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Using Subordinated Debt as an Instrument of Market Discipline
Source: Federal Reserve


This study has attempted to describe the motivations for a subordinated debt policy, to examine and contribute to the evidence regarding the current extent of market discipline provided by SND, and to analyze the pros and cons of various key characteristics that an SND policy might have. Our purpose was to conduct a broad review and evaluation of the issues but not to advance policy conclusions at this time. Indeed, as the study progressed, many issues proved to be more complex than we had anticipated.

Although we do not draw policy conclusions, our study makes clear that assessment of the benefits and costs of a policy proposal would be helped greatly by more research in a number of areas. For example, a better understanding of the marginal benefits of requiring banks to issue SND relative to the benefits of the existing SND market, along with associated marginal costs, would be quite useful. Such a study would need to examine the market discipline benefits of currently outstanding SND as well as the benefits of other medium- and long-term uninsured liabilities.  A second area of useful research would be a close examination of the potential benefits of using the existing SND market for banking organizations, and the current markets for BHC equity and selected uninsured bank liabilities, as aids to bank supervisory surveillance activities. Finally, the data currently available for bank and bank holding company SND prices, bid-ask spreads, and other key pieces of information clearly have significant deficiencies.  Construction of a high-quality data set for use in policy analysis and research would be a prerequisite for obtaining a better view of the potential benefits and costs of a mandatory subordinated debt policy.

Appendix A