An Analysis of Subordinated Debt in Banking: The Case of Costly Bankruptcy
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.
|Date of creation:||23 May 2001|
|Date of revision:||15 Oct 2001|
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- 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.
- 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.
- 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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