This paper benefited from discussion and consultation with an MCM advisory panel, comprising Raghuram Rajan (University of Chicago), Lauren Anderson (FDIC), Svein Andressen (FSB), Patrick Bolton Columbia University), Clive Briault (formerly FSA), Darrell Duffie (Stanford University), Wilson Ervin (Credit Swiss AG), Mark Flannery (University of Florida), Charles Goodhart (London School of Economics), Anil Kashyap (University of Chicago), Nick Le Pan (CIBC/CPAB), and David Scharftstein (Harvard Business School). We are grateful for the valuable insights and comments provided by the panel, and by Jan Brockmeijer, Jonathan Fiechter, Nadege Jassaud, Fabiana Melo, Robert Sheehy, Christopher Towe, and Jose Vinals.
For example, see The Squam Lake Report: Fixing The Financial System, 2010.
Throughout the paper, contingent capital refers to bank contingent capital only.
As bank managers may prefer to reduce their risk rather than reach the trigger point, this may lead to deleveraging. Large-scale asset sales by a systemic bank in a crisis could put significant downward pressure on asset prices, with a negative impact on the balance sheets of other institutions. The “fire sale” externality has been a significant factor of contagion in the recent crisis (see Brunnermeier, 2009; Adrian and Shin,2010).
Nonviability as defined by the Basel Committee (Section IV) or the level when a resolution process starts.
In this case, existing Tier l and Tier 2 instruments holders were made the offer to exchange their securities against the new CoCos (ECN—Enhanced Capital Note) after the bank had been intervened. The exchange was effective in reducing existing liabilities and providing extra loss-absorbing capital for times of future stress.
To accommodate fixed-income investors who are not allowed to hold equity as part of their mandate, financial structures are being formulated that would allow common equity to be held in trust or in other vehicles on behalf of CoCo holders or to facilitate the disposals of such equity for cash.
Under Basel III, Tier l capital ratio will incorporate up to 25 percent of “other qualifying” noncommon equity instruments, but based on stricter criteria.
See Bank for International Settlements, Press release (January 13, 2011): Basel Committee issues final elements of the reforms to raise the quality of regulatory capital; and Basel Committee on Banking Supervision (2010b).
The list of SIFIs is still being worked on at the FSB. The sample used in this report is based on the list published in the Financial Times, November l, 2010, “Regulators outline banking blueprint.”
The UK authorities may be considering a similar approach. See Bank of England, Financial Stability Report (December 2010).
Prepared by Vanessa Le Lesle. All data comes from publicly available sources, such as Bloomberg, Dealogic, and individual bank reports.
S&P (2010) also highlighted that contingent capital’s main use would be to replace the stock of disqualified capital instruments.