Contingent Capital Instruments for Large Financial Institutions: A Review of the Literature
Annual Review of Financial Economics, 6, 2014, DOI: 10.1146/annurev-financial-110613-034331
31 Pages Posted: 30 Jan 2014
There are 2 versions of this paper
Contingent Capital Instruments for Large Financial Institutions: A Review of the Literature
Contingent Capital Instruments for Large Financial Institutions: A Review of the Literature
Date Written: November 11, 2013
Abstract
As the recent financial crisis unfolded, a new financial instrument -- contingent capital (“coco”) bonds -- was widely considered as a mechanism for promptly re-capitalizing over-levered financial institutions. Essentially, coco bonds would replace supervisory discretion about banks’ capital adequacy with rules specifying when new equity was required. Academics and regulators conjectured that including sufficient cocos in a bank’s capital structure could insulate taxpayers from private investment losses. This potential fostered a substantial literature evaluating the effect of cocos on bank and financial sector stability, risktaking incentives, and corporate governance. This paper reviews the literature and suggests that regulatory capital definitions should be expanded to include substantial amounts of (carefully designed) coco bonds as a partial substitute for common equity in regulatory capital requirements.
Keywords: bank supervision, capital adequacy, contingent capital
JEL Classification: G21, G28, G18
Suggested Citation: Suggested Citation