Hence, at least in principle, the issuance and secondary market spreads on subordinated debt should be particularly sensitive to banking organization risk. In contrast, since equity holders may also benefit from the upside gains associated with risk-taking, equity issuance may provide inadequate direct market discipline, and the signals of bank risk derived from secondary market prices may be blurred and difficult to interpret.
In addition, subordinated debt has a relatively long maturity. This feature magnifies the risksensitivity of the debt and reduces the probability of a “silent run” on the bank occurring when the debt becomes due. Subordinated debt issued in place of insured deposits also provides an extra “cushion” for the deposit insurance fund in the event of bank failure.