In our paper, Why and How to Design a Contingent Convertible Debt Requirement, which was recently made publicly available on SSRN, we develop a proposal for a contingent capital (CoCo) requirement. We show that CoCos can play a unique role alongside a standard minimum book value of equity ratio requirement. If properly designed, a CoCo requirement can provide a more effective solution to the “too-big-to-fail” problem, by ensuring adequate capital relative to risk, and it can do so at a lower cost than a simple equity requirement. A proper CoCo requirement can provide strong incentives for the prompt recapitalization of banks after significant losses of equity, or for the proactive raising of equity capital when risk increases. Consequently, it can also provide strong incentives for effective risk governance by regulated banks, and can reduce forbearance (supervisory reluctance to recognize losses).

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