##uance may also result in lower spreads as the market ’ s familiarity with the issuers increases. this would, of course, reduce the cost of a subordinated debt requirement. on the other hand, a lower required frequency of issuance may allow banks to signal their financial condition through their timing of issuance. flexibility with respect to issuance may also allow banks to avoid the unnecessary cost of issuing subordinated debt during periods in which the bond market is turbulent. on balance, a mandated frequency of once or twice a year would seem reasonable, and would be in line with current practice for larger banking organizations. should subordinated debt with standardized characteristics be required? there are also tradeoffs associated with requiring banking organizations to issue a standardized debt instrument with the same maturity, option characteristics, and covenants. the benefit of standardized debt is fairly obvious. it makes it easier for market participants to decipher the signals of a banking organization ’ s condition. the costs are also pretty clear. a standardized debt instrument could be more costly for some banks to issue than for others because bank capital structures differ across organizations. and, a standardized debt instrument may be very costly during certain market conditions. for example, in periods of actual or expected interest rate volatility, spreads on debt without put options may be relatively high. i would expect that the benefits of standardization in ensuring a purer signal about the relative risk of different banking institutions would outweigh the costs associated with such a restriction. should put options be required? some proposals have advocated that the required subordinated debt have put options. these options have been suggested for two reasons. first, they would provide debt holders with a powerful tool for increasing the cost of bank risktaking. with a put option, debt holders would be able to force early repayment of debt when a bank changed its risk profile. second, under some proposals, put options take the closure decision out of the hands of the regulators and place it in the hands of the debt holders. not coincidentally, these proposals arose in the wake of the savings and loan crisis during which regulators were criticized for their forbearance. put options may also increase indirect discipline if they trigger supervisory actions. as disciplinary as they may be, there are strong arguments against the inclusion of put options. first, the exercise of put options can be extremely draconian, inducing liquidations and possibly premature closures. second, the high correlation of risks across banks may induce a simultaneous exercise of put options, which could

mr meyer ’ s remarks on market discipline as a component of banking supervision and regulation speech by mr laurence h meyer, a member of the board of governors of the us federal reserve system, at the conference on reforming bank capital standards in new york on 14 june 1999. good afternoon. the topic of this conference – reforming bank capital standards – could not be more timely. reform is very much an issue on the minds of all supervisors and market participants. but regulatory capital standards are only one component of the overall framework for maintaining bank safety and soundness. this overall framework can be described, as in the consultative paper recently released by the basle supervisors committee, in terms of “ three pillars ” – bank supervision, market discipline, and regulatory capital standards. there are two approaches to assessing the adequacy of the overall framework. first, we could consider merely rebalancing the existing components, in search of the most efficient combination. some have argued, for example, that enhancing market discipline could permit reduced reliance on the more intrusive and burdensome regulatory and supervisory components. second, to the extent that recent changes in banking and financial markets have made bank regulation and supervision more difficult, we may also need to incrementally improve capital standards and supervisory practices as well as enhance market discipline. my remarks today will focus on the market - discipline component of the three - pillars framework, specifically on how we might enhance market discipline in banking as we adapt to changes in banking and financial markets that have made bank supervision and regulation more difficult. there is an irony here in that it might take additional regulation – for example, increased disclosures and / or a mandatory subordinated debt requirement – to enhance market discipline. i will also discuss practical issues that must be considered and questions that must be answered if we are to move in this direction. adapting to change as we all know, financial markets and institutions are evolving at a rapid and unprecedented pace. this evolution has been driven in part by statutory reforms and dramatic regulatory changes. the abolition of interstate banking constraints has allowed for the creation of a growing number of very large banking organizations. the erosion of legal and regulatory barriers has permitted banking organizations to expand their scope of activities. and both the relaxation of trade barriers and the freer flow of capital have facilitated the operation of banks across national boundaries. financial and technological innovations have had an equally dramatic effect on financial markets and institutions. as a result of technological innovations, the increased speed and reduced cost of transacting have