The potential role of subordinated debt programs in enhancing market discipline in banking

by Douglas Darrell Evanoff

Publisher: Research Division, Federal Reserve Bank of Kansas City in Kansas City [Mo.]

Written in English
Published: Downloads: 975
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Previous studies have found that subordinated debt (sub-debt) markets do differentiate between banks with different risk profiles. This finding satisfies a necessary condition for regulatory proposals which would mandate increased reliance on sub-debt in the bank capital structure to discipline banks" risk taking. Such proposals, however, have not been implemented, partially because there are still concerns about the quality of the signal generated in current debt markets. We argue that previous studies evaluating the potential usefulness of sub-debt proposals have evaluated spreads in an environment that is very different from the one that will characterize a fully implemented sub-debt program. With a fully implemented program, the market will become deeper, issuance will be more frequent, debt will be viewed as a more viable means to raise capital, bond dealers will be less reluctant to publicly disclose more details on debt transactions, and generally, the market will be more closely followed. As a test to see how the quality of the signal may change, we evaluate the risk-spread relationship, accounting for the enhanced market transparency surrounding new debt issues. Our empirical results indicate a superior risk-spread relationship surrounding the period of new debt issuance due, we posit, to greater liquidity and transparency. Our results overall suggest that the degree of market discipline would likely be enhanced by a mandatory sub-debt program requiring banks to regularly approach the market to issue sub-debt.

Edition Notes

StatementDouglas D. Evanoff, Julapa Jagtiani, and Taisuke Nakata.
SeriesRWP -- 07-07
ContributionsJagtiani, Julapa., Nakata, Taisuke., Federal Reserve Bank of Kansas City. Research Division.
Classifications
LC ClassificationsHB1
The Physical Object
FormatElectronic resource
ID Numbers
Open LibraryOL16370404M
LC Control Number2007619398

The $ billion-asset Univest issued $45 million of subordinated debt on July 1, adding to a $50 million sale last year. Banks also like subordinated debt because the interest payments are tax-deductible and the issues help bolster Tier 2 capital ratios, said Michael Rave, a lawyer at Day Pitney. It also helps to have a market for the debt. Working Paper File Downloads Abstract Views; Last month: 3 months: 12 months: Total: Last month: 3 months: 12 months: Total: A Survey of Fintech Research and Policy Discussion.   Senior debt remained the most common form of bank debt last year, as it has been since the financial crisis. But subordinated debt issuance is growing faster. Last year, public U.S. banks and thrifts sold about $ billion in subordinated debt, according to SNL Financial. Banking. Banker Resources. Application by Organization; Banker Training, Tools and Information There is also a growing realization that bank regulation must more effectively incorporate market discipline to encourage prudent risk management. One means recommended to accomplish this is to increase the role of subordinated debt in the bank.

Corporate finance for the pre-industrial world began to emerge in the Italian city-states and the low countries of Europe from the 15th century. Public markets for investment securities developed in the Dutch Republic during the 17th century. By the early s, London acted as a center of corporate finance for companies around the world, which innovated new forms of lending and investment. A pitch book of financial information is generated to market the bank to a potential M&A client; if the pitch is successful, the bank arranges the deal for the client. See Financial analyst #Investment Banking. The investment banking division (IBD) is generally divided .

The potential role of subordinated debt programs in enhancing market discipline in banking by Douglas Darrell Evanoff Download PDF EPUB FB2

Our results overall suggest that the degree of market discipline would likely be enhanced by a mandatory sub-debt program requiring banks to regularly approach the market to issue sub-debt.

Previous studies have found that subordinated debt (sub-debt) markets do differentiate between banks with different risk profiles. Our results overall suggest that the degree of market discipline would be significantly enhanced by a mandatory sub-debt program, thus suggesting a potential role for sub-debt in the banking.

Abstract: Previous studies have found that subordinated debt (sub-debt) markets do differentiate between banks with different risk profiles. This finding satisfies a necessary condition for regulatory proposals which would mandate increased reliance on sub-debt in the bank capital structure to discipline banks ’ risk taking.

Previous studies have found that subordinated debt (sub-debt) markets do differentiate between banks with different risk profiles. This finding satisfies a necessary condition for regulatory proposals which would mandate increased reliance on sub-debt in the bank capital structure to discipline banks’ risk taking.

This paper evaluates the potential role of mandatory subordinated debt (MSD) in enhancing market discipline in emerging markets. The conceptual merits and key preconditions of MSD are first reviewed. Then, the extent to which emerging markets satisfy these preconditions—among them the monitorability of bank assets, the presence of nonbank financial investors, and liquid and Cited by: In such a situation, subordinated debt can play a complementary role in enhancing bank capital.

Pillar II of Basel Accord II emphasises supervisory review process. To this end, subordinated debt can provide quality market signals, which can be used by the supervisors to identify distress in bank management. subordinated debt and they are traded in considerably more liquid markets.

The moral hazard arising from the limited liability of equity may not be offset by the market discipline from subordinated debt, particularly when banks are near insolvency and/or the debt is not frequently refinanced. economy. Hence, there is an increased call for more market discipline on banking firms.

Subordinated debt has been widely proposed as a means to achieve this end. Proponents of increased use of subordinated debt by banking firms argue that it can impose both direct and indirect market discipline on these firms.

Direct discipline is. that both components of market discipline obtain.3 The purpose of market discipline in the context of bank regulation is, after all, to control or effect changes in bank behavior.

The intuition underlying efforts to enhance market discipline of banking firms through mandated subordinated debt issuance is both simple and intu-itively appealing. Published Economics. Economic Perspectives.

Requiring banks to issue subordinated debt is one proposal to bring market discipline to bear in aiding regulatory supervision.

This article explores the frictions that produce a need for discipline (agency problems) and the mechanisms markets have evolved for dealing with these frictions.

Following an examination of the rationales and assumptions underlying. While subordinated debt can be used to increase market discipline on banks by playing a corporate governance role in the presence of a federal safety net that encourages risk taking, it also has implications for banks’ loan sales.

Using two measures of banks’ loan sales activity, we find greater proportions of subordinated debt increase the likelihood that banks engage in loan sales. With a sub-debt program, the market will likely become deeper as issuance will be more frequent, debt will be viewed as a more viable means to raise capital, more attention will be paid to individual bank debt yields, bond dealers will be less reluctant to publicly disclose more details on debt transactions, and generally, the market will be more closely followed and sub-debt signals.

The Potential Role of Subordinated Debt Programs In Enhancing Market Discipline in Banking Douglas D. Evanoff, Julapa Jagtiani, and Taisuke Nakata September RWP Abstract: Previous studies have found that subordinated debt (sub-debt) markets do differentiate between banks with different risk profiles.

This finding satisfies a. We argue that previous studies evaluating the potential usefulness of sub-debt proposals have evaluated sub-debt spreads in a very different environment from that characterized by a fully implemented sub-debt program, where the market will become deeper, issuance will be more frequent, debt will be viewed as a more viable means to raise capital, bond dealers will be less reluctant to publicly disclose more details on debt transactions, and generally.

The incorporation of bankruptcy cost in the framework of the analysis provides some new evidence about the potential role of subordinated debt. The extent of market discipline of subordinated debt critically depends on its relative magnitude to senior debt and bankruptcy costs.

If loans in one bank’s book have to be marked down, that affects capital levels. “You might want to have a little bit of sub debt to offset that temporary capital gap until the loans begin to creep back into income and that can provide a buffer,” he adds.

Nuts and bolts. Subordinated debt has certain strict features to qualify as Tier 2. Using US commercial bank data over the period towe examine how the issuance of subordinated debt (SND) affects bank risk-taking and stability, efficiency, and deposit and loan growth rates.

We identify the channels by which these effects occur and, using fixed- and random-effects models and system-GMM estimations, we provide evidence that supports these channels. The Potential Role of Subordinated Debt Programs In Enhancing Market Discipline in Banking By Douglas D. Evanoff, Julapa A.

Jagtiani, and Taisuke Nakata (RWP September ) Previous studies have found that subordinated debt (sub-debt) markets do differentiate between banks with different risk profiles. subordinated debt is the latest in a long series of calls from academics, regulators, and public officials for investigation into the potential benefits that market discipline—that is, using the private sector to.

monitor and regulate bank risk taking—may provide to the U.S. sYs-tem of bank regulation.'[ Since the s, the academic literature has.

The Potential Role of Subordinated Debt Programs In Enhancing Market Discipline in Banking. By Douglas D. Evanoff, Julapa A. Jagtiani, and Taisuke Nakata (RWP September ) Previous studies have found that subordinated debt (sub-debt) markets do differentiate between banks with different risk profiles.

The US National Credit Union Administration (NCUA) proposed a new rule on 23 January stating that “new credit unions” and existing “complex credit unions” (those with a minimum of USDm of assets) can issue subordinated debt to maintain their regulatory capital requirement.

At present, only low-income nominated credit unions (where more than 50% of [ ]. The Potential Role of Subordinated Debt Programs in Enhancing Market Discipline in Banking. FRB of Kansas City Economic Research Paper No.

Number of pages: 44 Posted: 14 Sep Last Revised: 12 Mar Douglas D. Evanoff, Julapa Jagtiani and Taisuke Nakata. The potential role of subordinated debt programs in enhancing market discipline in banking Research Working Paper, Federal Reserve Bank of Kansas City View citations (4) The role of bank advisors in mergers and acquisitions Staff Reports, Federal Reserve Bank of.

By Elijah Brewer III, William E. Jackson III and Julapa A. Jagtiani The Potential Role of Subordinated Debt Programs In Enhancing Market Discipline in Banking By Douglas D. Evanoff, Julapa A.

Jagtiani and Taisuke Nakata How Much Would Banks Be Willing to Pay to. Guidelines for Subordinated Debt. April 3, I. Introduction. Subordinated debt (or subordinated debt note) is a financing tool that can be recognized in regulatory capital, if structured appropriately.

The Office of the Comptroller of the Currency (OCC) has separate licensing rules for subordinated debt issued by national banks (12 CFR. Subordinated Debt is a loan or security that ranks below other loans or securities with regard to claims on assets or earnings. Subordinated debt is also known as a junior security or subordinated.

Reforming Bank Capital Regulation: Using Subordinated Debt to Enhance Market and Supervisory Discipline Contemporary Economic Policy, Vol.

19, Issue 4, pp.10 Pages Posted: 27 May The Report concludes that subordinated debt does provide direct market discipline. A policy of mandatory subordinated debt could enhance this direct market discipline because large banking organizations could be required to continue to issue subordinated debt during times of.

However, a more concrete potential market discipline mechanism, in the form of subordinated debt requirements, has long been discussed in academic and some regulatory circles. [1] Such proposals are currently gaining regulatory prominence, particularly in the U.S.

The potential role of subordinated debt programs in enhancing market discipline in banking by Douglas D. Evanoff & Julapa Jagtiani & Taisuke Nakata; The trend growth rate of employment: past, present, and future by Todd E. Clark & Taisuke Nakata; Has the behavior of inflation and long-term inflation expectations changed.

by Todd E. Clark. The potential role of subordinated debt programs in enhancing market discipline in banking by Douglas D. Evanoff & Julapa Jagtiani & Taisuke Nakata Predicting inadequate capitalization: early warning system for bank supervision.The potential role of subordinated debt programs in enhancing market discipline in banking Research Working Paper, Federal Reserve Bank of Kansas City View citations (4) Subordinated debt and prompt corrective regulatory action Working Paper Series, Federal Reserve Bank of Chicago View citations (3).The Potential Role of Subordinated Debt Programs In Enhancing Market Discipline in Banking by Julapa Jagtiani, Douglas D.

Evanoff and Taisuke Nakata Federal Reserve Bank of Kansas City Research Working Papers (Paper: RWP, ).