Stabilizing Large Financial Institutions with Contingent Capital Certificates

34 Pages Posted: 10 Oct 2009

See all articles by Mark J. Flannery

Mark J. Flannery

University of Florida - Department of Finance, Insurance and Real Estate

Multiple version iconThere are 2 versions of this paper

Date Written: October 6, 2009

Abstract

The financial crisis has clearly indicated that government regulators are reluctant to permit a large financial institution to fail. In order to minimize the transfer of future losses to taxpayers or to solvent banks, we need a system for assuring that large institutions always maintain sufficient capital. For a variety of reasons, supervisors find it difficult to require institutions to sell new shares after they have suffered losses. This paper describes and evaluates a new security, which converts from debt to equityautomatically when the issuer's equity ratio falls too low. "Contingent capital certificates" can greatly reduce the probability that a large financial firm will suffer losses in excess of its common equity, and will provide market discipline by forcing shareholders to internalize more of their assets' poor outcomes.

Keywords: contingent capital, market discipline, prudential supervision

JEL Classification: G21, G28

Suggested Citation

Flannery, Mark Jeffrey, Stabilizing Large Financial Institutions with Contingent Capital Certificates (October 6, 2009). Available at SSRN: https://ssrn.com/abstract=1485689 or http://dx.doi.org/10.2139/ssrn.1485689

Mark Jeffrey Flannery (Contact Author)

University of Florida - Department of Finance, Insurance and Real Estate ( email )

P.O. Box 117168
Gainesville, FL 32611
United States
352-392-3184 (Phone)
352-392-0103 (Fax)

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