Contingent Convertible Bonds

One of the main measures in order to strengthen capital of the banks is investment  in Contingent Convertible Bonds (CoCo), which are a result of the Third Basel Accord (Basel III) http://www.bis.org/publ/bcbs189.pdf . I will explain this concept in this post.

A contingent convertible bond is a subordinated debt instrument which pays a periodic coupon as a standard bond does, but there exists an additional condition in which investors are forced to convert their bonds into shares of the bank. 

The most common condition is to force conversion when the capital of the entity falls below a predetermined level, that is, when the risk of insolvency is high. It will serve as an equity injection right at the moment when the firm is failing to meet a capital requirement.

When this condition is met, the debt level would be reduced and the capital level would increase in the same amount. Automatically, the ratio of capital will be improved as well.