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Working Paper

The Effect of Subordinated Debt and Surety Bonds on Banks' Cost of Capital and on the Value of Federal Deposit Insurance

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This paper examines two proposals to correct the risk-taking incentives embedded in the current deposit insurance system and to provide protection to the deposit insurance fund. The first would require banks to issue subordinated debt, and the second would require bank stockholders to post surety bonds. We use the cash-flow version of the Capital Asset Pricing Model to show how each proposal would affect the values and rates of return on uninsured deposits and equity. We then indicate the impact that each proposal would have on the values of the Federal Deposit Insurance Corporation claim and on the bank, emphasizing the role of deposit insurance pricing.
10.01.1990ISSN 2573-7953 WP 90-12DOI 10.26509/frbc-wp-199012

Working Papers of the Federal Reserve Bank of Cleveland are preliminary materials circulated to stimulate discussion and critical comment on research in progress. They may not have been subject to the formal editorial review accorded official Federal Reserve Bank of Cleveland publications. The views expressed in this paper are those of the authors and do not represent the views of the Federal Reserve Bank of Cleveland or the Federal Reserve System.

Suggested Citation

Osterberg, William P., and James B. Thomson. 1990. “The Effect of Subordinated Debt and Surety Bonds on Banks' Cost of Capital and on the Value of Federal Deposit Insurance.” Federal Reserve Bank of Cleveland, Working Paper No. 90-12. https://doi.org/10.26509/frbc-wp-199012