Bank subordinated debt: a source of capital for lenders or a source of concern for retail investors?

To address that question, this note first provides a primer on subordinated bonds, covering a number of key concepts and definitions. The role of subordinated bonds as a source of bank regulatory capital («Tier 2 capital») is then discussed, showing that lenders have been relying heavily on this type of securities to comply with supervisory requirements, and that a significant share of Tier 2 issues is held by retail investors. We then look at how recent rules on bank bailout and resolution (including the Bank Recovery and Resolution Directive) have changed the risk attached to subordinated bonds and to other bank liabilities that rank senior to them. Key rules on the placement of subordinated bonds to retail clients are also briefly surveyed, highlighting how MiFID II will change the regulatory landscape since 2018, by imposing additional requirements on appropriateness, product governance and conflicts of interest, and by giving supervisors the power to impose extraordinary bans on unsuitable financial products. In the last part of this note we argue that, rather than prohibiting the sale of subordinated debt to small investors, supervisors should tackle the risk originating from self-placement practices through a thorough and uniform implementation of MiFID (and MiFID II) provisions. Competent authorities may e.g. require banks to: i) set maximum concentration limits in their customers’ portfolios; ii) develop adequate pricing procedures; iii) to ensure that remuneration schemes do not lead to improper selling practices.