Forbearance, Subordinated Debt, and the Cost of Capital for Insured Depository Institutions
Among the proposals intended to prevent the commercial banking industry from suffering a fate similar to that of the nation's savings and loans (S&Ls) is the requirement that banks issue subordinated debt. The claims of the holders of such debt are subordinate to the claims of the Federal Deposit Insurance Corporation (FDIC), which reduces the agency's exposure to loss. Furthermore, the rates paid on subordinated debt theoretically reflect a bank's riskiness; thus, a subordinated debt requirement penalizes relatively risky institutions by imposing market discipline. However, as is the case with competing regulatory proposals, the efficacy of a subordinated debt requirement is directly affected by regulators' adherence to stated guidelines.
Suggested citation: Osterberg, William P., and James B. Thomson. “Forbearance, Subordinated Debt, and the Cost of Capital for Insured Depository Institutions,” Federal Reserve Bank of Cleveland, Economic Review, vol. 28, no. 3, pp. 16-26, 09.01.1992.