Evidence from the Behavior of Subordinated Creditors on the Market Discipline

This paper evaluates the potential role of subordinated creditors in enhancing market discipline. The following conclusions were drawn in the paper: (i) The study demonstrates that subordinated creditors would impose sanctions on banks that exhibit high levels of risk, notably credit risk and market risk; (ii) Our research reveals indications of a deterioration in discipline when banks are subject to regulatory scrutiny, particularly in developing market banks. (iii) The study’s findings highlight the reasons why banks do not report bank risks in accordance with the Basel III framework’s third pillar. For bank managers, politicians, and supervisors, our findings have ramifications. Overall, this study is the first effort to use the LASSO regression model to evaluate the subordinated creditors’ discipline under new capital and liquidity regulations. This study is also the first to look at how four distinct risk categories affect the discipline of subordinated creditors (as needed by the Basel regulatory framework to increase transparency).