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

See all articles by Mark J. Flannery

Mark J. Flannery

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

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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

Flannery, Mark Jeffrey, Contingent Capital Instruments for Large Financial Institutions: A Review of the Literature (November 11, 2013). Annual Review of Financial Economics, 6, 2014, DOI: 10.1146/annurev-financial-110613-034331. Available at SSRN: https://ssrn.com/abstract=2387251

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
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352-392-0103 (Fax)

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