Monitoring and controlling bank risk: does risky debt serve any purpose?

To examine whether mandating banks to issue subordinated debt would enhance market monitoring and control risk-taking, the authors extract the credit-spread curve for each banking firm in their sample. After controlling for changes in market and liquidity variables, they find that changes in credit spreads do not reflect changes in bank risk variables. The result is robust to firm type, examination rating, size, leverage, and profitability, as well as to different model specifications. They also find that issuing subordinated debt does not alter banks' risk-taking behavior. They conclude that a mandatory subordinated debt requirement for banks is unlikely to provide the intended benefits of enhancing risk-monitoring or controlling risk-taking.Bank capital ; Risk

On Credit Spread Slopes and Predicting Bank Risk

We examine whether credit-spread curves, engendered by a mandatory subordinated-debt requirement for banks, would help predict bank risk. We extract the credit-spread curves each quarter for each bank in our sample, and analyze the information content of credit-spread slopes. We find that credit-spread slopes are significant predictors of future credit spreads. However, credit-spread slopes do not provide significant additional information on future bank-risk variables, over and above other bank-specific and market-wide information. (Constructing Credit-Spread Curves; Credit-Spread Slopes; Predicting Credit Spreads and Bank Risk)

On Credit-Spread Slopes and Predicting Bank Risk

We examine whether bank credit-spread curves, engendered by subordinated debt, would help predict bank risk. We extract credit-spread curves for each bank each quarter and analyze the predictive properties of credit-spread slopes. We find that credit-spread slopes are significant predictors of future credit spreads. We also find that credit-spread slopes provide significant additional information on future bank risk variables, over and above other bank-specific and market-wide information.