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

Mark J. Flannery ()
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Mark J. Flannery: Department of Finance and Real Estate, University of Florida, Gainesville, Florida 32611-7168

Annual Review of Financial Economics, 2014, vol. 6, issue 1, 225-240

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.

Keywords: bank failures; too big to fail; financial supervision (search for similar items in EconPapers)
JEL-codes: G21 G23 G28 G32 (search for similar items in EconPapers)
Date: 2014
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Citations: View citations in EconPapers (40)

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