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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.

Suggested Citation

  • von Furstenberg, George M., 2011. "Contingent capital to strengthen the private safety net for financial institutions: Cocos to the rescue?," Discussion Paper Series 2: Banking and Financial Studies 2011,01, Deutsche Bundesbank.
  • Handle: RePEc:zbw:bubdp2:201101
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    References listed on IDEAS

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    7. Michael Koetter & Tigran Poghosyan & Thomas Kick, 2010. "Recovery Determinants of Distressed Banks; Regulators, Market Discipline, or the Environment?," IMF Working Papers 10/27, International Monetary Fund.
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    9. 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," Discussion Paper Series of the Max Planck Institute for Research on Collective Goods 2010_42, Max Planck Institute for Research on Collective Goods.
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    More about this item

    Keywords

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

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation

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