Research

Work in progress:

Instabilities of two-layered CoCo capital structures

In this paper we develop a theoretical model of bank runs, using cash-in-the-market pricing, to analyze the effects of different layers of CoCo debt. Contingent Convertible Bonds (CoCos) are promoted by regulators as a bail-in mechanism in times of distress. CoCo debt is debt which converts into equity or is written down at pre-specifed trigger levels which indicate a bad state of the bank. Basel III imposes a minimum requirement for the trigger level (low trigger). Only a few large banks world-wide hold both high (above minimum requirement) and low trigger going concern CoCos on their balance sheet, either by choice or by regulation. We analyze the effects of CoCo conversion for banks with a two-layer CoCo capital structure. We find that this structure can be detrimental for the bank’s financial health, due to premature conversion and runs on equity. We argue that initial capital structure matters for the range of inefficient conversion, and provide an argument against market-based triggers.In contrast with existing literature, we show that book-based trigger CoCos can provide a first best outcome, as long as they incorporate expected credit losses. Our main insights can be generalized to any event with a strong informational value, not only to a high trigger CoCo conversion.

Capital Allocation, Leverage Ratio Requirement and Banks’ Risk-Taking (joint with Quynh- Anh Vo, Bank of England)