The Federal Reserve and Wall Street executives are discussing a new way to provide bank capital in times of crisis. They want to issue a new security called a contingent convertible (CoCo).
What is a CoCos and how does it work? CoCos are hybrid securities, In normal times they operate like a bond and pay coupons to investors. However, in times of crisis they automatically convert into equity. If bank capital fell below prescribed limits they would trigger the conversion from bonds to equity.
Supporters of CoCos say they would be able to raise equity capital in times of stress and that any losses would be borne by the investors and not the government. In other words CoCos are a fancy way of avoiding bank bailouts.
Of course, the key question is whether or not CoCos would do the job of bailing out a bank in crisis. Would the capital raised be enough to avoid disaster?
Securities similar to CoCos have been pioneered by Lloyds Banking Group in the UK and are in their early stages.
Bankers and analysts argue that securities such as CoCos could help banks worldwide to refinance some $7 trillion dollars in debt that is due to expire in the next three years.
It seems that governments, particularly in the UK and the US want to shed bank bailouts in the future. The use of CoCos is one way to do this. Only time would tell if such a scheme would work in times of crisis. Would the capital raised in the conversion to equity be enough to stave off bankruptcy? Would the bankers again turn to their government to bail them out?
What is you reaction to the use of CoCos securities?
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