Subordinated bonds

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On April 30, the Seoul Central District Court finally announced that four savings banks were declared bankrupt. As the savings bank collapsed, victims from volatized subordinated bonds have been a big issue. Many of the victims seem to belong to low-income class and the elderly. Many of them are preparing lawsuit, to get some of their money back. So what is subordinated bond anyway and what is so serious about it?

subordinate bonds

Subordinated bond is a type of bond which the bond holder has second priority of repayment when the creditor or company collapses. That means when a bank goes bankrupt, they repay the debt to ordinary bond holders first, and repay subordinated bonds afterwards. Usually, banks in bankruptcy cannot afford to repay all of their debts, so in reality subordinated bond holders rarely get repaid. Strange, isn’t it? Why do banks issue bonds which they cannot repay? And why people buy risky bonds?
By issuing subordinated bonds, banks can maintain BIS (Bank for International settlement) ratio which is ratio of equity capital to debt higher and that means higher financial soundness. Internationally, banks with BIS ratio of 8% or higher are recognized to be in a sound financial status and 4% for other financial companies. While ordinary bonds are regarded as debts that belong to banks, subordinated bonds are regarded as equity capital. For this reason, banks have been using subordinated bonds as a means to make BIS ratio higher and exaggerate their financial soundness. Especially when economy is under depression or when it is difficult for the banks to maintain standard BIS ratio, they issue subordinated bonds as a solution. They aggressively recommend the bonds to investors and the investors were appealed to its high interest rate.
It has been an issue that a savings bank promoted subordinated bonds without providing accurate information to ordinary customers. Many of them were low income workers and old who do not have enough knowledge about subordinated bonds which became a big problem after that savings bank had collapsed. Although regulation of direct promotion of subordinated bonds of ordinary banks are now crossing lips, the most important thing for investors is to be more cautious. As we see from the savings bank incident, dear my friends, it will be better to consider high return is accompanied by high risk when you invest in securities.

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