Subordinated Debt: A Capital Markets Approach to Bank Regulation

Abstract

Banking organizations in the United States are growing larger; more complex and more diversified in their operations. As a result, bank regulators are becoming less able to understand and supervise their regulatory charges. The recently enacted Gramm-Leach-Bliley Act contributed to this trend by expanding the activities in which banks and their affiliates may engage. The authors argue that increasing the amount of market discipline to which banks are subject promises to remedy many of the shortcomings of government supervision and regulation. This Article proposes that large banks should be required to issue a minimum amount of long-term subordinated debt to third-party investors and sets forth a comprehensive subordinated debt program as a complement to government regulation of banks. Actual and prospective holders of bank subordinated debt will constrain bank risk taking roughly in accordance with the interests of the federal government and without the bureaucratic and other inefficiencies entailed in government regulation. Holders of bank subordinated debt, as they buy and sell bank debt securities in the secondary market and negotiate purchases in the primary market, will also signal to federal regulators the private sector's view as to the value of a bank's enterprise.