TY - UNPB

T1 - Monitoring matters

T2 - debt seniority, market discipline and bank conduct

AU - Danisewicz, Piotr

AU - McGowan, Danny

AU - Onali, Enrico

AU - Schaeck, Klaus

PY - 2014

Y1 - 2014

N2 - We examine if junior debtholders monitor banks and if such monitoring constrains risk-taking. Leveraging an unexplored natural experiment in the U.S. that changes the priority structure of claims on failed banks’ assets, we provide novel insights into the debate on market discipline. We document asymmetric effects for monitoring effort depending on whether a creditor class moves up or down the priority ladder. Conferring priority to all depositors causes declines in deposit interest rates but increases interest rates for non-deposit liabilities, suggesting greater incentives for junior debtholders to exert monitoring effort. Consistent with the idea that senior claims require lower risk premiums, banks increasingly rely on deposit funding following changes in priority structure. More intensive monitoring also influences conduct: subordinating non-depositor claims reduces risk taking. Our results inform the debate about bail-ins and highlight that changes in the priority structure are a complementary tool to regulation which has received little attention in prior work.

AB - We examine if junior debtholders monitor banks and if such monitoring constrains risk-taking. Leveraging an unexplored natural experiment in the U.S. that changes the priority structure of claims on failed banks’ assets, we provide novel insights into the debate on market discipline. We document asymmetric effects for monitoring effort depending on whether a creditor class moves up or down the priority ladder. Conferring priority to all depositors causes declines in deposit interest rates but increases interest rates for non-deposit liabilities, suggesting greater incentives for junior debtholders to exert monitoring effort. Consistent with the idea that senior claims require lower risk premiums, banks increasingly rely on deposit funding following changes in priority structure. More intensive monitoring also influences conduct: subordinating non-depositor claims reduces risk taking. Our results inform the debate about bail-ins and highlight that changes in the priority structure are a complementary tool to regulation which has received little attention in prior work.

M3 - Working paper

BT - Monitoring matters

ER -