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

Abstract

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