Does the market discipline banks? New evidence from the regulatory capital mix

Adam B. Ashcraft ()

No 244, Staff Reports from Federal Reserve Bank of New York

Abstract: Although bank capital regulation permits a bank to choose freely between equity and subordinated debt to meet capital requirements, lenders and investors view debt and equity as imperfect substitutes. It follows that the mix of debt in regulatory capital should isolate the role that the market plays in disciplining banks. I document that since the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) reduced the ability of the FDIC to absorb losses of subordinated debt investors, the mix of debt has had a positive effect on the future outcomes of distressed banks, as if the presence of debt investors has worked to limit moral hazard. To mitigate concerns about selection, I use the variation across banks in the mix of debt in capital generated by cross-state variation in state corporate income tax rates. Interestingly, instrumental variables (IV) estimates document that selection problems are indeed important, but suggest that the benefits of subordinated debt are even larger. I conclude that the market may play a useful direct role in regulating banks.

Keywords: Bank capital; Federal Deposit Insurance Corporation Improvement Act of 1991; Debt; Bank supervision (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-fmk and nep-reg
Date: 2006
View list of references View citations in EconPapers

Downloads: (external link)
http://www.newyorkfed.org/research/staff_reports/sr244.html (text/html)
http://www.newyorkfed.org/research/staff_reports/sr244.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: http://EconPapers.repec.org/RePEc:fip:fednsr:244

Ordering information: This working paper can be ordered from
http://www.ny.frb.org/rmaghome/staff_rp/

Access Statistics for this paper

More papers in Staff Reports from Federal Reserve Bank of New York
Contact information at EDIRC.
Series data maintained by Diane Rosenberger ().