Although additional Basel Committee on Banking Supervision guidance on contingent capital requirements for systemically important financial institutions is forthcoming, market participants believe that contingent capital will play a significant future role in bank capital. But with so many questions about contingent capital still unanswered, is post-financial crisis trauma causing the industry to move forward too quickly?
Contingent capital instruments (CoCos) have received enthusiastic endorsement from regulators, who usually refer to contingent capital as a hybrid debt instrument convertible into equity during a stress scenario or at the point of non-viability. This is just one formulation of contingent capital. The premise of a contingent capital instrument is that a financial institution will offer securities that constitute high-quality capital during good times, which will provide a buffer or enhanced loss absorbency during times of stress when the financial institution requires, but cannot raise additional capital. Although discussions focus on mandatorily convertible debt securities with regulatory triggers, one can envision other structures, such as a debt security with a principal write-down feature, or a 'contingent' committed funding facility, or even a collateralised insurance policy.
