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We investigate whether or not market discipline on banking firms changed after the Dodd–Frank Wall Street Reform and Consumer Protection Act (DFA) of 2010. If market discipline is improved, we should see a lower discount for size on yield spreads, particularly for banks identified as too-big-to-fail (TBTF) or systemically important (SIFI). Using secondary market subordinated debt transactions we find that the size discount is reduced by 47% and TBTF discount is reduced by 94% after the DFA. The DFA has been effective in reducing, but not in eliminating the size and TBTF discounts on yield spreads. Market discipline of banks appears to have improved further after the rating criteria changes by Moody’s.

We investigate whether or not market discipline on banking firms changed after the Dodd–Frank Wall Street Reform and Consumer Protection Act2 (DFA) of 2010. Using secondary market bond transactions, we investigate whether or not yield spreads levels (the difference between the yield to maturity of a risky bond and risk-free bond of similar maturity and other characteristics) and yield spread changes on subordinated notes and debentures (SNDs) increase for large banks in general, and too-big-to-fail banks in particular due to the passage of the DFA. In other words, we study if the size discount and more particularly the too-big-to-fail (TBTF) discount is removed or reduced from the yield spreads on SNDs issued by bank holding companies (BHCs) after the DFA was passed.

We investigate whether or not bond market discipline has improved after the enactment of the Dodd–Frank Act (DFA) on July 21, 2010. If market discipline improves after the DFA, we should observe an increase in yield spreads through a reduction in the discount for size, the so-called “too-big-to-fail” (TBTF) discount, and other firm-specific default risk proxies will have a higher magnitude and statistical significance. Market discipline on large banks is greatly diminished because of government intervention, thus one of the main objectives of the DFA is to restore and improve the market discipline on banks. When we examine the secondary market bond transactions of bank-issued subordinated notes and debentures, we find a TBTF discount of 187 basis points in the yield spreads during the pre-DFA period, but the TBTF discount is reduced by 176 basis points during the post-DFA period, a reduction of nearly 94% in the TBTF discount. We also observe a reduction in size discount of 47% during the post-DFA period. The size discount and the TBTF discount lower yield spread for TBTF banks compared to non-TBTF banks, even after the DFA. Our results indicate that although market discipline is improved, the TBTF discount is not yet eliminated. We rank the impact of each variable by dividing the coefficients by the respective standard errors. The impact rank indicates the importance of size and being too-big-to-fail has decreased for subordinated bonds after the DFA.