Getting the Most Out of a Mandatory Subordinated Debt Requirement

Recent advances in asset pricing—the reduced-form approach to pricing risky debt and derivatives—are used to quantitatively evaluate several proposals for mandatory bank issue of subordinated debt. We find that credit spreads on both fixed and floating rate subordinated debt provide relatively clean signals of bank risk and are not unduly influenced by non-risk factors. Fixed rate debt with a put is unacceptable, but making the putable debt floating resolves most problems. Our approach also helps to clarify several different notions of "bank risk".