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Do Markets 'Discipline' All Banks Equally?

This paper investigates whether the bond market disciplines all banks equally in the sense of demanding the same relative risk premium across banks of different risk over time. To test this hypothesis the paper compares the difference between the credit spreads in the primary market of bank and firm bonds with the same credit rating issued during expansions with that same difference of spreads for bonds issued during recessions. Our results show that the bond market is relatively "tougher" on riskier banks than on safer ones. This is an important issue because otherwise a bond-issuance policy aimed at promoting market discipline will affect the relative funding costs of banks. Further, the information that can be extracted from the credit spreads on bank bonds will vary across banks for reasons unrelated to their risk.