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PERFORMANCE SENSITIVE DEBT – THE EFFECT
ON RENEGOTIATIONS, LEVERAGE, AND
DIVIDEND POLICY


Kwangsoo Lim
THE ROLE OF SUBORDINATED BONDS ON BANK
REGUALTION
Kwangsoo Lim1
Central Connecticut State University, U.S.A.


ABSTRACT


The Basel III international bank regulatory framework adopts subordinated
bonds as the third pillar of bank regulation. This article examines the market discipline hypothesis that monitoring by the bond marke enhances the effectiveness of bank regulation through disseminating information on bank default risk and suppressing excessive risk taking behaviors. This article empirically tests the association between the size of subordinated bonds and a bank’s financial soundness using regression analysis. The data on bank samples are drawn from COMPUSTAT Bank File and the sampling periods are from 2005 to 2010, when the 2008 financial crisis revealed the information on regulatory effectiveness and bankruptcy risk. This study finds that subordinated bonds have an incremental explanatory power on the financial soundness of banks beyond regulatory capital,  but in a smaller scale than regulatory capital. For bank regulation, subordinated bonds would be complementary to regulatory capital, but should not be substituted for regulatory capital.

Key words: bank regulation, subordinated bond, financial soundness, financial crisis

JEL Codes: G01, G21, G28


1Kwangsoo Lim Ph.D., Central Connecticut State University, 1615 Stanley Street New Britain, Connecticut, 06050,
Tel 860-874-3634, E-mail lim@ccsu.edu.