Subordinated Debt: A Skeptical Component of Regulatory Capital

Abstract

In the previous chapters (Chapters 4 and 5), we argued that the quantification of credit risk by ECAIs was deviated from the real credit risk, due partly to the low quality of ECAI’s credit information, presumably resulting in the huge accumulation of NPLs in Bangladeshi banks. As NPLs are accumulated, the RWA tends to increase. In turn to maintain the minimum CRAR, banks require to increase their regulatory capital as it is the numerator of the capital adequacy ratio. In this sense, the regulatory capital is mattered to maintain minimum CRAR. In this chapter, we shed an analytical light on the funding of the regulatory capital of Bangladeshi banks that enables them to maintain the minimum CRAR. This analysis attempts to solve the anomaly (ii) that we raised in introduction part of the book. Simultaneously, we point out here that their naïve reliance on the subordinated debt, we name this problem as the ‘sub-debt trap,’ may have undermined the resilience of the Bangladeshi banking industry. To investigate this, we chiefly attempt to examine the overall magnitude of the ‘sub-debt trap’ through empirical study upon an econometric approach in this chapter. It would help the readers to understand the real performance of Bangladeshi banks if they had not tapped into the ‘sub-debt trap.’ Then we further analyze the issue from sub-debt funding mechanism perspective. The structure of this chapter is as follows: Sect. 6.2 discusses how sub-debt is institutionally considered as RC in Bangladesh. Section 6.3 presents the details of the econometric model, results and discussion on said results. Section 6.4 demonstrates the overall magnitude of the ‘sub-debt trap’ in the financial system. Section 6.5 concludes.