A Discussion On The Redeemable Right Of Subordinated Debt And Its' Effect On The Capital Adequacy Ratio

In recent years, most of big commercial banks in China issued a great sum of subordinated debt, which increased their capital adequacy ratio. As banks usually embed a redeemable right on the publicly issued bonds, this article tries to evaluate the price of the right by using the H-J-M model. It concludes that risk, which is represented by variance, is very important to option pricing, and consequently greatly affects the price of bonds. Moreover, as subordinated debt carries more credit risk and liquidity risk than treasury bills, the variance should be higher than that of T-bills. Therefore the price of redeemable right ought to be taken into the consideration of financial institutions. Meanwhile, this article also argues that though issuance of subordinate debt is an effective way to increase capital adequacy ratio, it cannot completely solve the problem of capital insufficiency. As a result, commercial banks, issuing party or purchasing party, should be as cautious as possible when making a decision on the issuance of subordinated debt.