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Federal Reserve Bank of Cleveland
Working Papers (Old Series)
The effect of subordinated debt and surety bonds on banks' cost of capital and on the value of federal deposit insurance
William P. Osterberg
James B. Thomson
Abstract

This paper examines two proposals to correct the risk-taking incentives embedded in the current deposit insurance system and to provide protection to the deposit insurance fund. the first would require banks to issue subordinated debt, and the second would require bank stockholders to post surety bonds. We use the cash-flow version of the Capital Asset Pricing Model to show how each proposal would affect the values and rates of return on uninsured deposits and equity. We then indicate the impact that each proposal would have on the values of the Federal Deposit insurance Corporation claim and on the bank, emphasizing the role of deposit insurance pricing.


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William P. Osterberg & James B. Thomson, The effect of subordinated debt and surety bonds on banks' cost of capital and on the value of federal deposit insurance, Federal Reserve Bank of Cleveland, Working Papers (Old Series) 9012, 1990.
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Keywords: Deposit insurance ; Bank capital
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