Contingent Convertible Capital: A New Capital Requirement to Solve 'Too Big to Fail'
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Date
2016-04-29T16:20:56Z
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Abstract
The adoption of Basel III capital requirements has been championed as one of the primary means for addressing the ‘Too Big to Fail’ conundrum. However, many have argued that higher standards do not effectively solve the ‘Too Big to Fail’ problem while imposing significant costs on the banking industry, which ultimately are transferred to the economy as a whole. This decision memorandum examines to what extent CoCos would effectively address the shortcomings of the current capital structure required by regulators. CoCos are hybrid capital securities that absorb losses when the capital of the issuing bank falls below a certain level, especially in times of stress. This recapitalization restores banks to a viable position of capital adequacy and thereby avoids regulatory resolution and possible government bailouts. The main objective of the contingent capital would be to provide strong incentives for the voluntary, preemptive, and timely issuance of equity. However, in the U.S. experience with CoCos is quite limited and there are a range of potential issues that could be associated with these instruments, being the most controversial the market manipulation (CoCos short-selling). Therefore, the implementation of CoCos in the U.S. market should be considered as a long-term measure. Thus, before fully implementing CoCos in the U.S market, further empirical studies should be made. In the meantime regulators should allow banks to issue minimum quantity of CoCos by the largest banks, which are the ones that assume the highest burden of the stringent regulation under Dodd-Frank Act. However, the permission to issue CoCos should be in accordance with some requirements in order to avoid unexpected risks that could affect the entire market.
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Too Big to Fail, Banks, Capital, Contigent Convertible, CoCos