Contingent Convertible Bonds as an Alternative to Strengthen Banks' Ability in Financing a Real Economy

Abstract

The main goal of this paper is to analyse whether Contingent Convertible Bonds (CoCos) are equally safe for banks and for the real economy because of their, sometimes, uneasy to understand features. It is still too early to estimate precisely an impact of CoCos for credit institutions because European Union is in the process of moving towards new regulatory framework with an aim to strengthen banks’ resistance against future shocks. CoCos have not passed any serious test in this context but, from the point of banks’ view they seem to be very promising. How will they behave during periods of market stresses it than has to be demonstrated.

Main methods are studies of the available literature, especially recommended by Calomiris & Herring (2013) and Borio (2013). A particular attention has been paid to various models of CoCos.

My findings confirm that there are still unidentified threats connected with CoCos that could jeopardize future proper functioning of a financial system and then – a real economy. Still, if not materialized, these threats will by easily outweighed by advantages for resistant balance sheets of banks.

CoCos can serve as a valuable instrument to upgrade a capital base of banks. However, it is important to make some efforts to design certain standardized features to enable comparison and valuation, to avoid unintended negative consequences for banks and economy, as a whole. Negative consequences for banks could result from overreliance on this source of capital and  for economy – in a form of rescue packages from taxpayers money.

My studies are an attempt of a comparison of pros and cons of CoCos. Moreover, it is an attempt to present CoCos in a broader context of banking regulations.

Keywords

contingent convertible bonds, trigger point, loss absorption mechanism, regulatory capital requirements

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