Testing for Market Discipline in the European Banking Industry: Evidence from Subordinated Debt Issues

By A. Sironi. 2000

441 citations recorded by the source corpus.

The question of whether private investors can discriminate between the risk taken by banks is empirically investigated by testing the risk sensitivity of European banks' subordinated notes and debentures (SND) spreads. A unique dataset of spreads, ratings, and accounting measures of bank risk is used for a sample of SND issued during the 1991-2000:Q1 period. Moody's Bank Financial Strength (MBFS) and FitchIBCA Individual (FII) ratings, which omit the influence of government and other external support on risk borne by investors, are used as bank risk proxies together with accounting variables to explain the variability of spreads. Empirical results support the hypothesis that SND investors are sensitive to bank risk, with the exception of SND issued by public sector banks, i.e., government owned or guaranteed institutions. Results also show that the sensitivity of SND spreads to measures of stand-alone risk (i.e., measures that do not incorporate external guarantees) has been increasing from the first to the second part of the 1990s, with the perception of too-big-to-fail type guarantees by private investors gradually disappearing. This result can be attributed to the joint effect of the loss of monetary policy by national central banks and the public budget constraints imposed by the European Monetary Union (EMU).

Subfields: Finance

View Paper: https://www.semanticscholar.org/paper/160e58832761431a2b5e9e81ef15b8e96b3d1cc7

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Citations in the corpus

Competition, Risk-Shifting, and Public Bail-Out Policies (2011, positive): “Market discipline: Public guarantees reduce market discipline because creditors anticipate their bank’s bail-out and therefore have lower incentives to monitor the bank’s risk-taking or to demand risk premia for higher observed risk-taking (Flannery, 1998, Sironi, 2003; Gropp et al., 2006).”
Market Discipline in Property/Casualty Insurance: Evidence from Premium Growth Surrounding Changes in Financial Strength Ratings (2006, positive): “Evidence indicates that credit spreads on uninsured deposits and subordinated debt are generally positively related to bank risk (e.g., Flannery and Sorescu, 1996, Sironi, 2003).”
The Bank Lending Channel: Lessons from the Crisis (2011, positive): “In this respect, there is evidence that investors in banks’ debt are quite sensitive to bank risk (Sironi, 2003).”
Testing for Opaqueness in the European Banking Industry: Evidence from Bond Credit Ratings (2006, positive): “aware of three empirical studies based on European banks: Bruni and Paterno (1995), Gropp et al. (2001) and Sironi (2003) .”
The End of Market Discipline? Investor Expectations of Implicit State Guarantees (2013, background): “Sironi (2003) reaches a similar conclusion in his study of European banks during the 1991-2001 period.”
The impact of government ownership on bank risk (2013, positive): “Using a sample of subordinated bonds issued over 1991–2000:Q1, Sironi (2003) finds that spreads at issuance reflect quite accurately banks’ individual ratings.”