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

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  • Nivorozhkin, Eugene

    (Department of Economics, School of Economics and Commercial Law, Göteborg University)

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.

Suggested Citation

  • Nivorozhkin, Eugene, 2001. "An Analysis of Subordinated Debt in Banking: The Case of Costly Bankruptcy," Working Papers in Economics 44, University of Gothenburg, Department of Economics, revised 19 Dec 2001.
    • Handle: RePEc:hhs:gunwpe:0044
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    References listed on IDEAS

    as
    1. 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 351-367, May.
    2. Douglas D. Evanoff & Larry D. Wall, 2000. "Subordinated debt and bank capital reform," Working Paper Series WP-00-7, Federal Reserve Bank of Chicago.
    3. Anderson, Ronald W & Sundaresan, Suresh, 1996. "Design and Valuation of Debt Contracts," The Review of Financial Studies, Society for Financial Studies, vol. 9(1), pages 37-68.
    4. Douglas D. Evanoff & Larry D. Wall, 2000. "Subordinated debt as bank capital: a proposal for regulatory reform," Economic Perspectives, Federal Reserve Bank of Chicago, vol. 25(Q II), pages 40-53.
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    Cited by:

    1. Adrian POP, 2005. "La Politique de Dette Subordonnée comme alternative au IIIè Pilier de Bâle II : est-elle faisable?," Discussion Papers (REL - Recherches Economiques de Louvain) 2005023, Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES).
    2. Nivorozhkin, Eugene, 2005. "The informational content of subordinated debt and equity prices in the presence of bankruptcy costs," European Journal of Operational Research, Elsevier, vol. 163(1), pages 94-101, May.

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    More about this item

    Keywords

    bank; subordinated debt; market discipline; bankruptcy costs; deposit insurance;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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