Market Discipline by Bank Creditors During the 2008-2010 Crisis

Abstract

This paper shows that the liability classes most likely to exhibit evidence of market discipline during the recent financial crisis were uninsured depositors, insured depositors, and general creditors. We evaluate the FDIC’s expectations about losses to creditors at banks that failed between 2008 and 2010 to establish that these creditors expected to incur loss. Our empirical tests find evidence of quantity market discipline that tends to begin far enough in advance to signal to both banks and supervisors that corrective actions can and should be taken. Consistent with the literature, our results suggest that during the crisis, quantity discipline was relatively strong and price market discipline was relatively weak. Our findings support several policy implications for encouraging market discipline.

Keywords: bank failures, financial crisis, market discipline

JEL Classification: G01, G21, G28, G33, H12