Magazine article American Banker

Subordinated Debt Touted as Enforcer of Market Discipline and Capital Idea

Magazine article American Banker

Subordinated Debt Touted as Enforcer of Market Discipline and Capital Idea

Article excerpt

One concept we are evaluating is to require a significant increase in the level of capital, the burden of which can be alleviated by the use of subordinated debt. This would have the dual advantage of providing additional protection for depositors and enhancing marketplace discipline.

Subordinated lenders are certainly apt to be more sophisticated and comfortable in evaluating credit risk than depositors. Whereas most uninsured deposits mature within a few months or can be withdrawn on demand, subordinated lenders typically are in a very different position. Once having made the investment, they generally cannot flee during adversity. They have to view bank operations from a longer-term perspective. Unlike depositors, they cannot count on the probability of being completely protected at the time a bank fails. If and when a failure occurs, subordinated note holders provide a protective cushion to the FDIC and other general creditors.

Stockholders, of course, also invest for the long term and cushion the FDIC and other general creditors in event of a failure. Stockholders, though, receive compensation for taking long-term and sometimes speculative risks through potential increased dividends and market appreciation. Subordinated debt holders are locked into a fixed return with no appreciation potential. Thus, their investment is predicated largely on perceived risk relative to rate of return, not speculative appreciation possibilities. …

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