An Analysis of Subordinated Debt in Banking: The Case of Costly Bankruptcy

Eugene Nivorozhkin ()

No 44, Working Papers in Economics from University of Gothenburg, Department of Economics

Abstract: 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.

Keywords: bank; subordinated debt; market discipline; bankruptcy costs; deposit insurance (search for similar items in EconPapers)
JEL-codes: G12 G13 G21 G28 G33 (search for similar items in EconPapers)
Pages: 48 pages
Date: 2001-05-23, Revised 2001-12-19
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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