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JEL Code

F30, G18, G28

Abstract

Basel III introduced significant innovations in bank regulation. One of them is the minimum required leverage ratio. To help banks implementing the new measure , Basel III created two different core capital measures: Common Equity Tier 1 (CET1) and Additional Tier 1 (AT1). Since raising capital for CET1 is expensive, other instruments are used to build up AT1 in case of need, like for example Contingent Convertible (CoCo), which can convert to equity or written-down when a bank is under stress. In this paper we show that CoCos are not suitable as regulatory core capital instruments. Problems of timing, incentives, systemic risk, regulatory discretion and regulatory capture make CoCos unreliable as core capital instruments, and regulators should not treat them as such.

Submission Date

June 2020

Approval Date

3-31-2020

Publication Date

5-25-2020

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