The Role of an Explicit Subordinate Debt Policy in the Smooth Transition to Basel II

The major concern for the banking sector of Bangladesh is that implementation of Basel II will cause banks to raise capital appreciably and thus undermine their existing capital position. In such a situation subordinated debt can play a complementary role in enhancing bank capital. Pillar II of Basel Accord II emphasizes supervisory review process. To this end, subordinated debt can provide quality market signal which can be used by the supervisors to identify distress in bank management. Pillar III of Basel Accord II argues that financial market would discipline banks. Since investors in subordinated debt face maximum potential financial loss, they have the incentive to closely monitor bank activities and may react promptly through the financial market. Therefore, a policy guideline for subordinate debt seems to be an immediate necessity for smooth transition to Basel II. This is likely to strengthen capital mix of banks, help to develop the bond market and facilitate harmonization of capital regulation in South Asia.