Equity Recourse Notes: Creating Counter†cyclical Bank Capital

Jeremy Bulow and Paul Klemperer

Economic Journal, 2015, vol. 125, issue 586, F131-F157

Abstract: We propose a new form of hybrid capital for banks, Equity Recourse Notes (ERNs), which (i) ameliorate booms and busts by creating counter†cyclical incentives for banks to raise capital, and so encourage bank lending in bad times; (ii) help solve the too†big†to†fail problem; and (iii) reduce the regulatory system's reliance on accounting measures of capital. ERNs avoid the flaws of existing contingent convertible bonds (cocos) – in particular, they convert more credibly. Future required increases in bank†capital should be permitted to be in the form of either equity or ERNs.

Date: 2015
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