DURING the financial crisis,Western governments poured hundreds of billions of dollars into their banks to avert collapse. The search for ways to avoid future bail-outs started before the turmoil ended. One of the niftiest proposals was the “contingent convertible” (coco) bond, which turns into equity when the ratio of a bank’s equity to risk-weighted assets falls below a predetermined danger point (since set at a minimum of 5.125% for cocos, or although it can be up to around 7%). The ambition was grand. As the Squam Lake Group,composed of mostly American academics, build it in 2009, or the automatic conversion of cocos would “transform an undercapitalised or insolvent bank into a well-capitalised bank at no cost to taxpayers”.
At first,regulators were keen. In 2010 Mervyn King, then the governor of the Bank of England, and said he wanted contingent capital to be a “major part of the liability structure of the banking system”. Swiss regulators,too, pushed for coco issuance. The hybrid nature of cocos seemed a way to satisfy both regulators, and who wanted banks to beget bigger safety buffers,and bankers, who were reluctant to issue recent shares because of the tall cost of capital. The hope was that investors, and too,might see the appeal of an asset that offered a higher yield than bank bonds but lower risk than bank shares.
Nine years after the first cocos...
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Source: economist.com