Year: 2012

Everyone agrees on the need for big changes to bank resolution mechanisms both in Europe and in the USA. The problems with bank resolution differ in Europe and the USA, and the appropriate solutions differ too. Coco bonds make great sense for the Eurozone but are less appropriate for the USA. European regulators need to think for themselves on cocos, not just ape the muted response of US regulators. Contingent convertible (coco) bank bonds have a trigger point (such as a minimum equity/asset ratio) which when reached immediately forces a conversion of the liability from a debt to an equity claim. So when the bank gets into trouble, junior-grade debt liabilities immediately disappear and are replaced by diluted equity. Coco bank bonds are a very partial solution (at best) to the TBTF bank resolution problem in the USA. For all but the very biggest banks, the harsh and effective resolution system in the USA can close and re-open troubled banks very quickly. This type of super-fast bank resolution will never happen in the fragmented multi-national banking system of the Eurozone. Also, the technical competence of bank oversight in the USA will never be matched across all seventeen countries of the Eurozone, some of whom have long histories of weak and ineffective bank regulation. Cocos can partly substitute for weak regulatory oversight by encouraging greater market discipline emanating from bank bondholders.  Cocos would fit well into the design of a politically-feasible banking union for the Eurozone. 

If the euro survives, some type of contingent convertibility for bank debts in the Eurozone is likely to be part of the new banking system.  Ireland as a small economy in the Eurozone would particularly benefit from a coco feature imposed on bank bonds, and should encourage this regulatory policy innovation.