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Contingent Capital Instruments for Large Financial Institutions: A Review of the Literature

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  • Mark J. Flannery

    () (Department of Finance and Real Estate, University of Florida, Gainesville, Florida 32611-7168)

Abstract

As the recent financial crisis unfolded, a new financial instrument—contingent convertible (coco) bonds—was widely considered as a mechanism for promptly recapitalizing overlevered financial institutions. Essentially, the conversion feature of 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 substantially insulate taxpayers from private investment losses. This potential fostered a literature evaluating the effect of cocos on bank and financial sector stability, risk-taking incentives, and corporate governance. I review this literature and suggest 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.

Suggested Citation

  • Mark J. Flannery, 2014. "Contingent Capital Instruments for Large Financial Institutions: A Review of the Literature," Annual Review of Financial Economics, Annual Reviews, vol. 6(1), pages 225-240, December.
  • Handle: RePEc:anr:refeco:v:6:y:2014:p:225-240
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    File URL: http://www.annualreviews.org/doi/abs/10.1146/annurev-financial-110613-034331
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    Citations

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    Cited by:

    1. Bolton, Patrick & Oehmke, Martin, 2018. "Bank Resolution and the Structure of Global Banks," CEPR Discussion Papers 13032, C.E.P.R. Discussion Papers.
    2. Daniël Vullings, 2016. "Contingent convertible bonds with floating coupon payments: fixing the equilibrium problem," DNB Working Papers 517, Netherlands Central Bank, Research Department.
    3. Masror Khah, Sara Abed & Vermaelen, Theo & Wolff, Christian C, 2015. "The Determinants of CoCo Bond Prices," CEPR Discussion Papers 10996, C.E.P.R. Discussion Papers.
    4. Kiewiet, Gera & van Lelyveld, Iman Paul Pieter & van Wijnbergen, Sweder, 2017. "Contingent Convertibles: Can the Market handle them?," CEPR Discussion Papers 12359, C.E.P.R. Discussion Papers.
    5. repec:eee:jmacro:v:54:y:2017:i:pb:p:285-305 is not listed on IDEAS
    6. Flannery, Mark J. & Giacomini, Emanuela, 2015. "Maintaining adequate bank capital: An empirical analysis of the supervision of European banks," Journal of Banking & Finance, Elsevier, vol. 59(C), pages 236-249.
    7. Martijn A. Boermans & Sweder van Wijnbergen, 2018. "Contingent convertible bonds: Who invests in European CoCos?," Applied Economics Letters, Taylor & Francis Journals, vol. 25(4), pages 234-238, February.
    8. Consiglio, Andrea & Zenios, Stavros A., 2015. "The Case for Contingent Convertible Debt for Sovereignst," Working Papers 15-13, University of Pennsylvania, Wharton School, Weiss Center.
    9. Kenjiro Hori & Jorge Martin Cerón, 2017. "Contingent Convertible Bonds: Payoff Structures and Incentive Effects," Birkbeck Working Papers in Economics and Finance 1711, Birkbeck, Department of Economics, Mathematics & Statistics.
    10. Fatouh, Mahmoud & McMunn, Ayowande, 2019. "Shareholder risk-taking incentives in the presence of contingent capital," Bank of England working papers 775, Bank of England.
    11. repec:ces:ifofor:v:15:y:2014:i:03:p:65-71 is not listed on IDEAS

    More about this item

    Keywords

    bank failures; too big to fail; financial supervision;

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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