The thesis examines subordinated debt holder market discipline in UK credit institutions during the period 1995 to 2002. The topic is relevant as current research is
questioning the role and effectiveness of rules-based bank regulatory oversight, and
favouring, instead, incentive-compatible regulatory design and market discipline. In
particular, the literature proposes using signals from subordinated debt holders to
constrain bank risk-taking. In addition, this market oversight may provide information
signals to regulatory agencies that are useful in improving bank regulatory design.
The thesis researches two prominent issues related to subordinated debt holder market
discipline and, therefore, contributes to the debate in introducing incentive-compatible polices in bank regulatory design. First, testing the risk sensitivity of UK credit institution subordinated debt spreads assesses whether investors are signalling bank risk in market prices. The UK evidence supports the theoretical literature in claiming that eliminating too-big-to-fail policies can encourage effective incentive-based mechanisms. Secondly, the research examines the appropriateness of introducing a mandatory subordinated debt policy in the UK. The empirical analysis raises a number of themes, many of which are in stark contrast to US and other European
banks' subordinated debt characteristics. The conclusion is that the regular issuance of subordinated debt should be the overriding policy tool to signal and constrain bank risk-taking (i.e. direct discipline). Extending the policy to include indirect market discipline through a standardised mandatory subordinated debt requirement would impose substantial costs and should not be implemented.
A Doctoral Thesis. Submitted in partial fulfillment of the requirements for the award of Doctor of Philosophy of Loughborough University.