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Contingent capital to strengthen the private safety net for financial institutions: Cocos to the rescue?

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  • von Furstenberg, George M.

Abstract

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. --

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Bibliographic Info

Paper provided by Deutsche Bundesbank, Research Centre in its series Discussion Paper Series 2: Banking and Financial Studies with number 2011,01.

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Date of creation: 2011
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Handle: RePEc:zbw:bubdp2:201101

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Keywords: financial reforms; regulatory insolvency; contingent capital; bank regulations; cocos;

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  1. Anat R. Admati & Peter M. DeMarzo & Martin F. Hellwig & Paul Pfleiderer, 2010. "Fallacies, Irrelevant Facts, and Myths in the Discussion of Capital Regulation: Why Bank Equity is Not Expensive," Working Paper Series of the Max Planck Institute for Research on Collective Goods 2010_42, Max Planck Institute for Research on Collective Goods.
  2. Kick, Thomas & Koetter, Michael & Poghosyan, Tigran, 2010. "Recovery determinants of distressed banks: Regulators, market discipline, or the environment?," Discussion Paper Series 2: Banking and Financial Studies 2010,02, Deutsche Bundesbank, Research Centre.
  3. Raghuram G. Rajan, 2009. "The credit crisis and cycle-proof regulation," Review, Federal Reserve Bank of St. Louis, issue Sep, pages 397-402.
  4. Memmel, Christoph & Raupach, Peter, 2010. "How do banks adjust their capital ratios?," Journal of Financial Intermediation, Elsevier, vol. 19(4), pages 509-528, October.
  5. Berry K. Wilson & Edward J. Kane, 1996. "The Demise of Double Liability as an Optimal Contract for Large-Bank Stockholders," NBER Working Papers 5848, National Bureau of Economic Research, Inc.
  6. Alon Raviv, 2004. "Bank Stability and Market Discipline: Debt-for-Equity Swap versus Subordinated Notes," Finance 0408003, EconWPA.
  7. An Yan & Debarshi Nandy & Thomas Chemmanur, 2004. "Why Issue Mandatory Convertibles? Theory and Empirical Evidence," Econometric Society 2004 North American Winter Meetings 456, Econometric Society.
  8. Michael Koetter & Tigran Poghosyan & Thomas Kick, 2010. "Recovery Determinants of Distressed Banks," IMF Working Papers 10/27, International Monetary Fund.
  9. Thierry Tressel, 2010. "Financial Contagion Through Bank Deleveraging," IMF Working Papers 10/236, International Monetary Fund.
  10. Fabian Valencia, 2010. "Bank Capital and Uncertainty," IMF Working Papers 10/208, International Monetary Fund.
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