The Role of Subordinated Debt in Market Discipline

This paper evaluates the potential role of mandatory subordinated debt (MSD) in enhancing market discipline in emerging markets. The conceptual merits and key preconditions of MSD are first reviewed. Then, the extent to which emerging markets satisfy these preconditions—among them the monitorability of bank assets, the presence of nonbank financial investors, and liquid and “clean” capital markets—are evaluated. We find that emerging markets do not satisfy the preconditions for the successful implementation of a MSD policy. Therefore, efforts to enhance market discipline should first focus on satisfying these preconditions and improving the overall incentive environment and market infrastructure.Capital;Emerging markets;investors, bond, subordinated debt, commercial banks, bond markets, financial institutions, financial intermediaries, institutional investors, bond market, domestic capital markets, financial markets, foreign investors, excessive risk, financial system, stock market, private bond, risk assessment, international investors, domestic capital, financial systems, expropriation, deposit insurance, regulatory action, bondholders, financial intermediation, financial safety net, regulatory framework, minority shareholders, insider trading, risky banks, stock markets, stock market capitalization, bonds, cash flow, disclosure requirements, investment banking, foreign ownership, financial sector, global capital, bond issues, equity shares, private capital, financial market, private pension, hedge, domestic bonds, international capital, public bond, debt stocks, bond market development, international capital markets, emerging market bond, international financial statistics, investment decisions, financial assets, total market capitalization, equity market, mutual funds, direct investment, credit rating agencies, firm valuation, financial economics, liquid markets, foreign direct investment, equity capital, moral hazard, bond prices, international bond, international bond issues, stock market turnover, stock ownership, international bonds, financial fragility, stock prices, market bond, financial contagion