Market Discipline and Subordinated Debt of Australian Banks
Michael G Kollo
Ian G. Sharpe
We examine evidence of market discipline in domestic and international subordinated debt of Australian banks. We estimate fixed effects panel error correction models to examine long-run relationships and short-run dynamics between bond risk spreads and accounting measures of bank risk. We find a significant long-run equilibrium relationship between the risk spread and both the impaired loans ratio and risk-adjusted capital ratio of Australian banks, consistent with the presence of market discipline. There is also evidence of significant short-run causality with changes in the one quarter lagged risk spread predicting changes in the current impaired loans ratio and somewhat weaker evidence of reverse causality. The results generally support the Basel Committee?s regulatory approach of seeking a greater role for market discipline in prudential regulation and supervision.
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