Risk-Taking, Competition and Uncertainty: Do Contingent Convertible (CoCo) Bonds Increase the Risk Appetite of Banks?

63 Pages Posted: 29 Mar 2022

See all articles by Mahmoud Fatou

Mahmoud Fatou

Bank of England

Ioana Neamțu

Bank of England

Sweder van Wijnbergen

Universiteit van Amsterdam; Tinbergen Institute; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Date Written: February 2022

Abstract

We assess the impact of contingent convertible (CoCo) bonds and the wealth transfers they imply conditional on conversion on the risk-taking behaviour of the issuing bank. We also test for regulatory arbitrage: do banks by issuing CoCo bonds try to maintain risk-taking incentives when regulators reduce them through higher capitalization ratios? While we test for and reject sample selection bias, we show that CoCo bonds issuance has a strong positive effect on risk-taking behaviour, and so do conversion parameters that reduce dilution of existing shareholders upon conversion. Higher volatility amplifies the impact of CoCo bonds on risk-taking.

Keywords: Bank Capital Structure, Contingent Convertible Bonds, risk-taking, Selection Bias

JEL Classification: G01, G11, G21, G32

Suggested Citation

Fatou, Mahmoud and Neamțu, Ioana and van Wijnbergen, Sweder, Risk-Taking, Competition and Uncertainty: Do Contingent Convertible (CoCo) Bonds Increase the Risk Appetite of Banks? (February 2022). CEPR Discussion Paper No. DP17062, Available at SSRN: https://ssrn.com/abstract=4069853

Mahmoud Fatou (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Ioana Neamțu

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Sweder Van Wijnbergen

Universiteit van Amsterdam ( email )

Roetersstraat 11
Amsterdam, 1018 WB
Netherlands
+31 20 525 4011 / 4203 (Phone)
+31-35-624 91 82 (Fax)

Tinbergen Institute

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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