Contingent Capital to Strengthen the Private Safety Net for Financial Institutions: Cocos to the Rescue?
88 Pages Posted: 8 Jun 2016
Date Written: 2011
This study examines the promise of reducing expected resolution costs of financial institutions through either voluntary or mandated addition of contingently convertible debt securities to their long-term financing mix. I model the stochastic process by which an initially very well capitalized banking firm may come to violate its minimum capital maintenance requirement. Conversion of cocos then provides a second chance because the firm's initial capitalization is restored. Although regulatory insolvency remains a distant threat, the expected reductions in the cost of bankruptcy and hence the cost of capital are such that cocos may win a place in the liability structure of financial institutions without the need for mandates.
Keywords: financial reforms, regulatory insolvency, contingent capital, bank regulations, cocos
JEL Classification: E44, G33, G38
Suggested Citation: Suggested Citation