Market discipline and subordinated debt: A review of some salient issues
Academics and regulatory economists have long been
concerned that mispriced deposit insurance undermines
monitoring of banks by investors and increases incentives
for bank risk-taking. Government supervision
provides a partial substitute for the private corporate
governance services provided by a firm.s shareholders
and creditors. As financial firms have become more
complex, however, government supervisors have found
it more difficult to monitor them in a timely manner.
This is particularly true of large, complex banking
organizations. Accordingly, many analysts.both
inside and outside the regulatory agencies.have
suggested that supervisors should rely on .market
discipline. to supplement their traditional supervisory
methods (Meyer, 1999). The Basel Committee on
Banking Supervision.s consultative paper on capital
adequacy (Basel Committee, 1999) asserts that
.[m]arket discipline imposes strong incentives on
banks to conduct their business in a safe, sound, and
efficient manner,. and designates market discipline
as one of the three pillars on which future financial
regulation should be based. (The other two pillars are
minimum capital standards and supervisory review
of capital adequacy.)