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Using Subordinated Debt as an Instrument of Market Discipline
Source: Federal Reserve

What Institutions Should Be Subject to an SND Policy?

Size Alone or Size Plus Other Criteria?

According to study group interviews with market participants, about fifteen to twenty, and perhaps as many as thirty, of the largest banks and bank holding companies have actively traded SND, although many more have issued some SND.  In addition, market participants argued that the principal issuers have total assets of at least $50 billion.  The secondary market for the SND of such firms was generally said to be highly liquid most of the time, to the point that the market provides a useful vehicle for trading and hedging. Market liquidity for the SND of smaller firms was, by implication, problematic. If correct, and the data presented next support the market participants' views, these arguments suggest that unless policymakers are willing to require substantial augmentation of the existing market for bank or BHC SND, an SND policy will have to be limited to the largest firms, probably considerably less than the largest fifty banks or bank holding companies.

More important, if an SND policy is focused on using market discipline to help constrain systemic risk, then limiting an SND policy to the largest institutions has considerable appeal. Clearly, the largest institutions are generally the firms that hold the most significant potential for systemic risk.  However, a criterion based solely on total assets, or even risk-weighted assets, may be too rough to capture the banks or bank holding companies most likely to pose significant systemic risks.  An appealing alternative set of criteria is that used by the Federal Reserve Board's Division of Bank Supervision and Regulation to define large, complex banking organizations (LCBOs). These criteria are meant to capture those banking organizations most likely to raise concerns about systemic risk.  In general, LCBOs (1) have significant on- and off-balance-sheet risk exposures, (2) offer a broad range of products and services at the domestic and international levels, (3) are subject to multiple supervisors in the United States and abroad, and (4) participate extensively in large-value payment and settlement systems.

Tables 4 and 5 provide a variety of data on SND issuance by U.S. banks and bank holding companies, respectively. Each table is arranged in selected years in the 1990s and selected size classes. As is clear from the tables, SND issuance at both the bank and the BHC levels is overwhelmingly accounted for by the largest institutions. For example, as of the end of 1998, 90 percent of the top fifty banks and 96 percent of the top fifty bank holding companies had SND outstanding.46 In contrast, even among size class 3 banks and bank holding companies (those with total assets between $500 million and $10 billion), less than 20 percent of banks and less than 12 percent of bank holding companies issued SND.

With the exception of the group of the very largest (the top fifty) institutions, the percentage of both banks and bank holding companies issuing SND declined over the 1990s. For the three smallest size classes of firms, the declines were substantial. Although the reasons for this decline are uncertain, part of the explanation may lie in the increasing minimum size of an individual SND issue, which was noted by many of the market participants interviewed by the study group.47 This hypothesis is supported by the dramatic increase in outstanding SND at both banks and bank holding companies during the 1990s, virtually all of which occurred at the largest institutions (see tables 4 and 5). Indeed, the total amount of BHC SND outstanding grew from $24.6 billion (in 1998 dollars) at the end of 1991 to $102.8 billion at the end of 1998, a compound annual growth rate of 23 percent. At the end of 1998, $100.0 billion (97 percent) of outstanding SND had been issued by the top fifty bank holding companies. In short, over the 1990s a rapidly growing amount of SND was accounted for by an increasingly small number of institutions, which were overwhelmingly in the top fifty.

Even the level of disaggregation given in tables 4 and 5 can hide important characteristics of the market for bank and BHC SND. Thus, tables 6 and 7 provide data, as of the end of 1998, for the fifty largest U.S. banks and bank holding companies, respectively, ranked by total assets. As may be seen in the tables, the $50 billion asset size cutoff indicated by market participants suggests that an SND policy would apply only to the top fifteen banks or the largest twenty bank holding companies.

The LCBO columns of tables 6 and 7 identify whether the bank or bank holding company is a large, complex banking organization. Clearly, the link between size and the LCBO list is close. The largest eighteen of the top twenty banks are part of an LCBO organization, and all the largest twenty bank holding companies are LCBOs. Of the thirtytwo LCBOs, all but eight foreign banking organizations are among the top fifty bank holding companies. However, once below the top twenty banks and bank holding companies ranked by total assets, the link with size deteriorates. Only six of the twelve banks ranked from 21 through 32 are LCBOs, and just two of the twelve bank holding companies so ranked are LCBOs.

An alternative criterion that might be considered is to apply an SND policy to those banks or banking organizations that use market risk models to meet a portion of their risk-based capital requirements.  Such banks must have met several criteria established by the bank regulators that identify them as having acceptable, normally state-of-the-art, riskmanagement policies and procedures. Thus, by this definition they are ''sophisticated'' banking organizations, although the link with systemic risk concerns is not so clear as with the criteria of either size or size plus complexity. In addition, as of mid-March 1999, only thirteen banks or bank holding companies were using market risk models to meet their riskbased capital requirements. These organizations are identified in the MRMB columns of tables 6 and 7.  As can be seen in the tables, all of the banks and bank holding companies that are MRMB organizations are also currently listed as LCBOs. In addition, eleven of the twelve banks that are on the MRMB list are among the top twenty banks ranked by total assets, and eleven of the thirteen bank holding companies that are on the MRMB list are among the top twenty.

  1. It is important to note that most bank SND are not traded, a point that will be discussed later.

  2. Currently, the minimum size of issuance appears to be about $150 million. For more on this point, see appendix B.

4. Subordinated Debt Issuance by U.S. Insured Commercial Banks, 1991-98

Item1

Size 1

Size 2

Size 3

Size 4

Top 50

All banks

Total banks (number)            
1991
9.925 1.417 576 49 50 11.967
1995
7.823 1.483 604 74 50 9.984
1997
7.029 1.498 595 65 50 9.187
1998
6.593 1.566 588 70 50 8.817
Banks issuing subordinated debt            
Number            
1991
186 110 156 41 42 493
1995
65 53 116 59 42 293
1997
42 29 105 53 42 229
1998
35 26 109 56 45 226
Percent            
1991
1.87 7.76 27.08 83.67 84.00 4.12
1995
0.83 3.57 19.21 79.73 84.00 2.93
1997
0.60 1.94 17.65 81.54 86.00 2.49
1998
0.53 1.66 18.54 80.00 90.00 2.56
Amount of subordinated debt (millions of 1998 dollars)            
1991
204 310 4.091 23.569 23.608 28.175
1995
52 164 6.338 38.078 35.210 44.631
1997
37 112 6.865 54.686 52.844 61.700
1998
35 84 6.432 65.595 62.889 72.145
Compounded annual growth rate (percent)            
1991-98
-22 -17 7 16 15 14
Average ratio of subordinated debt to total assets for those banks issuing subordinated debt            
Equally weighted            
1991
.0156 .0080 .0080 .0122 .0120 .0113
1995
.0122 .0108 .0142 .0167 .0177 .0136
1997
.0136 .0016 .0172 .0181 .0188 .0160
1998
.0148 .0116 .0170 .0202 .0203 .0168
Weighted by total assets            
1991
.0145 .0086 .0077 .0166 .0165 .0141
1995
.0121 .0105 .0148 .0180 .0184 .0174
1997
.0132 .0121 .0189 .0189 .0191 .0189
1998
.0135 .0111 .0186 .0201 .0202 .0200
Average ratio of subordinated debt to risk-weighted assets for those banks issuing subordinated debt            
Equally weighted            
1991
.0223 .0134 .0102 .0139 .0136 .0158
1995
.0209 .0137 .0169 .0203 .0215 .0185
1997
.0225 .0158 .0215 .0214 .0222 .0210
1998
.0245 .0167 .0206 .0227 .0231 .0213
Weighted by risk-weighted assets            
1991
.0228 .0130 .0102 .0187 .0185 .0166
1995
.0190 .0151 .0183 .0227 .0233 .0219
1997
.0200 .0167 .0226 .0233 .0235 .0232
1998
.0196 .0163 .0221 .0238 .0240 .0237

NOTE. 

Size 1: total assets < $150 million;

Size 2: $150 million total assets < $500 million;

Size 3: $500 million total assets < $10 billion;

Size 4: total assets $10 billion;

Top 50: top fifty banks by total assets.

  1. As of December 31 of each year.

5. Subordinated Debt Issuance by Top-Tier U.S. Bank Holding Companies (BHCs) with Consolidated Assets of Greater than $150 Million

Item1

Size 1

Size 2

Size 3

Size 4

Top 50

Top-tier BHCs

Total top-tier BHCs (number)            
1991
0 739 349 56 50 1.144
1995
0 844 338 65 50 1.247
1997
0 943 406 60 50 1.409
1998
0 1.039 420 62 50 1.521
Top-tier BHCs issuing subordinated debt
Number
           
1991
0 120 122 54 49 296
1995
0 75 60 61 48 196
1997
0 69 47 56 49 172
1998
0 63 49 55 48 167
Percent            
1991
.00 16.24 34.96 96.43 98.00 25.87
1995
.00 8.89 17.75 93.85 96.00 15.72
1997
.00 7.32 11.58 93.33 98.00 12.21
1998
.00 6.06 11.67 88.71 96.00 10.98
Amount of subordinated debt
(millions of 1998 dollars)
           
1991
0 477 3.053 21.075 20.863 24.605
1995
0 152 1.945 63.753 61.842 65.850
1997
0 161 1.924 84.701 83.681 86.786
1998
0 137 1.876 100.780 100.040 102.790
Compounded annual growth rate (percent)            
1991-98
0 -16 -7 25 25 23
Average ratio of subordinated debt to total assets for those top-tier BHCs issuing subordinated debt
Equally weighted
           
1991
.0000 .0141 .0084 .0093 .0098 .0109
1995
.0000 .0077 .0108 .0179 .0193 .0118
1997
.0000 .0080 .0104 .0182 .0192 .0120
1998
.0000 .0076 .0110 .0185 .0201 .0122
Weighted by total assets            
1991
.0000 .0174 .0100 .0115 .0117 .0114
1995
.0000 .0077 .0103 .0214 .0219 .0207
1997
.0000 .0082 .0116 .0227 .0230 .0222
1998
.0000 .0078 .0124 .0223 .0226 .0219
Average ratio of subordinated debt to risk-weighted assets for those top-tier BHCs issuing subordinated debt            
Equally weighted            
1991
.0000 .0134 .0121 .0123 .0130 .0126
1995
.0000 .0123 .0165 .0241 .0258 .0172
1997
.0000 .0124 .0148 .0234 .0245 .0167
1998
.0000 .0116 .0161 .0233 .0251 .0168
Weighted by risk-weighted assets            
1991
.0000 .0124 .0146 .0135 .0137 .0137
1995
.0000 .0118 .0144 .0276 .0281 .0268
1997
.0000 .0121 .0157 .0288 .0291 .0282
1998
.0000 .0116 .0172 .0283 .0286 .0279

NOTE.

Size 1: total assets < $150 million;

Size 2: $150 million total assets < $500 million;

Size 3: $500 million total assets < $10 billion;

Size 4: total assets $10 billion;

Top 50: top fifty banks by total assets.

  1. As of December 31 of each year.

6. The Fifty Largest U.S. Insured Commercial Banks by Total Assets, 1998:Q4

Rank

Bank name

City

State

Total assets (millions of dollars)

LCBO

MRMB

1 Bank of America National Trust & Savings Association1 San Francisco

CA

574,606

1

1

2 Citibank, National Association New York

NY

300,895

1

1

3 Chase Manhattan Bank New York

NY

296,717

1

1

4 First Union National Bank Charlotte

NC

222,483

1

1

5 Morgan Guaranty Trust Company New York

NY

175,827

1

1

6 Wells Fargo Bank, National Association San Francisco

CA

118,556

1

0

7 Bankers Trust Company New York

NY

104,558

1

1

8 Fleet National Bank Providence

RI

75,601

1

0

9 First National Bank of Chicago Chicago

IL

74,201

1

1

10 Keybank, National Association Cleveland

OH

73,862

1

0

11 PNC Bank, National Association Pittsburgh

PA

71,230

1

0

12 U S Bank, National Association Minneapolis

MN

69,713

1

0

13 BankBoston, National Association Boston

MA

69,547

1

1

14 Wachovia Bank, National Association Winston-Salem

NC

62,006

1

0

15 Bank of New York New York

NY

60,078

1

1

16 Republic National Bank of New York New York

NY

46,460

1

1

17 State Street Bank & Trust Company Boston

MA

43,185

1

1

18 Mellon Bank, National Association Pittsburgh

PA

42,235

1

0

19 Southtrust Bank, National Association  Birmingham

AL

38,054

0

0

20 Regions Bank Birmingham

AL

37,128

0

0

21 Marine Midland Bank Buffalo

NY

33,776

1

1

22 Chase Manhattan Bank USA, National Association Wilmington

DE

32,988

1

0

23 Union Bank of California, National Association San Francisco

CA

32,053

0

0

24 National City Bank Cleveland

OH

31,049

1

0

26 Summit Bank Hackensack

NJ

29,504

0

0

27 Comerica Bank Detroit

MI

29,375

0

0

28 Huntington National Bank Columbus

OH

28,108

0

0

29 Fleet Bank, National Association Jersey City

NJ

27,978

1

0

30 Crestar Bank Richmond

VA

27,620

1

0

31 Union Planters Bank, National Association Memphis

TN

27,407

0

0

32 Branch Banking & Trust Company Winston-Salem

NC

25,985

0

0

34 Chase Bank Texas, National Association Houston

TX

24,488

1

0

35 MBNA America Bank, National Association Wilmington

DE

23,602

0

0

36 Northern Trust Company Chicago

IL

23,304

0

0

37 NBD Bank Detroit

MI

22,955

1

0

38 Mercantile Bank, National Association Saint Louis

MO

22,791

0

0

39 LaSalle National Bank Chicago

IL

22,445

1

0

41 First American National Bank Nashville

TN

20,359

0

0

42 Manufacturers & Traders Trust Company Buffalo

NY

20,074

0

0

43 Amsouth Bank Birmingham

AL

19,833

0

0

44 National City Bank Milwaukee/Ilinois Bannockburn

IL

19,827

1

0

45 Suntrust Bank Atlanta

GA

19,635

1

0

46 Harris Trust & Savings Bank Chicago

IL

18,101

1

0

47 First Tennessee Bank, National Association, Memphis Memphis

TN

17,786

0

0

48 Star Bank, National Association Cincinnati

OH

17,331

0

0

49 First Security Bank, National Association Ogden

UT

17,239

0

0

50 First Maryland Bancorp Bank Baltimore

MD

17,115

0

0

NOTES. LCBO = Large, complex banking organization. MRMB = Market risk model bank. 1 = member of group, 0 = not member.

  1. Includes Nations Bank.

7. The Fifty Largest U.S. Bank Holding Companies (BHCs) by Total Assets, 1998:Q4

Rank

BHC name

Total assets
(millions of dollars)

RWA
(millions of dollars)

Bank assets1/ BHC assets
(percent)

Tier 1/RWA
(percent)

SND/RWA
(percent)

LCBO

MRMB

1 Citigroup

668,641

481,411

36.12

8.70

1.65

1

1

2 BankAmerica Corporation

617,679

521,576

90.47

7.07

3.16

1

1

3 Chase Manhattan Corporation

365,875

289,291

91.49

8.32

2.93

1

1

5 J P Morgan & Company, Inc.

261,067

140,171

40.81

8.02

3.65

1

1

6 First Union Corporation

237,363

193,818

95.12

7.01

4.91

1

1

7 Wells Fargo & Company

202,475

153,772

84.62

8.08

1.77

1

0

8 Bankers Trust Corporation

133,115

67,962

63.22

7.92

5.83

1

1

9 Fleet Financial Group, Inc.

104,554

105,670

93.44

6.99

3.22

1

0

10 SunTrust Bank, Inc.

93,170

80,586

94.09

8.17

1.71

1

0

11 National City Corporation

88,246

72,055

98.62

8.65

2.71

1

0

12 KeyCorp

79,966

74,660

98.45

7.21

3.63

1

1

13 PNC Bank Corporation

77,232

71,121

97.38

7.80

2.22

1

0

14 U S Bancorp

76,438

76,790

95.14

6.40

3.98

1

0

15 BankBoston Corporation

73,513

70,370

94.94

7.15

3.81

1

1

16 Wachovia Corporation

64,123

69,929

97.27

7.99

3.96

1

0

17 Bank of NY Company, Inc.

63,503

61,319

97.45

7.91

3.24

1

1

18 ABN Amro North America, Inc.

61,308

40,516

...

7.30

2.21

1

0

19 Mellon Bank Corporation

51,018

49,283

96.81

6.41

4.45

1

0

20 Republic New York Corporation

50,424

26,495

...

12.92

9.99

1

1

21 State Street Corporation

47,082

19,230

99.31

14.17

0.01

1

1

22 Regions Financial Corporation

39,140

25,939

...

10.12

0.77

0

0

23 Firstar (Wi) Corporation

38,476

31,230

98.85

9.01

1.69

0

0

24 SouthTrust Corporation

38,134

33,158

99.77

6.58

2.94

0

0

25 Bankmont Financial Corporation

38,080

23,949

...

9.66

2.29

0

0

26 Comerica, Inc.

36,697

43,144

...

6.24

3.20

0

0

27 Mercantile Bancorporation, Inc.

35,974

25,374

99.96

9.66

1.68

0

0

28 Branch Banking & Trust Corporation

34,427

23,098

98.01

9.97

3.72

0

0

29 HSBC Americas, Inc.

33,944

26,081

...

8.62

2.39

1

1

30 Summit Bancorp

33,130

23,645

98.89

10.85

0.95

0

0

31 UnionBanCal Corporation

32,301

30,753

...

9.64

0.97

0

0

32 Union Planters Corporation

31,692

20,591

100.00

13.4

2.34

0

0

33 Fifth Third Bancorp

28,922

24,345

99.66

12.02

1.02

0

0

34 Huntington Bancshares, Inc.

28,296

24,239

99.95

7.10

2.88

0

0

35 Northern Trust Corporation

27,870

20,074

100.00

9.78

2.12

1

0

36 MBNA Corporation

25,808

24,738

92.98

11.44

2.03

0

0

37 Popular, Inc.

23,160

13,485

...

10.76

0.93

0

0

38 First Security Corporation

21,689

16,207

98.95

8.98

1.23

0

0

39 Marshall & Ilsley Corporation

21,566

16,121

97.42

12.78

0.62

0

0

40 First American Corporation

20,722

14,995

...

10.36

0.66

0

0

41 M & T Bank Corporation

20,584

16,279

100.00

8.43

1.08

0

0

42 Amsouth Bancorporation

19,919

17,912

...

6.55

3.37

0

0

43 First Tennessee National Corporation

18,735

13,100

99.88

7.13

2.46

0

0

44 Citizens Financial Group, Inc.

18,430

12,540

...

10.89

0.00

0

0

45 First Maryland Bancorp

18,408

14,817

...

9.38

2.08

0

0

46 Compass Bancshares, Inc.

17,301

13,491

...

8.81

1.00

0

0

47 Zions Bancorporation

16,650

11,830

...

8.46

1.92

0

0

48 Old Kent Financial Corporation

16,589

11,735

99.86

9.32

0.85

0

0

49 Bancwest Corporation

15,050

13,219

...

8.17

1.54

0

0

50 Pacific Century Financial Corporation

15,017

11,708

100.00

9.42

1.01

0

0

NOTE. RWA = risk-weighted assets. SND = subordinated notes and debentures. LCBO = Large, complex banking organization. MRMB = Market risk model bank. . . . = a missing value. 1 = member of group, 0 = not member.

1. BHC banking assets = BHC total assets - BHC net nonbank assets. BHC net nonbank assets = Total nonbank assets - Balances due from parent BHC - Balances due from other nonbank subsidiaries of the BHC