Capital access bonds: contingent capital with an option to convert

Caught between Scylla and Charybdis? Regulating bank leverage when there is rent seeking and risk shifting

Patrick Bolton and Frédéric Samama

Economic Policy, 2012, vol. 27, issue 70, 275-317

Abstract: This paper argues that there is a Coasean bargain available to banks, long-term investors, and bank regulators around a particular form of “contingent capital”. By purchasing rights to issue equity in crisis events at a pre-specified price from long-term investors, banks can ensure that they will have sufficient regulatory capital available when they need it most: in a crisis. By selling these rights (effectively, a form of crisis insurance) long-term investors can monetize their counter-cyclical investments strategies in banks and, thus, obtain an adequate return as long-term investors. Bank regulators, in turn, gain as they can thereby implement a more efficient (transparent and flexible) form of equity-capital regulation. The form of contingent capital we propose (capital access bond) reflects a balance between investors’ preferences, issuers’ constraints, and regulators’ objectives.— Patrick Bolton and Frédéric Samama

Date: 2012
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