A Study of Market Discipline in Indian Banking: Role of Subordinated Debt Market

44 Pages Posted: 18 Jan 2009

See all articles by Abhijit Sarkar

Abhijit Sarkar

Indian Institute of Technology (IIT), Gandhinagar - School of HSSM

L. M. Bhole

Indian Institute of Technology (IIT), Bombay - Department of Humanities and Social Sciences

Date Written: January 16, 2009

Abstract

Though Basel II has been adopted by many emerging economies and guidelines on Market Discipline have been issued, question may be raised as to what extent market can act as an effective disciplinary force in these immature financial markets. This paper examines risk sensitivity of Indian banks' subordinated debt (SND) spreads (primary market) to ascertain whether debt investors act as a disciplinarian by discriminating across banks based on risk. A unique dataset of SND issues is compiled from issue documents filed with National Stock Exchange (NSE) at the time of issue/listing. The dataset includes issues listed with NSE as on 31st August 2007 and covers the period March 1999 to July 2007. Significant issue clustering in the highest rating-low risk categories is observed, both in terms of number and aggregate issue size. The pooled panel OLS results suggest sort of equi-spread clustering along the rating scale giving rise to a step-wise weakly monotonous increase in spread with enhanced issue risk. Dominance by government owned Public sector banks (PSB) in the SND market considerably weakens market discipline. The spread on PSB SND issues are generally lower relative to Private issues in the same rating scale. Even though more than half of the SNDs were issued over the last 28 months of the data period, no increased risk sensitivity of spreads is noticed. Issue ratings perform better as risk proxy relative to accounting measures of risks. Overall, market disciplinary role of the Indian SND market participants proves to be rather weak.

Keywords: Basel II, Market Discipline, Subordinated Debt, Ratings

JEL Classification: G12, G21, G24, G28

Suggested Citation

Sarkar, Abhijit and Bhole, Laxman Madhao, A Study of Market Discipline in Indian Banking: Role of Subordinated Debt Market (January 16, 2009). Available at SSRN: https://ssrn.com/abstract=1329003 or http://dx.doi.org/10.2139/ssrn.1329003

Abhijit Sarkar (Contact Author)

Indian Institute of Technology (IIT), Gandhinagar - School of HSSM ( email )

Visat-Gandhinagar Highway
Chandkheda
Ahmedabad, Gujarat 382424
India
00919099010523 (Phone)
00917923972622 (Fax)

HOME PAGE: http://www.geocities.com/ovi.sarkar

Laxman Madhao Bhole

Indian Institute of Technology (IIT), Bombay - Department of Humanities and Social Sciences ( email )

Bombay
IIT Bombay, Powai
Powai, Mumbai, ND
India

HOME PAGE: http://www.hss.iitb.ac.in/bhole

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