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.

Bail In

To a greater or lesser degree, all of us have suffered this dreadful crisis. We have plenty of reasons to be upset and apportion blame. Governments have been forced to bail out banks in order to prevent an unstoppable systematic crisis. These bail outs have cost the governments and taxpayer enormous amounts and risen public debt levels to figures never known before. Nevertheless, many countries have reached a indebtedness close to 100% of their GDP.
Then, somebody could say: let banks fail. Why must they be bailed out? 

To be honest, we must think a minute so as to realize that there is no point in that. Just let's remember the bankruptcy of Lehman Brothers and everything that came afterwards. Nowadays, banking is the circulatory system of the world.

This situation should be prevented in the future. The financial industry should be subjected to a strong regulation so as to the banks manage to recapitalize themselves, that is, we have to stop thinking about bail out and start thinking about 'bail in'. What's more, the governmental bail out programs should disappear and be replaced by any sort of internal mechanism. 

How to do that? Coming up with a range of financial instruments or tools so that the bank recapitalizes himself  in difficult times.

The rules of the play are being changed. We have to stop thinking about bail out and start thinking about 'bail in' and seek a strong new regulation.

In the next post I will discuss some topics and explain some of these financial tools such as some known as Contingent Convertibles Bonds (CoCos) 

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