Mechanics
Subordination describes where a claim sits in the order in which a bank's creditors are repaid. Subordinated debt ranks below ordinary unsecured, or senior, liabilities: in insolvency its holders are paid only after senior creditors have been satisfied in full, and only ahead of the bank's shareholders. That deeper position in the creditor hierarchy is compensated by a higher coupon, and it is exactly what makes subordinated debt useful for absorbing losses without recourse to public funds.
In the regulatory capital stack the most common form of subordinated debt is Tier 2 capital. The CRR sets out its eligibility conditions, including an original maturity of at least five years, limited incentives to redeem and effective subordination to senior claims. Tier 2 ranks below Additional Tier 1 (AT1) instruments but above senior debt, whether senior non-preferred or ordinary senior preferred. Subordination can be achieved contractually, through the terms of the instrument, or statutorily, where national law fixes the ranking; the resolution framework relies on the ranking being legally robust so that losses fall where investors expect.
Role in resolution
Subordinated debt is central to the bail-in logic of the resolution framework. When a bank enters resolution, losses are allocated up the hierarchy from the bottom: common equity first, then AT1 instruments, then Tier 2 and other subordinated claims, and only afterwards senior non-preferred and senior preferred liabilities. Resolution authorities apply the write-down and conversion power in this sequence so that the no creditor worse off safeguard is respected, each class absorbing loss before the class above it is touched.
Because subordinated instruments are contractually junior, they can be written down or converted into equity with greater legal certainty than senior debt, and they help a bank meet the subordinated component of its MREL. Investors therefore price subordinated bank debt for the explicit risk of loss at the point of non-viability, a risk distinct from the residual one on senior instruments.
Relevance for banks and investors
For issuers, subordinated debt is a comparatively cheap way to build gone-concern loss-absorbing capacity and to satisfy the subordinated part of MREL and, for the largest banks, TLAC. For investors, it offers yield in exchange for a defined place near the front of the loss queue; analysts assess it by reference to the issuer's capital position, the specific instrument's terms and its ranking relative to other liabilities. The exact treatment of any instrument ultimately depends on the national insolvency law transposing the BRRD creditor-hierarchy rules, so documentation and governing law matter as much as the label the instrument carries.