How does subordinated debt affect the cost of capital for banks?

Abstract

This paper studies the relationship between banks’ subordinated debt and the cost of capital in OECD countries from 2000 to 2019. Consistent with the hypothesis that subordinated debt disciplines risk-taking, empirical results show that the total cost of capital decreases with subordinated debt, keeping the equity capitalization and deposits constant. The main results hold for the US and the EU subsamples and are driven by the Global Financial Crisis of 2007–2009. Furthermore, the paper demonstrates that one-time subordinated debt issuance and low levels of subordinated debt do not suffice to discipline risk-taking.