debt spreads in supervisory monitoring, support the need for careful judgment when interpreting such spreads, highlight difficulties with currently available data sources, and motivate the need for further research.

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    File URL: http://www.federalreserve.gov/pubs/feds/2001/200122/200122abs.html
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    File URL: http://www.federalreserve.gov/pubs/feds/2001/200122/200122pap.pdf
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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 2001-22.

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    Date of creation: 2001
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    Handle: RePEc:fip:fedgfe:2001-22
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    1. Douglas D. Evanoff & Larry D. Wall, 2000. "Subordinated debt and bank capital reform," Working Paper 2000-24, Federal Reserve Bank of Atlanta.
    2. 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.
    3. Sarig, Oded & Warga, Arthur, 1989. "Bond Price Data and Bond Market Liquidity," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 24(03), pages 367-378, September.
    4. 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.
    5. Julapa Jagtiani & Catharine Lemieux, 1999. "Stumbling blocks to increasing market discipline in the banking sector: a note on bond pricing and funding strategy prior to failure," Emerging Issues, Federal Reserve Bank of Chicago, issue Sep.
    6. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
    7. Jones, David S. & King, Kathleen Kuester, 1995. "The implementation of prompt corrective action: An assessment," Journal of Banking & Finance, Elsevier, vol. 19(3-4), pages 491-510, June.
    8. Nunn, Kenneth P. & Hill, Joanne & Schneeweis, Thomas, 1986. "Corporate Bond Price Data Sources and Return/Risk Measurement," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 21(02), pages 197-208, June.
    9. 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.
    10. Lisa M. DeFerrari & David E. Palmer, 2001. "Supervision of large complex banking organizations," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Feb, pages 47-57.
    11. Robert DeYoung & Mark J. Flannery & William W. Lang & Sorin M. Sorescu, 1998. "The informational advantage of specialized monitors: the case of bank examiners," Working Paper Series WP-98-4, Federal Reserve Bank of Chicago.
    12. Mark Fisher & Douglas Nychka & David Zervos, 1995. "Fitting the term structure of interest rates with smoothing splines," Finance and Economics Discussion Series 95-1, Board of Governors of the Federal Reserve System (U.S.).
    13. 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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