Equity Recourse Notes: Creating Counter-Cyclical Bank Capital

40 Pages Posted: 21 Oct 2014

See all articles by Jeremy Bulow

Jeremy Bulow

Stanford University; National Bureau of Economic Research (NBER)

Paul Klemperer

University of Oxford - Department of Economics; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 3 versions of this paper

Date Written: October 2014

Abstract

We propose a new form of hybrid capital for banks, Equity Recourse Notes (ERNs), which ameliorate booms and busts by creating counter-cyclical incentives for banks to raise capital, and so encourage bank lending in bad times. They avoid the flaws of existing contingent convertible bonds (cocos) - in particular, they convert more credibly - so ERNs also help solve the too-big-to-fail problem: rather than forcing banks to increase equity, we should require the same or larger capital increase but permit it to be in the form of either equity or ERNs - this also gives some choice to those who claim (rightly or wrongly) that equity is more costly than debt. ERNs can be introduced within the current regulatory system, but also provide a way to reduce the existing system's heavy reliance on measures of regulatory-capital.

Keywords: bail-in, bank, bank capital, capital requirements, coco, contingent capital, contingent convertible bond, SIFI

JEL Classification: G10, G21, G28, G32

Suggested Citation

Bulow, Jeremy I. and Klemperer, Paul, Equity Recourse Notes: Creating Counter-Cyclical Bank Capital (October 2014). CEPR Discussion Paper No. DP10213. Available at SSRN: https://ssrn.com/abstract=2512741

Jeremy I. Bulow (Contact Author)

Stanford University ( email )

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National Bureau of Economic Research (NBER)

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Paul Klemperer

University of Oxford - Department of Economics ( email )

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Centre for Economic Policy Research (CEPR) ( email )

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