Finance and Economics Discussion Series (FEDS)
April 2001
Using Subordinated Debt to Monitor Bank Holding Companies: Is it Feasible?
Diana Hancock and Myron L. Kwast
Abstract:
Academics, policymakers and bank supervisors have expressed considerable interest in using subordinated debt and other market data in the surveillance of banking organizations, especially large and complex financial institutions. However, little research has been devoted to developing practical means of implementing such an approach for subordinated debt. This paper attempts to fill a portion of this gap.
A major problem with using subordinated debt spreads is that accurate prices of individual subordinated debt issues are difficult to come by. The bond market is largely an over-the-counter market where dealer prices are proprietary. The approach used here is to evaluate a number of data sources, including price series from vendors and broker-dealers.
Our results indicate that subordinated debt spreads are most consistent across sources for the most liquid bond issues. We also find that the most liquid bonds are those that have a relatively large issuance size, have a relatively young age, have been issued by a relatively large banking organization, and are traded in a relatively robust overall bond market. Moreover, although there are substantial differences in spread levels for individual bonds across data sources, there is a high degree of concordance in rankings of banking organizations by their minimum spreads across issues. There is especially strong agreement about which large banking organizations are in the tails of the spread distribution at a given point in time. However, time series results indicate that movements of subordinated debt spreads at individual institutions are sensitive to the data source for bond prices, thus complicating interpretation of such movements.
On balance, our results support and provide guidance for the use of subordinated debt spreads in supervisory monitoring. However, they also support the need for careful judgment when interpreting such spreads, highlight difficulties with currently available data sources, and motivate the need for further research.
Keywords: Bonds, subordinated debt, bank holding companies, monitoring, data quality
PDF: Full Paper
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