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Combining various aspects from existing theoretical and practical literature, this paper first presents a CoCo pricing framework that allows a flexible and comprehensible valuation of real-world equity or TIER-1 ratio-triggered CoCos. Contingent convertible capital instruments CoCos are hybrid capital securities that absorb losses when the capital of the issuing bank falls below a certain level. In this article, we go over the structure of CoCos, trace the evolution of their issuance, and examine their pricing in primary and secondary markets. CoCo issuance is primarily driven by their potential to satisfy regulatory capital requirements.

The bulk of the demand for CoCos has come from small investors, while institutional investors have been relatively restrained so far. The spreads of CoCos over other subordinated debt greatly depend on their two main design characteristics — the trigger level and the loss absorption mechanism. CoCo spreads are more correlated with the spreads of other subordinated debt than with CDS spreads and equity prices. This article summarizes the key proposals of the report by the Liikanen Commission. It starts with an explanation of a crisis narrative underlying the Report and its proposals.

The proposals aim for a revitalization of market discipline in financial markets. The two main structural proposals of the Liikanen Report are: The credibility of this commitment to private liability is achieved by strict holding restrictions. The anticipated consequences of the introduction of these structural regulations for the financial industry and markets are addressed in a concluding part. Assessing the Cost of Financial Regulation. This study assesses the overall impact on credit of the financial regulatory reforms in Europe, Japan, and the United States.

Long-term cost estimates are provided for Basel III capital and liquidity requirements, derivatives reforms, and higher taxes and fees. Overall, average lending rates in the base case would rise by 18 bps in Europe, 8 bps in Japan, and 28 bps in the United States. As a result, they are markedly lower than those of the IIF. The dog and the Frisbee. This paper explores why the type of complex financial regulation developed over recent decades may be a suboptimal response to the increasing complexity of the financial system.

Examples from other disciplines illustrate how decision-making in a complex environment can benefit from simple rules of thumb or 'heuristics'.

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We perform a set of empirical experiments to assess the relative performance of simple versus complex rules in a financial setting. We find that simple metrics, such as the leverage ratio and market-based measures of capital, outperform more complex risk-weighted measures and multiple-indicator models in their capacity to predict bank failure. A consistent message from these experiments is that complexity of models or portfolios can generate robustness problems.

We outline five policy lessons from these findings, covering both the design of financial regulation itself and possible measures aimed at reducing complexity of the financial system more directly. Making Everything and Nothing Possible? Contingent Convertible CoCo bonds are subject to a considerable theoretical and practical debate. Focusing on the banking industry, this paper offers a brief introduction to financial crisis review and a systematic analysis of CoCo-related publications based on a content analysis approach.

This unique and critical analysis considers — in addition to academic journal articles — first—tier grey literature in order to receive the most comprehensive picture possible and cover the multidisciplinary linking points, the current state of knowledge as well as the possible future direction of CoCos. The Case of Spain. In this article we analyse the feasibility of a bail-in for Spain. The bail-in procedure recently announced by the Council of the European Union provides for a bail-in, although important liabilities are excluded.

However, following the path and rules set out by the Council we can show that a bail-in would have been feasible in the case of the Spanish banks. Finally, we set out the advantages of such a bail-in over a bail-out in the Spanish case. E30, G21, G32, G33, H Mar J Financ Stabil. Enhancing Prudential Standards in Financial Regulations. May J Financ Serv Res.


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The financial crisis has generated fundamental reforms in the financial regulatory system in the U. Much of this reform was in direct response to the weaknesses revealed in the pre-crisis system. Systemic risk is the key factor in financial stability, but our current understanding of systemic risk is rather limited. While the goal of using regulation to maintain financial stability is clear, it is not obvious how to design an effective regulatory framework that achieves the financial stability objective while also promoting financial innovations.

This article discusses academic research and expert opinions on this vital subject of financial stability and regulatory reforms. Specifically, among other issues, it discusses the impact of increasing public disclosure of supervisory information, effectiveness of bank stress testing as a tool to enhance financial stability, whether the financial crisis was caused by TBTF, and whether the DFA resolution regime would be effective in achieving financial stability and ending TBTF.

Evidence from Bank Internal Capital Markets. Oct Financ Market Inst Instrum. We investigate the role played by the internal capital markets of bank holding companies in the distribution of the Capital Purchase Program funds to subsidiaries. We find that while all banks used a similar internal capital allocation to support their subsidiaries, program participants transferred more capital to their subsidiaries than nonparticipants. Smaller bank subsidiaries with lower capital and earnings received more capital than other subsidiaries. Our results support the argument that the distribution of capital was done in accordance with regulatory requirements that mandate bank holding companies to act as a source of strength for their subsidiaries.

Banks' capital regulation and risk: Does bank vary in size? Empirical evidence from Bangladesh. This paper primarily examines both causality effect of banks' capital regulation and risk-taking behavior based on generalized methods of moment GMM for a dynamic unbalanced panel observation of 32 commercial banks in Bangladesh over the period — The empirical findings of this study suggest that capital regulation has a significant effect on risk-taking behavior, and excessive risks impede the growth of capital ratio as well as the stability.

Moreover, from bank-level data, size does not uniformly affect the quantity of capital and risk. Large banks have poor capital ratio and higher inclination to risk than small size counterpart. Small size banks are well managed in capital ratio and risk-taking that glitter their stability through the periods. Besides these effects, corporate governance notably influenced banks to reduce credit risk and enhance stability.

Finally, this paper provides some implications for the think tanks and stakeholders of the country. Contingent convertible bonds as countercyclical capital measures. The procyclical nature of capital models under the Basel II Accord has been widely criticised for exacerbating lending in economic expansions and restricting lending during economic contractions. These criticisms have led regulators to employ countercyclical measures in subsequent Basel accords.

One of these measures, the countercyclical capital buffer CCB , has been proposed as an effective countercyclical measure in expansionary periods as a deterrent to excessive lending through increased bank capital requirements. The effectiveness of the CCB during contractions is not obvious. Contingent convertible CoCo bonds — which are bond-like until triggered by a deterioration of a prescribed capital metric, at which point they convert into a form of equity — are explored as a supplementary countercyclical capital measure for such periods to establish whether or not they function effectively.

The analysis is undertaken using global bank CoCo data, and then applied to South African banks. The Hodrick Prescott filter was applied to empirical historical data. The CCB functions as a good countercyclical capital measure in times of economic expansion by absorbing losses and stabilising the capital base through equity issuance. The issuance of CoCo bonds — if their trigger mechanisms are designed correctly — may prove helpful to banks and the broader financial sector in times of economic contraction through the countercyclical capital properties that manifest through CoCo bonds under these economic conditions.

Do these actions help to rebuild trust in the European financial sector, or are these interventions providing only short-term relief? The financial crisis and its aftermath have demonstrated the need for regulatory changes that have been realised under Basel III. New capital and liquidity requirements aimed at stabilising financial markets create severe challenges for the financial industry.

One financial instrument extensively discussed to increase the loss-absorbing capacity of banks is Contingent Convertible CoCo Bonds. These debt-like instruments automatically convert into equity once the issuing bank slides into financial difficulties and a pre-agreed trigger is pulled.

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Bank stock performance and bank regulation around the globe. Sep Eur J Finance. We analyze the effect of bank capital, regulation, and supervision on the annual stock performance of global banks during the period of — We study a large comprehensive panel of international banks and find that higher Tier 1 capital decreases a bank's stock performance over the whole sample period. However, during turbulent times stocks of more highly capitalized banks perform significantly better.

Additionally, we find strong evidence that banks that are more likely to receive government bailout during financial distress realize smaller stock performance. In contrast, we find no convincing evidence that banks that generate higher non-interest income have a higher performance. We link genetic diversity in the country of origin of the firms' board members with corporate performance via board members' nationality.

We hypothesize that our approach captures deep-rooted differences in cultural, institutional, social, psychological, physiological, and other traits that cannot be captured by other recently measured indices of diversity. Using a panel of firms listed in the North American and U. This effect prevails when we control for a number of cultural, institutional, firm-level, and board member characteristics, as well as for the nationality of the board of directors. To identify the relationship, we use as instrumental variables for our diversity indices the migratory distance from East Africa and the level of ultraviolet exposure in the directors' country of nationality.

Canadian bank capital during the Great Depression of the s: A comparison to the Basel III requirements. Apr J Bank Regul. The goal of Basel III is to make large international banks financially stable so that government bailouts will not be necessary in the future as they were during the — financial crises. In other words, the goal is to make banks as resilient as Canadian banks were during the Great Depression.

We find that Basel III does not require banks to hold as much common equity Tier 1 as Canadian banks held during the s. Comparisons regarding contingent and countercyclical capital were made, but conclusions are hard to draw because of differences in structure and purpose. We conclude that the capital buildup of Canadian banks during the s, while their economy was growing, was a key element in preparing the Canadian banking system for the Great Depression to come. Should there be a next financial crisis, regulators may again be forced to sell a large failing bank to a larger banking institution, creating yet another too-big-to-fail TBTF institution.

Regulatory plans for using OLA focus on injecting parent holding company capital into the critical operating subsidiaries of systemically important financial institutions SIFIs to keep these subsidiaries open and operating. This goal can be achieved without OLA by imposing substantially higher minimum capital requirements on critical operating subsidiaries instead of imposing them on parent SIFIs.

Investor perceptions of TBTF arise naturally given flaws in the existing deposit insurance bank resolution process, and the predilection for regulatory forbearance created by conflicting responsibilities assigned to the Federal Reserve Board FRB. The FRB duty to be the consolidated supervisor of largest BHCs and other designated SIFIs, the guardian of financial stability, and the lender of last resort make it rational for investors to expect large financial institution to receive special assistance to forestall their failure or protect their creditors from loss.

In contrast, other institutions that offer similar financial services will be allowed to fail and impose losses on similarly situated creditors. To end TBTF, financial regulation must be refocused on: The alternative approach of higher capital requirements at operating subsidiaries does not require OLA or new regulations to operationalize OLA—rules requiring minimum total loss absorbing capacity or contingent convertible debt.

These reforms will simplify regulation, improve transparency, protect taxpayers from the expense of future SIFI bailouts and eliminate the TBTF subsidy without abridging property rights and legal protection for parent SIFI creditors. Systemic Harms and Shareholder Value. The financial crisis has demonstrated serious flaws in the corporate governance of systemically important financial firms. In particular, the norm that managers should seek to maximize shareholder value, as measured by the stock price, proves to be a faulty guide for managerial action in systemically important firms.

This is not only because the failure of such firms will have spillovers that defy the cost-internalization of the tort system, but also because these spillovers will harm their own majoritarian shareholders. The interests of diversified shareholders fundamentally diverge from the interests of managers and other controllers because the failure of a systemically important financial firm will produce losses throughout a diversified portfolio, not just own-firm losses.

To encourage appropriate modification of incentives, we propose officer and director liability rules as a complement to and substitute for the prescriptive rules that have emerged from the financial crisis. Preventing Banking Crises--with Private Insurance? In this article, we review the functioning of private insurance against banking crises and identify its potential. The essential idea is that banks are recapitalized by private investors when negative events would otherwise cause a write-down of capital—or even bank insolvency.

There are two modes of private insurance: In the former, funding of banks and insurance are separated, whereas in the latter, debt holders provide insurance. We summarize the main insights regarding the potential and limits of private insurance. We also discuss how such crisis insurance could be strengthened through complementary regulatory measures.

Finally, we outline the overall pecking order of buffers and insurance for banking systems. Public Policy and Financial Economics: Comments to Honor George G. Much of this reform was in direct response to the weaknesses revealed in the precrisis system. This paper discusses academic research and expert opinions on this vital subject of financial stability and regulatory reforms. Specifically, among other issues, it discusses the impact of increasing public disclosure of supervisory information, the effectiveness of bank stress testing as a tool to enhance financial stability, whether the financial crisis was caused by too big to fail TBTF , and whether the Dodd-Frank Wall Street Reform and Consumer Protection Act DFA resolution regime would be effective in achieving financial stability and ending TBTF.

Aug J Money Credit Bank. We report an experiment that evaluates three market-based regimes for triggering the conversion of contingent capital bonds into equity: Consistent with theory, we observe inefficiencies and conversion errors in the fixed-trigger and regulator regimes. The prediction market somewhat improves the regulator's performance, but inefficiencies and conversion errors persist.


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The regulator regime has conversion errors over the widest range of shocks. Dec J Financ Serv Res. The current financial crisis offers a unique opportunity to investigate the leading properties of market indicators in a stressed environment and their usefulness from a banking supervision perspective. One pool of relevant information that has been little explored in the empirical literature is the market for bank's exchange-traded option contracts.

In this paper, we first extract implied volatility indicators from the prices of the most actively traded option contracts on financial firms' equity. We then examine empirically their ability to predict financial distress by applying survival analysis techniques to a sample of large US financial firms. We find that market indicators extracted from option prices significantly explain the survival time of troubled financial firms and do a better job in predicting financial distress than other time-varying covariates typically included in bank failure models.

Overall, both accounting information and option prices contain useful information of subsequent financial problems and, more importantly, the combination produces good forecasts in a high-stress financial world, full of doubts and uncertainties. Corporate limited liability tends to make firms under-value the possibility that their actions will have extremely bad outcomes. This distortion has been a particular focus for banking firms because their equity capital ratios are low and the government has an interest in assuring a stable financial system.

This paper describes a novel security that large financial firms could issue in order to maintain their capital ratios above regulatory minima with a very high probability. This paper provides a formal model of contingent convertible bonds CCBs , debt instruments that automatically convert to equity if and when the issuing firm or bank reaches a specified level of financial distress. We develop closed-form solutions for the value of CCBs with market-based conversion triggers and show that under certain conditions on CCB parameters, the equilibrium is unique.

We also show that CCBs can increase firm value and reduce the chance of costly bankruptcy or bailout if properly implemented. Nonetheless, shareholders of overleveraged or too-big-to-fail firms may resist straight debt-for-CCB swaps due to the debt overhang effect or the loss of the government subsidy. CCBs can also create incentives to manipulate the stock market when the conversion value of the CCB is too low or too high. The combination of risky cash flows, leverage and absolute priority rules in bankruptcy create a well known agency problem; shareholders face incentives to take risky, as opposed to value maximizing, investment projects.

Recently, it has been argued that deviation from absolute priority rules in bankruptcy or workouts mitigates this problem. Working with the principle of contract theory that ex ante welfare gains can be maximized by pre-commitment if contracts are resistant to re-negotiation , we consider efficiency gains from pre-commitment to such alternatives to absolute priority. The instrument is an inversion of convertible debt in which the conversion option is held by the owners. This instrument can be designed so that the conversion option is less costly ex post i. This design not only lessens the ex ante incentive problem but avoids the transaction costs of bankruptcies and workouts.

Finally, we show that this form of debt is re-negotiation proof. Consolidated Supervision and Financial Conglomerates. Other entities, such as parent companies and non-bank including nonfinancial group entities, may also be relevant. Bank supervisors normally require a bank to submit a set of consolidated prudential returns in addition to the solo returns prepared using only the bank's assets and liabilities. The consolidated regulatory returns combine the assets, liabilities, and off-balance-sheet positions of banks and their related companies, treating them as if they were a single business unit.

The consolidated financial reports prepared by a group form the basis for consolidated supervision, i. Systemic risk after dodd-frank: Contingent capital and the need for regulatory strategies beyond oversight. Because the quickest, simplest way for a financial institution to increase its profitability is to increase its leverage, an enduring tension will exist between regulators and systemically significant financial institutions over the issues of risk and leverage.

Many have suggested that the financial crisis erupted because flawed systems of executive compensation induced financial institutions to increase leverage and accept undue risk. But that begs the question why such compensation formulas were adopted. Growing evidence suggests that shareholders favored these formulas to induce managers to accept higher risk and leverage. Shareholder pressure, then, is a factor that could cause the failure of a systemically significant financial institution.

What then can be done to prevent future such failures? The Dodd-Frank Act invests heavily in preventive control and regulatory oversight, but this Article argues that the political economy of financial regulation ensures that there will be an eventual relaxation of regulatory oversight the regulatory sine curve. Moreover; the Dodd-Frank Act significantly reduces the ability of financial regulators to effect a bailout of a distressed financial institution and largely compels them to subject such an institution to a forced receivership and liquidation under the auspices of the Federal Deposit Insurance Corporation.

But the political will to impose such a liquidation remains in doubt, both in the United States and in Europe. If bailouts are to be ended, something must replace them, beyond relying on the wisdom of regulators. Because financial institutions are inherently fragile and liquidity crises predictable, this Article proposes a "bail-in" alternative: However, unlike earlier proposals for contingent capital, the conversion would be on a gradual, incremental basis, and the debt would convert to a senior, nonconvertible preferred stock with cumulative dividends and voting rights.

The intent of this design is 1 to dilute the equity in a manner that deters excessive risk taking, 2 to create a class of voting preferred shareholders who would be rationally risk averse and would resist common shareholder pressure for increased leverage and risk taking, and 3 to avoid an "all or nothing" transition, which may evoke political resistance and bureaucratic indecision, by instead structuring a more incremental change. More generally, in the belief that reliance on enhanced agency oversight will likely produce an ad hoc and politically contingent system of regulation and thus significant disparities in treatment , this Article recommends, as a supplementary strategy, the use of objective market-based benchmarks that are embedded in the financial institution's corporate governance.

It argues that such controls are less subject to political exigencies and more able to provide the economic shock absorber and loss absorbency that an effective response to systemic risk requires.

We study the monetary-transmission mechanism with a data set that includes quarterly observations of every insured U. We find that the impact of monetary policy on lending is stronger for banks with less liquid balance sheets - i. Moreover, this pattern is largely attributable to the smaller banks, those in the bottom 95 percent of the size distribution. Our results support the existence of a "bank lending channel" of monetary transmission, though they do not allow us to make precise statements about its quantitative importance. No Pain, No Gain? The deadweight costs of financial distress limit many firms' incentive to include a lot of tax-advantaged debt in their capital structures.

It is therefore puzzling that firms do not make advance arrangements to re-capitalize themselves if large losses occur. Financial distress may be particularly important for large banking firms, which national supervisors are reluctant to let fail. The supervisors' inclination to support large financial firms when they become troubled mitigates the ex ante incentives of market investors to discipline these firms.

This paper proposes a new financial instrument that forestalls financial distress without distorting bank shareholders' risk-taking incentives. RCD provide a transparent mechanism for un-levering a firm if the need arises. Unlike conventional convertible bonds, RCD convert at the stock's current market price, which forces shareholders to bear the full cost of their risk-taking decisions.

Surprisingly, RCD investors are exposed to very limited credit risk under plausible conditions. The financial crisis has clearly indicated that government regulators are reluctant to permit a large financial institution to fail. In order to minimize the transfer of future losses to taxpayers or to solvent banks, we need a system for assuring that large institutions always maintain sufficient capital.

For a variety of reasons, supervisors find it difficult to require institutions to sell new shares after they have suffered losses. This paper describes and evaluates a new security, which converts from debt to equityautomatically when the issuer's equity ratio falls too low. Leading up to the recent crisis, government encouraged risky lending, and failed to measure banks' risks credibly or to require sufficient capital. Regulators also failed to losses or enforce intervention protocols for timely resolution.

This paper proposes radical policy changes to prevent a recurrence. The need is not for more complex rules and more supervisory discretion, but rather for simpler rules that are meaningful in measuring and limiting risk, hard for market participants to circumvent and credibly enforced by supervisors. Contingent Capital with a Dual Price Trigger. Feb J Financ Stabil. This paper proposes a form of contingent capital for financial institutions that converts from debt to equity if two conditions are met: This structure protects financial firms during a crisis, when all are performing badly, but during normal times permits a bank performing badly to go bankrupt.

I discuss a number of issues associated with the design of a contingent capital claim, including susceptibility to manipulation and whether conversion should be for a fixed dollar amount of shares or a fixed number of shares; the susceptibility of different contingent capital schemes to different kinds of errors under and over-capitalization ; and the losses likely to be incurred by shareholders upon the imposition of a requirement for contingent capital.

I also present some illustrative pricing examples. A bank that issues COERCs also has a smaller incentive to choose investments that are subject to large losses. We find that arguments made to support this view are either fallacious, irrelevant, or very weak. For example, the return on equity contains a risk premium that must go down if banks have more equity.

It is thus incorrect to assume that the required return on equity remains fixed as capital requirements increase. It is also incorrect to translate higher taxes paid by banks to a social cost. Policies that subsidize debt and indirectly penalize equity through taxes and implicit guarantees are distortive. Finally, suggestions that high leverage serves a necessary disciplining role are based on inadequate theory lacking empirical support.

We conclude that bank equity is not socially expensive, and that high leverage is not necessary for banks to perform all their socially valuable functions, including lending, taking deposits and issuing money-like securities. To the contrary, better capitalized banks suffer fewer distortions in lending decisions and would perform better.

The fact that banks choose high leverage does not imply that this is socially optimal, and, except for government subsidies and viewed from an ex ante perspective, high leverage may not even be privately optimal for banks. Setting equity requirements significantly higher than the levels currently proposed would entail large social benefits and minimal, if any, social costs. Approaches based on equity dominate alternatives, including contingent capital.

To achieve better capitalization quickly and efficiently and prevent disruption to lending, regulators must actively control equity payouts and issuance. If remaining challenges are addressed, capital regulation can be a powerful tool for enhancing the role of banks in the economy.

Coco coupon cournon 63

First Draft August 27, This draft March 23, This report analyses the impact of failures and weaknesses in corporate governance on the financial crisis, including risk management systems and executive salaries. It concludes that the financial crisis can be to an important extent attributed to failures and weaknesses in corporate governance arrangements which did not serve their purpose to safeguard against excessive risk taking in a number of financial services companies.

Accounting standards and regulatory requirements have also proved insufficient in some areas. Last but not least, remuneration systems have in a number of cases not been closely related to the strategy and risk appetite of the company and its longer term interests. The article also suggests that the importance of qualified board oversight and robust risk management is not limited to financial institutions.

The remuneration of boards and senior management also remains a highly controversial issue in many OECD countries. The current turmoil suggests a need for the OECD to re-examine the adequacy of its corporate governance principles in these key areas. The extent to which banking firms face external financing costs when funding new loans has important implications for the role of banks in the corporate capital acquisition process, for the effectiveness of monetary policy and for the impact of capital requirements.

We investigate this issue by examining the cash-flow sensitivity of loan growth at bank holding companies, and by examining the extent to which holding companies establish an internal capital market to allocate capital among their various subsidiaries. Overall, we find that loan growth at subsidiary banks is more sensitive to the holding company's cash flow and capital position than to the bank's own cash flow and capital. Moreover, we find that bank loan growth is negatively correlated with loan growth among the other subsidiaries within the holding company.

Overall, this evidence suggests that bank holding companies establish internal capital markets to allocate scarce capital among their various subsidiaries. This paper uses disaggregated data on bank balance sheets to provide a test of the lending view of monetary policy transmission.

We argue that if the lending view is correct, one should expect the loan and security portfolios of large and small banks to respond differentially to a contraction in monetary policy. We first develop this point with a theoretical model; we then test to see if the model's predictions are borne out in the data. Overall, the empirical results are supportive of the lending view. Building an Incentive-Compatible Safety Net. Bank safety nets, originally proposed as a means of stabilizing financial systems, have become an important destabilizing influence. Government protection of bank debts encourages banks to undertake excessive risk, particularly in response to adverse shocks to asset values.

Reforms that would remove the destabilizing moral hazard consequences of government protection are considered, both from the perspective of economic desirability and political feasibility. Requiring banks to maintain a minimal proportion of subordinated debt finance, and restricting the means by which government recapitalization of insolvent banks occurs are the central features of promising reforms to the safety net.

The subordinated debt alternative to Basel II. Dec J Financ Stabil. Basel II attempts to eliminate incentives for regulatory capital arbitrage and align capital regulation with best practices in credit risk management. Despite the imposition of very heavy compliance costs, it is unlikely to succeed in achieving either goal.

This paper describes an alternative approach, based on mandatory issues of subordinated debt, which makes use of market discipline to achieve these goals at much lower cost. Factors affecting efforts to limit payments to AIG counterparties. This paper develops a structural credit risk model of a bank that issues deposits, shareholders' equity, and fixed or floating coupon bonds in the form of contingent capital or subordinated debt.

The return on the bank's assets follows a jump-diffusion process, and default-free interest rates are stochastic. The equilibrium pricing of the bank's deposits, contingent capital, and shareholders' equity is studied for various parameter values haracterizing the bank's risk and the contractual terms of its contingent capital.

Allowing for the possibility of jumps in the bank's asset value, as might occur during a financial crisis, has distinctive implications for valuing contingent capital. Credit spreads on contingent capital are higher the lower is the value of shareholders' equity at which conversion occurs and the larger is the conversion discount from the bond's par value. The effect of requiring a decline in a financial stock price index for conversion dual price trigger is to make contingent capital more similar to non-convertible subordinated debt.

The paper also examines the bank's incentive to increase risk when it issues different forms of contingent capital as well as subordinated debt. In general, a bank that issues contingent capital has a moral hazard incentive to raise its assets' risk of jumps, particularly when the value of equity at the conversion threshold is low. However, moral hazard when issuing contingent capital tends to be less than when issuing subordinated debt. Because it reduces effective leverage and the pressure for government bailouts, contingent capital deserves serious consideration as part of a package of reforms that stabilize the financial system and eliminate "Too-Big-to-Fail.

Design of contingent capital with a Stock Price trigger for mandatory conversion. The proposal for banks to issue contingent capital that must convert into common equity when the banks' stock price falls below a specified threshold, or "trigger," does not in general lead to a unique equilibrium in equity and contingent capital prices. Multiple or no equilibrium arises because both equity and contingent capital are claims on the assets of the issuing bank.

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For a security to be robust to price manipulation, it must have a unique equilibrium. For a unique equilibrium to exist, mandatory conversion cannot result in any value transfers between equity holders and contingent capital investors. The necessary condition for unique equilibrium is usually not satisfied by contingent capital with a fixed coupon rate; however, contingent capital with a floating coupon rate is shown to have a unique equilibrium if the coupon rate is set equal to the risk-free rate. This structure of contingent capital anchors its value to par throughout the time before conversion, making it implementable in practice.

Although contingent capital with a unique equilibrium is robust to price manipulation, the no-value-transfer condition may preclude it from generating the desired incentives for bank managers and demand from investors. Bank Capital and Portfolio Management: Feb J Bus. We model the trade-off between low-asset risk and low leverage to satisfy preferences for low-risk deposits and apply it to interwar New York City banks.

During the s, profitable lending and low costs of raising capital produced increased bank asset risk and increased capital, with no deposit risk change. Differences in the costs of raising equity explain differences in asset risk and capital ratios. In the s, rising deposit default risk led to deposit withdrawals. In response, banks increased riskless assets and cut dividends.

Banks with high default risk or high costs of raising equity contracted dividends the most. This paper defines a set of banking stability measures which take account of distress dependence among the banks in a system, thereby providing a set of tools to analyze stability from complementary perspectives by allowing the measurement of i common distress of the banks in a system, ii distress between specific banks, and iii distress in the system associated with a specific bank.

Our approach defines the banking system as a portfolio of banks and infers the system's multivariate density BSMD from which the proposed measures are estimated. The BSMD embeds the banks' default inter-dependence structure that captures linear and non-linear distress dependencies among the banks in the system, and its changes at different times of the economic cycle. The BSMD is recovered using the CIMDO-approach, a new approach that in the presence of restricted data, improves density specification without explicitly imposing parametric forms that, under restricted data sets, are difficult to model.

Thus, the proposed measures can be constructed from a very limited set of publicly available data and can be provided for a wide range of both developing and developed countries. This paper examines the effects of the financial crisis of the s onthe path of aggregate output during that period. Our approach is complementary to that of Friedman and Schwartz, who emphasized the monetary impact of the bank failures; we focus on non-monetary primarily credit-related aspects of the financial sector--output link and consider the problems of debtors as well as those of the banking system.

We argue that the financial disruptions of reduced the efficiency of the credit allocation process; and that the resulting higher cost and reduced availability of credit acted to depress aggregate demand. Evidence suggests that effects of this type can help explain the unusual length and depth of the Great Depression.

Bank capital and portfolio management: Corporate Governance in Financial Institutions. The papers in the present publication are based on a sample of the presentations at the Seminar. Together, the papers illuminate a number of key issues in corporate governance in a variety of financial firms.

In the first paper based on a keynote address, Spyros G. Stavrinakis, Central Bank of Cyprus gives an overview of the legal framework for corporate governance in financial institutions in Cyprus. According to a Central BankDirective issued in , implementation of corporate governance principles is mandatory for all banks incorporated in Cyprus and their overseas branches and for some Cyprus branches of foreign banks domiciled outside the European Economic Area. Banks are obliged to have a robust internal governance framework, consistent lines of reporting and effective risk identification, management, monitoring and reporting procedures for all the risks to which credit institutions are actually or potentially exposed.

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