Quantity Eﬀects in the Market Discipline Transmission Mechanism

Adrian Pop∗-- Preliminary & incomplete draft --Abstract: A straightforward method to enhance market discipline in banking is the mandatory
Sub-Debt Policy (SDP), i.e. a requirement by which some large banks are forced to regularly issue
a certain minimum amount of subordinated and non-guaranteed debt. If the decision of issuing
sub-debt is endogenous and/or subordinated creditors are really able to influence bank managers’
behavior, we should be able to detect empirically a positive correlation between the amount of
sub-debt held in bank balance sheets and banking performance. By conducting statistical tests ona panel dataset comprising the largest European banks, we find that: (i) the sub-debt issues are
made generally by the most profitable banking organizations; (ii) voluntary sub-debt issues allowbanks to reduce their Tier 1 ratios, while improving their overall capitalization (Tier 1 + Tier 2
ratios); (iii) as far as the risk profile is concerned, the amount of sub-debt held in bank balance
sheet is negatively correlated with the quality of credit portfolio, but positively correlated with theratio of loan loss reserve to total (gross) loans. These results arouse several reflections about thevirtues and limitations of market discipline in banking in the absence of a formal SDP.
JEL classification: G15; G21; G28
Keywords: Banking Regulation; Market Discipline; Mandatory Sub-Debt Policy∗ University of Nantes, Laboratoire d’Economie de Nantes (LEN), Chemin de la Censive du Tertre, BP 52231,

44322 Nantes, Cedex 3, France, Tel.: +33-2-40141654; fax: +33-2-40141650. E-mail: adrian.pop@univ-nantes.fr
Acknowledgements
I should like to express my gratitude to Jean-Paul Pollin for his many suggestions and kind support. Also,
I am indebted to Anne Lavigne, Amine Tarazi, Michel Dietsch, and especially Larry Wall for useful comments
and criticism. Remarks and suggestions from participants at the 54th Annual Meetings of the French Economic
Association, 23 rd Symposium on Banking and Monetary Economics, and 4th INFINITI Conference on International
Finance — “Measuring and Managing Contagion ” are gratefully acknowledged. Responsibility for possible errors
is entirely mine.

"An invasion of armies can be resisted, but not an idea whose time has come."
V. Hugo1.

Introduction

Although the first reform proposals aiming to strengthen the role of market forces inbanking regulation emerged in the early 1980s, the literature on market discipline has beendeveloped very recently. Two main factors contributed to the renewal of interest for market
discipline in the academic research field, as well as in the public policy arena. The firstone is related to the pragmatic debate within the banking industry initiated by the BaselCommittee on its first attempt to reform the Cooke ratio. The 3rd Pillar of the new capital
adequacy accord (Basel II) recognizes the importance of market discipline in promoting
a safe and sound banking environment (BIS, 2004). The second factor is connected with
the US law on financial modernization (the Gramm-Leach-Bliley Act of 1998), which asks
for a study on the feasibility and desirability of a mandatory Subordinated Debt Policy(henceforth SDP) for systemically important banking organizations.1 Such a policy requiresthat certain large banking organizations regularly issue a minimum amount of subordinatedand non-guaranteed debt. The underlying idea in SDP proposals is to improve the corporate
governance of “too big to fail” institutions and hence to protect the financial system anddeposit insurance funds against their potential failure.
The heuristical value of such stimulating interactions between banking industry, regulators, and academics is far from being negligible. From the beginning of 2000s, a vast
research field has been developing around market discipline and subordinated debt in orderto answer this new challenge of economic policy. Despite the impressive number of studies— both theoretical and empirical —, very few research papers attempted to legitimate themandatory attribute of a SDP. Most defenders of market discipline through a mandatory
subordinated debt requirement focus their persuasive essays on arguments that amount tono more than. . . “common sense”: improving the informational content of market signals byboosting liquidity in the secondary sub-debt market; drawing more attention to individualbank issuers; standardizing the characteristics of sub-debt instruments in order to facilitate
the price formation process; highlighting the similar incentives of sub-debt holders and banksupervisor to monitor and limit bank risk-taking etc. To our knowledge, there is no rigorous
1

This study, elaborated following a fruitful collaboration between the Board of Governors of the Federal
Reserve System and the US Treasury, was achieved one year later, in December 2000 (see BGFRS&DT, 2000).
Even though immediate implementation of a SDP is not highly recommended in the conclusion of this study,
the interest for such a policy is plainly acknowledged: “The Board [of Governors of the Federal Reserve
System] and the Secretary [of the Treasury] believe that existing evidence supports eﬀorts to use subordinateddebt as a way to encourage market discipline. [. . . ] A policy of mandatory subordinated debt issuance may
potentially enhance market discipline and safety and soundness. Nonetheless, the Board and the Secretary
believe that additional evidence must be gathered before they can support a request for legislative authority
to impose a requirement that large insured depository institutions or they holding companies maintain some
portion of their capital in the form of subordinated debt.” (BGFRS&DT, 2000, pp. iv, 56-57)

Quantity Effects in the Market Discipline Transmission Mechanism

3

analysis up to date demonstrating the necessity of forcing banks to regularly issue minimum
amounts of subordinate debt. To fill this important gap in the literature, this article brings
into discussion some interesting elements justifying the mandatory character of SDP. In particular, we attempt to prove that forcing large banks to regularly issue sub-debt instruments
represents by itself an essential condition for eﬀective market discipline.
Under certain circumstances, the raison d’être of a mandatory SDP seems to be all themore problematic. First of all, it is worth emphasizing an interesting stylized fact regarding
the existing sub-debt markets. The largest banking organizations headquartered in mostdeveloped countries have already issued significant amounts of subordinated and other nonguaranteed debt securities in the last decade or so (BIS, 2003). Secondly, financial markets
behave according to the principles defended by the proponents of market discipline: (i ) prices
reflect the risk profiles of bank issuers reasonably well; and (ii ) high-risk banks decide topostpone the precise moment of their intervention in the primary market (or alternatively
these banks are simply rationed). Finally, as emphasized by certain authors (see e.g. thecomments of Myron L. Kwast on Calomiris and Litan, 2000), a mandatory SDP could haveat least two major drawbacks. On the one hand, a mandatory SDP is likely to generate
excessive costs for banks subject to such a policy. These costs would depend on the design
features of the adopted SDP, the intrinsic characteristics of each banking organization, thephase of the business cycle and. . . the “animal spirit”2 of financial markets. On the other
hand, the adoption of a formal SDP could limit the capacity of certain banks to manage
their capital structures in an eﬀective way, by introducing additional rigidity into the internal
decision-making process.
If financial markets already exercise a reasonable degree of discipline,3 why should regulators interfere, in a more or less aggressive way, in banks’ financing policies? At firstsight, an ordinary answer consists in underlying the superfluous nature of a mandatory
SDP. However, as we argue in Section 2, this kind of answer is overall simplistic and amandatory SDP may even be justifiable on fairly sound economic grounds. The intuition
behind our approach runs as follows. Within the current regulatory framework – thatis, in the absence of a formal SDP – market discipline can be easily alleviated because,
as banks’ conditions deteriorate, the funding managers shift toward insured deposits as a
primary source of funding and reduce their reliance on market-sensitive debt instruments.
A mandatory SDP eliminates this perverse quid pro quo by forcing banks to regularly tap
the primary market even when their financial conditions are weak. In this way, the market
forces are “active” at the very junctures when bank regulators need them, viz. when therisk profile starts to deteriorate.
Section 3 lends empirical support to that intuition. The dataset on which our empirical2

See also Covitz et al. (2000). This expression, belonging to J.M. Keynes (see notably ch. XII of his
General Theory, “The state of long-term expectation”, §VII, pp.161-162), points to the herding behavior ofinvestors likely to disrupt the market during periods of stress (“a spontaneous urge to action rather thaninaction” or “waves of irrational psychology ”).
3
For comprehensive reviews of the empirical literature on market discipline in banking, the reader canrefer to Flannery (1998), Evanoﬀ and Wall (2000b), and Flannery and Nikolova (2004).

Quantity Effects in the Market Discipline Transmission Mechanism

4

analysis is based includes more than 500 large European banking organizations, for whichannual financial reports from 1996 through 2003 are available in the Fitch-IBCA BankScope
database. Our strategy consists in comparing the characteristics of two distinct sub-samples:(i) banks exhibiting relatively low ratios of subordinated debt to total assets (sample A)and (ii) banks reporting very important amounts of subordinated debt on the right side of
their balance sheets (sample B). The bivariate comparisons are realized along three essential
dimensions of banking activity: profitability, capitalization, and risk profile. If the decisionof issuing sub-debt is endogenous and/or subordinated creditors are really able to influencebank managers’ decisions, we should find, ceteris paribus: (i) a better profitability; (ii)larger capital adequacy ratios; and (iii) a less deteriorated risk profile for the banks included
in sample B.
Our main empirical findings can be summarized as follows. First, the sub-debt issues are
generally made by the most profitable banking organizations. Second, voluntary sub-debt
issues allow banks to reduce their Tier 1 ratios, while improving their overall capitalization(Tier 1 + Tier 2 ratios). Third, as far as the risk profile is concerned, the amount of sub-debt
held in bank balance sheets is negatively correlated with the quality of credit portfolios, but
positively correlated with the ratio of loan loss reserve to total (gross) loans. These results
arouse serious reflections about the virtues and limitations of market discipline in banking
in the absence of a formal mandatory SDP.
Finally, Section 4 concludes.
2.

Why should a SDP be mandatory? A simple model of the banking firm

{Section in progress}
3. The “strong form” of market discipline: a bivariate analysis on European
data
The objective of this section is to provide some empirical support for our theoreticalintuition. The focus on European bank-level data is not fortuitous: the literature on theeﬀectiveness of market discipline in the European banking sector is scarce when comparedwith the empirical research carried out on the US markets for bank securities (see e.g. BIS,
2003).
The empirical strategy adopted in this study finds its roots in three strands of theliterature on market discipline in banking:• studies addressing the question of whether there is any correlation between the abilityof banks to attract non-guaranteed sources of funding and their risk profile (supply-side
quantity eﬀects);• empirical research on the sensitivity of the decision to issue subordinated debt to therisk profile of bank issuers (demand-side quantity eﬀects);

Quantity Effects in the Market Discipline Transmission Mechanism

5• recent contributions on the ability of market forces to influence bank management
behavior.
The question addressed in the analyses on supply-side quantity eﬀects is whether a significant deterioration in the financial condition has any eﬀect on the ability (or willingness)of banks to collect large uninsured deposits or other sensitive sources of market funding.
Berger (1991, p.427) also stressed the importance of this issue by asserting that priceeﬀects could be insignificant in the particular case of the under-capitalized banks. Parkand Peristiani (1998), Jagtiani and Lemieux (2000), Hall et al. (2002) document significant
quantity-eﬀects inherent to the market discipline transmission mechanism:4 (i) the deterioration of the bank risk profile leads to a decline in the proportion of uninsured deposits; (ii)sound banks are able to collect more uninsured deposits relative to their riskier competitors;(iii ) the default probability has a significant negative impact on the amount of uninsured
deposits likely to be raised. Goldberg and Hudgins (2002) and Maechler and McDill (2003)
take into account both type of eﬀects (i.e. price- and quantity-eﬀects) by investigating the
dynamics of depositors and banks’ behavior. While oﬀering more attractive interest rates
is generally a necessary condition to avoid massive withdrawals of uninsured deposits, thenet eﬀect of the simultaneous variation in the supply and demand imply an eﬀective exercise of market discipline: the amount of uninsured deposits decreases despite the higher
remunerations oﬀered by highly risk banks.
Several studies reveal the existence of substitution eﬀects between insured deposits andlarge certificates of deposit (so called Jumbo CDs). Such eﬀects take place either after
a rating downgrade (Billet et al., 1998) or several quarters before the actual bank failure(Marino and Bennett, 1999, Jordan, 2000, Goldberg and Hudgins, 2002). Jagtiani andLemieux (2000) show that far before their failure (8-10 quarters), bank funding managers
avoid market discipline by substantially increasing (by 80%) their use of insured deposits.
The second strand of the literature (see e.g. BGFRS, 1999, Covitz et al., 2000, 2004,
Covitz and Harison, 2004, Evanoﬀ and Jagtiani, 2004) concludes that the decision to issue
new subordinated debt instruments is endogenous, i.e. riskier bank issuers prefer not to tap
the primary market.
Finally, as far as the influencing issue is concerned, the findings of Bliss and Flannery(2002) and more recently Kwan (2004ab) and Krishnan et al. (2005) are not indicative of
the ability of market forces to eﬀectively constrain bank risk-taking. Consequently, theseauthors recommend that the supervisor must retain the entire responsibility to assure thediﬃcult task of influencing the bank management behavior.
4

However, Crabbe and Post (1994) finds that rating downgrades have no significant impact on the amountof CDs issued by large US BHCs. They explain this result by the presence of implicit governmental guarantees
before the adoption of the FDICIA in 1991. Conversely, the decline in the amount of commercial papers
is much more important several weeks after the rating downgrade. Gilbert and Vaughan (2001) also reveal
apathic reactions of the uninsured depositors to changes in the bank risk profile and various US legislativereforms during the last decade.

Quantity Effects in the Market Discipline Transmission Mechanism

6

Our study is similar in spirit to Kwan (2004a).5 His methodology consists in comparing
the performance of two distinct populations of banking organizations: (i) publicly owned
BHCs having issued securities traded on the secondary market, more likely to be constrainedby market discipline; and (ii) privately held BHCs, for which there is no public signal about
their soundness. If market discipline is eﬀective, the presence of a publicly observable
market signal should, ceteris paribus, give incentives to publicly traded banks to adopt
more prudent behavior than their privately held competitors. However, in contrast with
Kwan (2004a), we place more emphasis on the market discipline theory rather than on
agency theory (e.g. the impact of the ownership structure on banking performance). Moreprecisely, we are interested in a particular instrument for promoting market discipline inbanking: subordinated debt. Consequently, our own bivariate comparisons are performed on
two diﬀerent kinds of sub-samples:• sample A, which includes banks having issued insignificant amounts of subordinateddebt;• sample B, which consists of those banks exhibiting relatively high ratios of subordinated debt to total assets.
By definition, the “strong form”6 of market discipline is valid if the banks included insample B exhibit, in a systematic manner, better performance and less deteriorated risk
profiles than those being part of sample A.
3.1.

Data and methodology

3.1.1. Sample selection criteria. The final sample was constructed using a threestep selection procedure. First, from the overall banking organizations headquarteredin Europe, we selected those having available accounting information in the Fitch-IBCABankScope database over the 1996-2003 period. Second, in order to assure a minimum
degree of homogeneity in data, we excluded all the investment banks and bank holding
companies. According to an additional size criterion, we selected only the banks whose
total assets at the end of 2003 exceeded USD 1 billion. For the selected banks, we computed
the performance measures based on the consolidated financial statements. The final sample
consists of 560 banks from 16 countries: Germany (54), Austria (32), Belgium (13), Denmark (16), Spain (67), Finland (7), France (124), Ireland (16), Italy (52), Luxemburg (9),Norway (16), the Netherlands (22), Portugal (14), the United Kingdom (73), Sweden (18)and Switzerland (27). Among these banks, 130 are publicly listed and the rest represents
5

Our choices in terms of empirical strategy were considerably restricted because of the (annual) frequency
of available data, missing data relative to certain bank liabilities (e.g. the amount of total (un)insured
deposits), and the extremely reduced number of bank failures in Europe.
6
We borrowed this term from Kwan (2004b). It is worth noting that the “strong form” of market discipline
is a diametrically opposite concept to our “sine qua non” hypothesis defined in Pop (2004), in the sense thatit addresses the suﬃciency question.

Quantity Effects in the Market Discipline Transmission Mechanism

7

privately held banks (22 banks were delisted between 1996 and 2003). Most of the banks in
our final sample (95%) disclose information to their customers/investors through their own
websites.
As not all banks regularly report the amount of outstanding subordinated debt over the
analyzed period, the total number of observations varies between 505 (at the end of 2003)
and 309 (at the end of 1996). The total assets at the end of 2003 amount on average to
USD 68 billion on average, between a minimum of USD 1 billion and a maximum of USD
11,000 billion.
3.1.2. Empirical design. The assignment of banks to one of the two sub-samples isrealized with respect to the ratio of subordinated debt to total assets (SDT A), computedat the end of each year. All banks for which this ratio is inferior to the lower quartile(Q1 ) are assigned to sample A, while those exhibiting SDT A ratios superior to the upper
quartile (Q3) are included in sample B. As a robustness check, the overall sample was also
partitioned according to the median (Q2 ) of the SDT A ratio, i.e. SDT A < Q2 (A) andSDT A > Q2 (B), respectively. Table 4 reports the various quartiles of the distribution by
year of the SDT A ratio.
{Table 4}
The SDT A ratio is equal to 1.93% on average over the entire period, the standard
deviation being equal to 1.91%. Table 5 presents additional descriptive statistics relative tothe two sub-samples.
{Table 5}
As revealed by the data, in 2003 the amount of subordinated debt was, on average,
significantly lower in sample A than in sample B. Bearing in mind that large banks have in
general larger and more frequent issues of subordinated debt, one could expect the existenceof significant size eﬀects between the two sub-samples. However, these eﬀects are less important than those documented by Kwan (2004a).7 According to the total assets variable,
the two sub-samples are comparable on average, especially when the partition criterion is
the median value of the SDT A ratio (USD 64 billion against USD 71 billion, see Table
5). At the end of 2003, the portion of total assets financed by deposits is equal to 68% on
average (min. 1.8%; max. 97.8%), while market funding amounts to 18.9% of total assets
on average (min. 0%; max. 94.2%).
The three main dimensions of banking performance, namely, profitability, bank capitalization, and risk profile, are measured by using accounting data. The profitability is
proxied either by ROE or the ratio of net interest revenue to total assets (N IRA). Higher
7This fact does not mean that size eﬀects should be completely neglected. The existence of possible
threshold eﬀects can be taken into account correctly only by leading a multivariate econometric analysis of
the relationship between banking performance and the quantity of subordinated debt outstanding.

Quantity Effects in the Market Discipline Transmission Mechanism

8

N IRA generally indicates the existence of significant interest margins and thus, reasonable financing costs. Conventional wisdom strongly implies that investors prefer banks withhigh returns/enough margins provided that the asset quality and the franchise value arepreserved.
The bank capitalization is expressed by the equity/total liabilities ratio (EL) and theratio of capital funds (equity + hybrid capital instruments + subordinated debt) to total
assets (CF T A). Generally, the European banks issue subordinated debt, which is included
in Tier 2 regulatory capital defined under Basel standards, in order to improve their capital
adequacy ratios. Certain banks assert that they issue subordinated debt only if such a
decision positively aﬀects their Cooke ratios.8 Our choice for two distinct capital ratios
stems from the fact that it is possible that banks having issued important amounts ofsubordinated debt exhibit low Tier 1 ratios even if their overall capitalization is in fact
important.9
As in the previous cases, the bank risk profile is assessed based on two variables: theratio of non performing loans to total (gross) loans (N P LGL) and the ratio of loan loss
reserve to total (gross) loans (LLRGL). The first variable is a proxy for the quality of bankassets, while the second one can be considered as a measure of the financial cushion aiming
to absorb losses on the bank credit portfolio.
If market discipline is eﬀective in the European banking sector (either through supply- or
demand-side quantity eﬀects), the amount of subordinated debt should vary over time andacross banks. The testable hypothesis of the “strong form” eﬃciency of market discipline
can be expressed as follows:
H1 : (the “strong form” of market discipline) "If the issuing decision is endogenous and market
discipline is eﬀective, the amount of subordinated debt held on the right-side of the balance sheet
is positively correlated with various ex-post measures of bank performance (profitability, capital
adequacy, and sound risk management)."

Based on Kwan (2004a), we test this hypothesis by comparing the distribution of eachbank performance variable in the two sub-samples. In order to check the robustness of ourresults, we perform non parametric Wilcoxon rank sum tests separately for each year of theentire analyzed period (1996-2002), as well as for two separate sub-periods (1996-1998 and1999-2003, i.e. before and after the euro adoption).10
8

See BIS (2003, p.5 et passim) for an excellent discussion of how bank capital regulation aﬀects thedecision to issue subordinated debt.
9
Initially, we included in the analysis of bank capitalization the two most frequently used risk based capitalratios (Tier 1 and Total or Cooke ratios). It is worth noting that these capital adequacy ratios cannot becalculated simply by looking at the balance sheet data, because of the weights that are assigned internally byeach bank. Despite the fact that they are not obliged to do so, some banks voluntarily publish these ratios
in their annual report. However, more than 50% of the European banks included in our sample decided not
to publicly disclose this kind of information to investors.
10
From an oﬃcial point of view, 1998 represented a “turning point” in the euro adoption process: themember countries were identified by the European council, the governor of the ECB was appointed, andoﬃcial exchange rates between the European currencies were fixed. See Sironi (2003).

Quantity Effects in the Market Discipline Transmission Mechanism

3.2.

9

Results

Table 5 reports descriptive statistics on the main variables measuring the three dimensions of the banking performance, as well as the total number of observations (banks —years) in various samples. Our bivariate analyses presented in the next three sections are
performed with respect to each of these variables.
3.2.1. The first dimension of bank performance: profitability. The first measure of profitability, ROE, calculated separately for the two samples (mean and medianvalues), is presented in Table 6. Wilcoxon z statistics are highly significant for all periods(except year-end 2003). Banks included in sample B (SDT A > Q3 ) are more profitable on
average than their competitors holding largely insignificant amounts of subordinated debt
on the right-side of their balance sheets. The diﬀerence in profitability between the two
populations of banks is also significant from an economic point of view (4-5% at the beginning and 2-3% towards the end of the considered period). Moreover, this result is robust to
the criteria used to define the distribution of banks in the two sub-samples, i.e. according
to the median or upper/lower quartiles of the SDT A ratio.
{Table 6}
Under certain conditions, using ROE to compare bank profitability has an obvious downside. More exactly, this profitability measure is directly influenced by significant diﬀerencesin terms of financial leverage (that seems to be the case in our sample, vide infra). For
example, all else being equal, an under-capitalized bank might announce a high ROE even
if its income inflows are not satisfactory. To avoid this shortcoming, we used an alternative
measure of bank profitability, which is less sensitive to this interpretation problem and more
specific to banks: the ratio of net interest revenue to total assets (N IRA).11
Table 7 summarizes mean (median) values of this alternative measure of banking performance for the various sub-samples.
{Table 7}
The results are somewhat less convincing than those reported above. However, there
is a significant diﬀerence in the profitability of the two samples of banks, especially at theend of the analyzed period. This diﬀerence amounts to 20-30 bps on average between 1999
11

However, it is worth emphasizing that NIRA also has its own problems. First, to the extent that banking
markets are eﬃcient, a bank can obtain a higher expected margin only by taking more risk. Second, evenif banks’ ability to collect and process private information allows them to earn economic rents (as is usualy
the case), returns are still likely to be correlated with risk. Third, NIRA does not capture the eﬃciency
with which a bank produces its output. To be more precise, a bank could have a high NIRA but low
earnings because it is simply. . . ineﬃcient. In alternative specifications, we also used other measures of bankprofitability (return on average assets, ROA, and especially the cost to income ratio, CIR). Unfortunately,
the interpretation of the results obtained by using these alternative proxies for bank performance is lessclear-cut.

Quantity Effects in the Market Discipline Transmission Mechanism

10

and 2003 and 40-70 bps at the end of 2002 and 2003, respectively. As the higher numberof observations improves the power of the Wilcoxon test and the quality of the Gaussian
approximation of z statistics, we are able to reject the hypothesis of equality of the two
distributions between 1996 and 1998, even though the diﬀerences were not significant at theend of each of these years.
3.2.2. The second dimension of performance: bank capitalization. The implications of capital adequacy, another fundamental dimension of bank performance, forpromoting sound banking practices are well documented in the literature (see e.g. Santos,
2001). Bivariate comparisons of our first bank capitalization measure, the ratio of equity tototal liabilities (EL), are presented in Table 8.
{Table 8}
The results reveal the existence of a significant diﬀerence (at the 1% level) in the capitalization (stricto sensu) between the two sets of banks. This diﬀerence (2.5% on average
between 1996 and 2003) is a little bit lower towards the end of the period (1% in 2002
and 2003). Banks included in sample B (SDT A > Q3 ) report relatively lower EL ratios
as compared with their sample A (SDT A < Q1 ) competitors. Nevertheless, as we have already noted, this result is not surprising. Under current regulations, issuing large amountsof subordinated debt (i.e. Tier 2 capital) allows banks to lower their equity (Tier 1) ratios,
while still satisfying minimum capital requirements.
To test for this behavioral hypothesis, we also studied another capital adequacy measuredefined in a broader sense: CF T A. This new proxy for bank capitalization is computed asa ratio of capital funds (shareholders equity + hybrid capital instruments + subordinateddebt) to total assets. The results are presented in Table 9.
{Table 9}
The Wilcoxon z statistics are not statistically diﬀerent from 0 at the end of each year
from 1996 through 1998. However, the diﬀerences in capitalization become significant (atthe 1% level) over the 1999-2003 period, in particular 2.4% in 2001, 1.3% in 2002, and 1.4%
in 2003. This diﬀerence is in fact significant even between 1996 and 2003 thanks to thehigher number of observations obtained by pooling data over the entire analyzed period.
Consequently, our intuition is valid: banks having issued significant amounts of subordinateddebt report relatively higher Tier 1 + Tier 2 capital ratios, especially after euro adoption.
These results illustrate, to a certain extent, the idea of direct market discipline formalized in the continuous-time model proposed by Rochet (2004, Proposition 3 ). Under certain
restrictive conditions,12 a mandatory SDP allows the regulator to lower Tier 1 capital adequacy requirements. In other words, market discipline leads to a lower optimal closure
12E.g. long maturity, liquid secondary market, the absence of asset substitution strategies by bank managers.

Quantity Effects in the Market Discipline Transmission Mechanism

11threshold (defined with respect to the capital ratio) which approaches the first best. However, the SDP always leads to an increase in bank capital ratios defined in a broad sense(Tier 1 + Tier 2).
3.2.3. The third dimension of bank performance: credit quality. Finally, thelast dimension of the banking performance considered in our study is the quality of thecredit portfolio. One of the most frequently used measures is the ratio of non performing
loans to total (gross) loans (N P LGL). A higher value of this ratio indicates a deteriorated
credit risk profile. Table 10 summarizes the main findings of the bivariate comparisons.
{Table 10}
The two categories of banks present similar risk profiles: diﬀerences in credit quality
at the end of each year of the analyzed period are not significant at conventional levels.
Nevertheless, when the observations are pooled over the sub-period 1996-1998, the qualityof sample B banks is relatively higher (p = 0.01). This result is reversed after 1999 (p =0.05), so that, over the entire period, the sample B banks tend to hold relatively larger
amounts of bad loans in their credit portfolios. This finding should however be interpretedwith a lot of caution. Firstly, the total number of observations is relatively less important(about 1,600 against the potential maximum of 3,400), aﬀecting the quality of the Gaussian
approximations and the power of the Wilcoxon test. Secondly, sample A banks tend to besystematically more reticent to disclose this kind of sensitive information. Indeed, missing
data are relatively more frequent for banks included in sample A: the total number ofobservations is 648 (sample A) against 964 (sample B). As high-risk banks generally choose
not to disclose the bad quality of their credit portfolios, the tests are biased towards rejecting
the “strong form” of market discipline hypothesis, H1 .
An alternative proxy for this third dimension of the banking performance is the amountof reserves that banks constitute to protect themselves against future losses on their credit
portfolios. A satisfactory level of loan loss reserves increases the financial cushion to absorb
future declines in the value of assets and protects the bank against negative shocks. Bivariatecomparisons of this alternative measure of the risk profile (LLRGL) are presented in Table
11.
{Table 11}
Once again, if one considers the variable of interest at the end of each year between
1996 and 2003, the characteristics of the two sets of banks are not significantly diﬀerent
from a strict statistical point of view. However, over the entire period, as well as over thetwo considered sub-periods, the LLRGL ratio is relatively higher (50 bps, p = 0.01) for thebanks included in sample B. This result is more straightforward if the two sub-samples aredefined with respect to the median SDT A ratio.
All in all, even though sample B banks tend to hold higher amounts of bad loans in their
credit portfolios, they are better protected against the risk of future losses. Indeed, their

Quantity Effects in the Market Discipline Transmission Mechanism

12

capitalization (defined in a broad sense, Tier 1 + Tier 2), as well as their loan loss reserves,
are significantly higher as compared with those of their competitors.
4.

Concluding remarks and some interesting avenues for further research. . .

The market reality provides a puzzling paradox that could to some extent justify the
reluctance toward a mandatory SDP. On the one hand, the voluntary issues of subordinate
debt realized by large banks located in most developed countries are slightly superior to theminimum amounts proposed by the various proponents of SDP. On the other hand, primaryand secondary sub-debt markets seem to behave according to the fundamental principles
behind the market discipline theory. Under these circumstances, one could infer that the net
benefits of mandatory, regular, issues of subordinated debt would not necessary outweighthose currently involved under the voluntary issuance regime.
However, our approach provides a more convincing argument in favor of a mandatory
SDP by tracking down the basic flaws in the market discipline mechanism in the absence ofsuch a policy. If unconstrained by a SDP, banks are free to time their issuing decisions andpossess enough flexible instruments to substitute insured deposits for subordinate debt andso to avoid the burden of market discipline. A mandatory SDP eliminates these arbitrage
opportunities, by forcing banks to expose themselves to the investors’ judgment. In thismanner, market discipline is activated at the very junctures when bank regulators need it,that is, when the bank risk profile starts to deteriorate. This basic intuition is illustrated
by a simple two-period model of financing policy and risk-taking by banks in the presenceof a credible deposit insurance scheme.
In order to put our theoretical intuition into perspective, we performed several non parametric tests for detecting significant diﬀerences between the ex-post performance measuresof two distinct samples of large European banks. The first sample includes the banks exhibiting very low sub-debt/total assets ratios, whereas the second sample contains banks
having issued significant amounts of subordinated debt. Three essential dimensions of thebanking performance were explicitly considered: the profitability, capitalization, and risk
profile. All the variables of interest were expressed as ratios, computed by using balance
sheet data provided by Fitch-IBCA BankScope. We reveal that under current banking regulations the sub-debt issues are generally made by the most profitable European banks. As
far as bank capitalization is concerned, it is worth noting that voluntary sub-debt issues
allow banks to reduce their Tier 1 ratios, while improving their overall capitalization (Tier
1 + Tier 2 ratios). Finally, the amount of sub-debt reported on the right side of the bankbalance sheets is negatively correlated with the quality of credit portfolio, but positively
correlated with the ratio of loan loss reserve to total (gross) loans.
Our results can be partially interpreted as tentative evidence of the existence of a “strongform” of market discipline in the European banking sector. Indeed, if the issuing decision
is endogenous and investors are really able to influence the current behavior of bank managers, the quantity of subordinated debt held in the bank balance sheet should be positively

Quantity Effects in the Market Discipline Transmission Mechanism

13

correlated with the ex-post banking performance.
By way of conclusion, we propose some interesting directions for further research, likely
to strengthen the preliminary results reported in the paper and expand our understandingof the functioning of market discipline in banking.
1◦ The passage from a bivariate framework to a multivariate analysis, which takes into
account a large set of control variables (e.g. size, composition of bank assets and liabilities,
diﬀerences in bank regulation and supervision policies across countries, eﬃciency of nationalbond and equity markets), represents a natural further step to validate the relevance of ourfindings. In contrast to the US banking sector, where the largest banking organizations
are all private stock corporations, the European one is characterized by the presence ofa significant number of state owned banks and cooperative banks. This peculiarity of theEuropean banking sector may be relevant for the issues explored in the current study because
the owners of this kind of banks have diﬀerent goals than the owners of privately ownedbanks. Depending upon the country, state owned and cooperative banks may also face limits
on the types of customers they serve, on their access to the equity markets, and/or on thegeographic markets they serve. These institutional constraints could cause both diﬀerencesin their reliance on subordinated debt and diﬀerences in the variables of interest to thisstudy (i.e. profitability, capitalization, and credit quality). Moreover, the reliance of banks’funding managers on subordinated debt may also reflect diﬀerences in supervisory policy inthe various countries and/or the eﬃciency of national debt markets.
2◦ An empirical strategy able to distinguish between the two types of quantity eﬀects(i.e. demand - vs. supply-side eﬀects) in the mechanics of market discipline would also bevery useful. In the absence of such a strategy, our preliminary findings could be attributed
either to (i) the endogenous character of the issuing decision, (ii) the ability of investors to
influence banking performance, or (most likely!) (iii) various combinations of (i) and (ii).
In this last case (iii), simple OLS regressions of the banking performance variables on theamount of subordinated debt outstanding (and vice versa) generate biased and incoherent
estimates for the parameters of interest. A well suited solution to overcome this problem
consists in conducting a Hausman (1978) endogeneity test in order to identify the directionof causality and then to use the instrumental variable, 2SLS or GMM estimation procedure.
3◦ The contradictory impact of market discipline on the amount of impaired loans inbank credit portfolios deserves further investigation. Is this eﬀect attributable to the asymmetries characterizing the distribution of missing data in our sub-samples, i.e. to the reticence of certain high-risk banks to reveal this kind of sensitive information? Or, is it simply
due to the ineﬀectiveness of market discipline in the European banking sector?
4◦ An alternative measure of the bank risk profile, which would be interesting to study,
is the traditional and especially the financial strength ratings assigned by the specialized
agencies like Fitch-IBCA, S&P or Moody’s. Are banks issuing relatively large amounts of
sub-debt better rated than their competitors?
5◦ Another interesting avenue for future research is to analyze whether the distinction
between publicly oﬀered and privately placed subordinated debt have any particular rel-Quantity Effects in the Market Discipline Transmission Mechanism

14

evance for the market discipline transmission mechanism. At first sight, debt securities
exchanged in the secondary market constitute a better disciplinary tool because both channels of market discipline (direct and indirect) are likely to be eﬀective. Conversely, in thecase of private placements, the indirect channel is substantially ineﬀective because a continuous real time public market signal is not available on the secondary market. However, thedirect channel turns out to be more eﬀective in the case of private debt due to the relative
ease of future renegotiation of initial contracts and the absence of free riding in the direct
monitoring of bank issuers.13
6◦ Finally, this study could be broadened by including large bank holding companies,
which were voluntarily neglected in our empirical analysis. The topic is all the more insightful as these large multinational banking organizations are engaged in a wide range ofactivities (banking, underwriting, insurance etc.) and their supervision turns out to be avery complex and expensive task.

***

13

By studying a comprehensive sample of US industrial firms issuing both types of debt contracts, Kwan
and Carleton (2004) provide strong empirical evidence supporting this assertion. According to a study
conducted by the Basel Committee on Banking Supervision, the amount of bank subordinated debt issued
through public oﬀers in Europe represented 70% of total subordinated debt outstanding at the end of 2001
(see BIS, 2003).

Quantity Effects in the Market Discipline Transmission Mechanism

15

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19

QUANTITY EFFECTS IN THE MARKET DISCIPLINE TRANSMISSION MECHANISM

Table 1. Subordinated debt outstanding (large banking organizations,* average ratios SD/TA)Country

1996

1997

1998

1999

2000

2001

2002

2003

Germany

0.81%

1.00%

0.94%

1.13%

1.17%

1.22%

1.26%

1.24%

Austria

1.61%

2.11%

2.38%

2.27%

2.48%

2.64%

2.49%

2.10%

Belgium

1.85%

1.98%

2.05%

2.04%

2.16%

2.35%

2.30%

2.12%

Denmark

0.49%

1.39%

1.61%

1.98%

1.64%

1.77%

1.62%

1.53%

Spain

1.33%

1.32%

1.51%

1.90%

2.08%

2.99%

2.98%

2.81%

France

1.07%

1.06%

1.23%

1.14%

1.16%

1.24%

1.31%

1.30%

Ireland

1.90%

1.96%

1.73%

2.39%

2.23%

2.14%

1.89%

2.42%

Italy

1.01%

0.99%

1.23%

1.69%

2.36%

2.82%

2.93%

2.75%

Netherlands

1.43%

1.37%

1.30%

1.34%

1.32%

1.40%

1.57%

0.85%

UK

1.52%

1.43%

1.43%

1.98%

2.17%

2.21%

2.05%

2.15%

Sweden

1.87%

1.75%

1.69%

1.69%

1.63%

1.72%

1.72%

1.74%

Total U.E.

1.26%

1.33%

1.37%

1.78%

1.85%

2.05%

2.01%

1.91%

Suisse

1.45%

1.56%

1.98%

2.18%

1.78%

1.57%

1.46%

1.20%

United States

2.54%

2.36%

2.47%

2.45%

2.59%

2.78%

2.84%

2.73%

Japan

2.12%

2.48%

2.95%

3.17%

1.96%

1.77%

1.69%

1.75%

* total assets higher than USD 50 bn. at the end of 1999; SD = subordinated debt; TA = total assets; similar ratios relative
to the 1996–1999 period are also provided by Sironi (2001, p.240). Source : Fitch-IBCA BankScope

Table 2. Minimum amounts of subordinated debt recommended by various proponents of SDP
References

Minimum percentage

1. FDIC (1983)

5% of deposits

2. Eisenbeis and Horvitz (1986)

3-5% of deposits

3. Horvitz (1986)

4% of deposits

4. Cooper and Fraser (1988)

3% of deposits

5. Keehn (1988)

4% of risky assets

6. Wall (1989)

4-5% of RWA*

7. Field (1991)

5% of total assets

8. Evanoff (1992ab)

4% of RWA*

9. Randall (1994)
10. Calomiris (1997)4% of total assets
2% of total non-reserve assets
and off-balance sheet commitments

11. Litan and Rauch (1997)
12. Calomiris (1998)
13. The Bankers Roundtable (1998)

1-2% of RWA*
2% of RWA*
2% of total liabilities

14. BGFRS (1999)

2-3% of RWA*

15. Calomiris (1999)2% of risky assets (i.e. excluding T-bills)

16. BGFRS&DT (2000)

2% of RWA*

17. Calomiris and Litan (2000)
18. Evanoff and Wall (2000)

2% of RWA*
2% of RWA* in the second stage
3% of RWA* in the third stage

19. SFRC (2000)
20. Sironi (2001)
21. Lang and Robertson (2002)
22. Hamalainen et al. (2003)**2% of total assets and off-balance sheet commitments
4% of RWA*
2% of total assets
2.5% of RWA* at the beginning;

3.5% of RWA* afterward
23. White (2003)
2% of total assets* RWA is the acronym for Risk Weighted Assets (see BIS, 1988, for further details)** The recommended ratios concern exclusively the six largest banking organizations in the UK.

20

QUANTITY EFFECTS IN THE MARKET DISCIPLINE TRANSMISSION MECHANISM

Table 3. Distribution of bank sub-debt issues by rating class (Europe, 1991--2000:Q1)
Moody’s/S&P issue ratings,
at lunchRating class

Moody’s Bank Financial Strength/
FitchIBCA Individual ratings,
at lunch

Moody’s/S&P issuer ratings,
at lunch

Number of issues

Rating class

Number of issues

Rating class

Number of issues

AAA/Aaa17

AAA/Aaa36

A

27

AA+/Aa1

40

AA+/Aa1

68

B+, A/B

83

AA/Aa245

AA/Aa2

69

B

85

AA–/Aa3

73

AA-/Aa362

C+, B/C

47

A+/A1

43

A+/A1

16

C

41

A/A2

34

A/A2

38

D+, C/D

7

A–/A3

34

A–/A3

1

BBB+/Baa1
4
Total
290
Total
290
Total
NOTE: our representation based on the descriptive statistics reported by Sironi (2003)

290

Table 4. Distribution of the SDTA ratio (%) by year (1996--2003)
Year

N

Q1

Q2

Q3

1996

309

0.000

1.096

2.010

1997

366

0.000

1.060

1.880

1998

388

0.002

1.080

1.920

1999

430

0.206

1.146

1.991

2000

464

0.200

1.200

1.947

2001

480

0.380

1.290

2.160

2002

496

0.510

1.354

2.230

2003

505

0.480

1.470

2.260

Table 5. Descriptive statistics
Various sub-samples
Global sample
ROE
NIRA
EL
CFTA
NPLGL
LLRGL

A

B

A

B

SDTA<Q1

SDTA>Q3

SDTA<Q2

SDTA>Q2

10.62%

8.84%

12.08%

9.26%

11.98%(10.13%)(8.67%)(11.49%)(9.09%)(11.36%)

2.16%

2.17%

2.45%

2.07%

2.24%

(2.03%)(1.88%)(2.24%)(1.88%)(2.13%)

7.59%

9.95%

7.40%

8.42%

6.76%

(6.45%)(8.14%)(6.75%)(6.90%)(6.08%)

8.26%

9.09%

9.78%

7.99%

8.53%

(7.45%)(7.78%)(9.12%)(6.93%)(7.93%)

4.00%

3.43%

4.43%

3.68%

4.21%

(2.59%)(1.96%)(2.87%)(2.21%)(2.85%)

2.93%

2.72%

3.15%

2.75%

3.10%

(2.25%)(1.97%)(2.33%)(2.01%)(2.46%)

N

3.438

862

862

1719

1.719

Subordinated debt

1.149.9

19.4

2.062.1

617.3

1.680.6(2003, USD bn.)

(126.3)(0.0)(326.9)(31.6)(293.6)

Total deposits

39.155.4

12.875.2

34.128.1

37.511.2

40.799.8(2003, USD bn.)

(6.841.5)(4.090.0)(5.783.3)(6.153.4)(7.744.5)

Market funding

14.969.3

4.762.0

11.360.8

15.103.6

14.834.3(2003, USD bn.)

(1.408.7)(133.4)(1.915.4)(720.9)(1.962.5)

Total assets

68.000.0

19.000.0

69.000.0

64.000.0

71.000.0(2003, USD bn.)

(10.000.0)(6.411.9)(10.000.0)(8.741.0)(13.000.0)

NOTES: The reported numbers are mean (median) values. SDTA – the ratio of subordinateddebt to total assets; Q1, Q2, Q3 – the quartiles of the SDTA distribution; ROE – the return on
equity; NIRA – the ratio of net interest revenue to total assets; EL – the ratio of equity to total
liabilities; CFTA – the ratio of capital funds (equity + hybrid capital instruments + subordinateddebt) to total assets; NPLGL – the ratio of non performing loans to total (gross) loans; LLRGL –the ratio of loan loss reserve to total (gross) loans; N – number of total observations

21

QUANTITY EFFECTS IN THE MARKET DISCIPLINE TRANSMISSION MECHANISM

Table 6. Bivariate comparison of ROE
Year/
SampleperiodSDTA<Q1
Mean ROE(Median ROE)

SDTA>Q3
Mean ROE(Median ROE)

Wilcoxon z(p value)

SDTA<Q2
Mean ROE(Median ROE)

SDTA>Q2
Mean ROE(Median ROE)

Wilcoxon z(p value)

1996

7.588
12.922–3.1607***7.958
12.312–3.7186***(7.314)(10.264)(0.0016)(8.460)(10.339)(0.0002)
1997
8.612
13.907–3.1861***9.593
13.072–3.4101***(9.127)(12.832)(0.0014)(9.315)(11.694)(0.0006)
1998
9.871
12.148–2.7760***
10.09512.524–2.9832***(9.067)(11.605)(0.0055)(10.119)(11.896)(0.0029)1999
8.980
13.859–3.5128***9.781
13.745–4.8805***(9.858)(14.262)(0.0004)(9.709)(13.095)(0.0000)
2000
11.37513.559–2.6763***
11.58414.351–3.3918***(10.798)(14.109)(0.0074)(10.412)(12.928)(0.0007)2001
8.627
12.088–2.5308**
9.524
11.408–2.3288**(8.817)(11.311)(0.0114)(9.867)(11.257)(0.0199)
2002
6.148
9.757
–1.7555*
7.104
9.006
–2.3908**(7.395)(10.096)(0.0792)(7.822)(9.384)(0.0168)
2003
9.371
9.560
–1.4057
8.474
10.335–3.3125***(8.009)(10.321)(0.1598)(7.991)(10.680)(0.0009)
1996--1998
8.775
12.981–5.3486***
9.302
12.651–6.0767***(8.538)(11.570)(0.0000)(9.180)(11.465)(0.0000)
1999--2003
8.873
11.664–5.2804***
9.243
11.680–7.2713***(8.705)(11.394)(0.0000)(9.036)(11.325)(0.0000)
1996--2003
8.843
12.077–7.9110***9.261
11.981–8.8175***(8.671)(11.487)(0.0000)(9.091)(11.359)(0.0000)
NOTES: The results are based on a total number of about 3,400 observations between 1996 and 2003. If the sample size
is not the same, the Wilcoxon z statistics are calculated with respect to the smaller sub-sample.
***, **, and * indicate statistical significance at the 1%, 5%, and 10% level, respectively

Table 7. Bivariate analysis of an alternative measure of bank profitability (NIRA)
Year/
Sampleperiod1996

SDTA<Q1
Mean NIRA(Median NIRA)

SDTA>Q3
Mean NIRA(Median NIRA)

Wilcoxon z(p value)

SDTA<Q2
Mean NIRA(Median NIRA)

SDTA>Q2
Mean NIRA(Median NIRA)

Wilcoxon z(p value)

2.396
2.901
–1.59692.443
2.605–0.9845(2.204)(2.457)(0.1103)(2.112)(2.259)(0.3249)
1997
2.449
2.527
–1.0804
2.439
2.378–0.4241(2.157)(2.363)(0.2800)(2.203)(2.163)(0.6715)
1998
2.526
2.363
–0.6580
2.241
2.314–0.0902(2.191)(2.195)(0.5105)(2.079)(2.131)(0.9281)
1999
2.203
2.552
–1.7487*
2.078
2.257
–0.9606(1.903)(2.213)(0.0803)(1.941)(2.066)(0.3367)
2000
2.292
2.285
–0.5730
2.061
2.132–0.9187(1.914)(2.127)(0.5667)(1.790)(2.118)(0.3583)
2001
2.127
2.276
–1.4824
2.075
2.024–0.3284(1.750)(2.200)(0.1382)(1.889)(2.014)(0.7426)
2002
1.818
2.520
–4.0586***
1.781
2.228
–3.6931***(1.631)(2.322)(0.0000)(1.659)(2.210)(0.0002)
2003
1.799
2.376
–3.6899***
1.752
2.141
–3.5318***(1.638)(2.281)(0.0002)(1.573)(2.126)(0.0004)
1996--1998
2.462
2.577
–1.7686*
2.367
2.421
–0.2175(2.188)(2.323)(0.0770)(2.115)(2.178)(0.8279)
1999--2003
2.038
2.400
–5.2944***
1.943
2.155
–4.1277***(1.748)(2.230)(0.0000)(1.771)(2.099)(0.0000)
1996--2003
2.168
2.455
–5.4109***
2.073
2.237
–3.4963***(1.877)(2.245)(0.0000)(1.875)(2.126)(0.0005)
NOTES: NIRA is the ratio of net interest revenue to total assets. The results are based on a total number of about 3,400
observations between 1996 and 2003. If the sample size is not the same, the Wilcoxon z statistics are calculated withrespect to the smaller sub-sample.
***, **, and * indicate statistical significance at the 1%, 5%, and 10% level, respectively

22

QUANTITY EFFECTS IN THE MARKET DISCIPLINE TRANSMISSION MECHANISM

Table 8. Bivariate comparison of bank capitalization (stricto sensu, EL)
Year/
SampleperiodSDTA<Q1
Mean EL(Median EL)

SDTA>Q3
Mean EL(Median EL)

Wilcoxon z(p value)

SDTA<Q2
Mean EL(Median EL)

SDTA>Q2
Mean EL(Median EL)

Wilcoxon z(p value)

1996

10.211
7.202
4.6535***
8.581
6.723
3.0884***(8.514)(6.414)(0.0000)(6.783)(5.860)(0.0020)
1997
9.679
6.742
5.3550***
8.527
6.196
4.4683***(8.328)(6.128)(0.0000)(6.990)(5.704)(0.0000)
1998
10.4847.006
5.3974***
8.629
6.353
5.0131***(8.786)(6.255)(0.0000)(7.038)(5.520)(0.0000)
1999
9.840
7.444
4.1022***
8.470
6.514
4.1852***(7.903)(6.664)(0.0000)(7.310)(5.692)(0.0000)
2000
10.9557.034
5.1875***
8.690
6.379
4.5535***(8.174)(6.711)(0.0000)(7.132)(6.068)(0.0000)
2001
9.547
7.311
3.7152***
8.229
6.766
3.0900***(7.775)(6.772)(0.0002)(6.900)(5.994)(0.0020)
2002
9.589
7.789
2.3360**
8.122
7.057
1.6277(8.103)(7.093)(0.0195)(6.604)(6.303)(0.1036)
2003
9.499
8.314
2.1426**
8.248
7.813
1.4268(7.927)(7.215)(0.0321)(6.814)(6.770)(0.1536)
1996--1998
10.1276.883
8.9597***
8.580
6.407
7.2653***(8.466)(6.269)(0.0000)(6.988)(5.679)(0.0000)
1999--2003
9.875
7.596
7.4087***
8.344
6.927
6.5867***(8.036)(6.985)(0.0000)(6.869)(6.233)(0.0000)
1996--2003
9.953
7.402
11.0192***
8.417
6.765
9.5873***(8.142)(6.750)(0.0000)(6.901)(6.080)(0.0000)
NOTES: EL is the ratio of equity to total liabilities. The results are based on a total number of about 3,400 observations
between 1996 and 2003. If the sample size is not the same, the Wilcoxon z statistics are calculated with respect to thesmaller sub-sample.
***, **, and * indicate statistical significance at the 1%, 5%, and 10% level, respectively

Table 9. Bivariate analysis of bank capitalization (lato sensu, CFTA)
Year/
Sampleperiod1996

SDTA<Q1
Mean CFTA(Median CFTA)

SDTA>Q3
Mean CFTA(Median CFTA)

Wilcoxon z(p value)

SDTA<Q2
Mean CFTA(Median CFTA)

SDTA>Q2
Mean CFTA(Median CFTA)

Wilcoxon z(p value)

9.941
9.563
0.45668.213
8.483–1.1501(8.282)(8.997)(0.6479)(6.964)(7.758)(0.2501)
1997
9.335
9.203
–0.6577
8.208
8.047–0.4216(7.936)(8.498)(0.5107)(6.973)(7.766)(0.6733)
1998
9.642
9.416
0.68478.340
8.231
0.6445(8.444)(8.764)(0.4935)(7.161)(7.579)(0.5193)
1999
9.023
9.535
0.43218.085
8.257–0.8661(7.968)(8.899)(0.6657)(7.190)(7.401)(0.3865)
2000
9.237
9.446
–0.0489
8.200
8.184–0.6328(7.754)(8.948)(0.9610)(6.945)(7.540)(0.5268)2001
8.337
10.753–2.3672**
7.555
8.956
–3.0226***(7.327)(9.138)(0.0179)(6.827)(7.977)(0.0025)2002
8.754
10.003–2.7778***
7.737
8.759
–3.6987***(7.322)(9.283)(0.0055)(6.513)(8.235)(0.0002)
2003
8.763
10.097–1.8603*
7.785
9.175
–3.0660***(7.480)(9.737)(0.0628)(6.682)(8.604)(0.0022)
1996--1998
9.622
9.383
0.85278.258
8.239–0.5185(8.180)(8.767)(0.3938)(6.993)(7.691)(0.6041)
1999--2003
8.824
9.974
–3.0376***
7.867
8.674
–5.7160***(7.546)(9.214)(0.0024)(6.879)(8.082)(0.0000)
1996--2003
9.087
9.784
–1.6500*
7.995
8.534
–4.6057***(7.777)(9.118)(0.0989)(6.935)(7.935)(0.0000)
NOTES: CFTA is the ratio of capital funds (equity + hybrid capital instruments + subordinated debt) to total assets. The
results are based on a total number of about 2,700 observations between 1996 and 2003. If the sample size is not the same,
the Wilcoxon z statistics are calculated with respect to the smaller sub-sample.
***, **, and * indicate statistical significance at the 1%, 5%, and 10% level, respectively

23

QUANTITY EFFECTS IN THE MARKET DISCIPLINE TRANSMISSION MECHANISM

Table 10. Bivariate comparison of credit portfolio quality (NPLGL)
Year/
SampleperiodSDTA<Q1
Mean NPLGL(Median NPLGL)

SDTA>Q3
Mean NPLGL(Median NPLGL)

Wilcoxon z(p value)

SDTA<Q2
Mean NPLGL(Median NPLGL)

SDTA>Q2
Mean NPLGL(Median NPLGL)

Wilcoxon z(p value)

1996

6.036
5.211
–0.16905.398
6.203–0.2415(3.175)(3.877)(0.8658)(3.549)(4.125)(0.8092)
1997
4.716
4.499
–1.2551
5.297
4.546
0.3456(2.306)(2.774)(0.2094)(2.885)(2.956)(0.7296)
1998
4.810
5.142
–0.11365.311
4.625–0.0819(1.924)(4.364)(0.9096)(2.339)(3.044)(0.9347)
1999
3.162
3.827
–0.8960
3.933
4.218–0.1584(1.560)(2.197)(0.3703)(1.977)(2.589)(0.8741)
2000
2.738
4.201
–0.0857
2.730
3.840–2.9520***(1.404)(2.628)(0.9317)(1.726)(2.590)(0.0032)
2001
2.698
4.333
–0.8476
2.495
3.934–1.9847**(1.771)(2.713)(0.3967)(1.668)(2.883)(0.0472)
2002
2.761
4.528
–1.1569
2.892
3.939–1.4116(1.954)(3.080)(0.2473)(1.937)(2.608)(0.1581)
2003
2.852
4.273
0.5475
3.107
3.673–1.0746(1.866)(2.907)(0.5841)(2.090)(2.329)(0.2825)
1996--1998
5.054
4.933
–2.7782***
5.326
5.009
–0.2653(2.302)(3.540)(0.0055)(2.914)(3.257)(0.7908)
1999--2003
2.835
4.256
–2.2242**
3.009
3.910
–2.5105**(1.707)(2.620)(0.0261)(1.879)(2.593)(0.0121)
1996--2003
3.431
4.427
–4.0314***
3.681
4.212
–2.8532***(1.955)(2.866)(0.0001)(2.212)(2.850)(0.0043)
NOTES: NPLGL designates the ratio of non performing loans total assets. The results are based on a total number of about
1,600 observations between 1996 and 2003. If the sample size is not the same, the Wilcoxon z statistics are calculated withrespect to the smaller sub-sample.
***, **, and * indicate statistical significance at the 1%, 5%, and 10% level, respectively

Table 11. Bivariate analysis of an alternative measure of the bank risk profile (LLRGL)
Year/
Sampleperiod1996

SDTA<Q1
Mean LLRGL(Median LLRGL)

SDTA>Q3
Mean LLRGL(Median LLRGL)

Wilcoxon z(p value)

SDTA<Q2
Mean LLRGL(Median LLRGL)

SDTA>Q2
Mean LLRGL(Median LLRGL)

Wilcoxon z(p value)

3.435
3.300
–0.3495
3.209
3.916–1.2672(2.417)(2.821)(0.7267)(2.535)(3.044)(0.2051)
1997
3.034
3.084
–0.6039
3.187
3.194–1.1526(1.995)(2.269)(0.5459)(2.142)(2.506)(0.2491)
1998
3.054
3.459
–0.3730
3.221
3.365–1.2846(1.848)(2.845)(0.7091)(2.026)(2.812)(0.1989)
1999
2.363
2.948
–1.6002
2.667
3.054–1.4005(1.564)(1.961)(0.1096)(1.816)(2.579)(0.1614)
2000
2.545
2.797
–1.0572
2.421
2.735–1.8529*(1.903)(2.083)(0.2904)(1.764)(2.397)(0.0639)
2001
2.613
3.407
–0.06112.480
3.105–1.0872(1.935)(2.401)(0.9513)(1.906)(2.459)(0.2769)
2002
2.503
3.223
–0.92422.318
2.982–2.2438**(2.003)(2.364)(0.3554)(1.909)(2.339)(0.0248)
2003
2.520
3.117
–0.3072
2.808
2.866–1.3942(2.254)(2.180)(0.7587)(2.209)(2.180)(0.1633)
1996--1998
3.164
3.286
–1.5820
3.206
3.471–1.7832*(2.036)(2.622)(0.1137)(2.203)(2.752)(0.0746)
1999--2003
2.512
3.101
–1.7507*
2.536
2.947
–3.8199***(1.929)(2.208)(0.0800)(1.936)(2.373)(0.0001)
1996--2003
2.715
3.153
–2.5698**
2.749
3.103
–3.5565***(1.965)(2.329)(0.0102)(2.015)(2.459)(0.0004)
NOTES: LLRGL is the ratio of loan loss reserve to total assets. The results are based on a total number of about 2,500
observations between 1996 and 2003. If the sample size is not the same, the Wilcoxon z statistics are calculated withrespect to the smaller sub-sample.
***, **, and * indicate statistical significance at the 1%, 5%, and 10% level, respectively