Wake Me Up Before You CoCo Implications of contingent convertible capital for financial regulation

Contingent convertible capital (CoCo) is designed to improve the loss absorption capacity of the issuing bank without resorting to new equity or taxpayer-funded bailouts. However attractive they might seem to the regulator, they may have undesirable and unexpected consequences. This dissertation examines the implications of issuing CoCos for the financial system. For instance, CoCo conversion may be construed as signal about the asset quality of the bank, which may lead to contagious bank runs in the system. Another is that if the CoCo is inappropriately designed, the bank may accelerate the conversion by choosing high levels of risk to increase the bank’s residual equity value. Finally, the regulator’s desire for a trigger that she can control is an invitation for regulatory forbearance, which is what she was trying to avoid in the first place.