How Useful Are Contingent Convertible Instruments In Preventing Future Banking Crises?

By

ACKNOWLEDGEMENT

I would like to take this chance for thanking my research facilitator, friends & family for support they provided & their belief in me as well as guidance they provided without which I would have never been able to do this research.



DECLARATION

I, (Your name), would like to declare that all contents included in this thesis/dissertation stand for my individual work without any aid, & this thesis/dissertation has not been submitted for any examination at academic as well as professional level previously. It is also representing my very own views & not essentially which are associated with university.

Signature:

Date:

ABSTRACT

A recent proposal to enhance banking stability recommends the use of contingent convertibles (CoCos). Since these hybrid securities are mandatorily converted into equity when banks are in need of a recapitalization, they are credited for reducing banks' likelihood of financial distress. This paper also provides the examples based on UK & US Banks analyzing the balance sheet by looking at pillar 3 disclosure. This thesis also explores the different capital instruments and capital resources in banks balance sheet such as reserve shares, bonds, coco's, subordinated debts, step up bonds. Our main contribution is to demonstrate that there exist conditions under which CoCo bond financing increases investors' wealth, but also increases the bank's probability of financial distress, so that the banking system as a whole will be destabilized. Thus, individually rational decisions can have systemically undesirable outcomes. Further results indicate that CoCos should be used only in conjunction with devices to control risk shifting incentives.

Table of Contents

ACKNOWLEDGEMENTII

DECLARATIONIII

ABSTRACTIV

CHAPTER 01: INTRODUCTION1

Background of the Study1

Problem Statement2

Aims and Objectives of the Study3

Research Questions4

Rationale of the Study5

Significance of the Study7

CHAPTER 02: LITERATURE REVIEW8

Convertibles as a Unique Asset Class8

Reasons of Issuing Convertibles8

Return and Risk of Convertibles9

Potential Explanations of Superior Performance9

General model framework10

Contingent Capital & The Financial Crisis21

An example of contingent capital with dual market triggers22

Why contingent capital instead of equity?26

CHAPTER 03: RESEARCH METHODOLOGY29

Research approach29

Research Design29

CHAPTER 4: RESULTS & DISCUSSION31

10 Examples of UK & US banks by analysing the balance sheet- pillar 3 disclosure31

Lloyds TSB Bank Plc33

Credit Suisse34

Royal Bank of Scotland (RBS)36

Bank of England36

Standard Chartered Bank- UK40

Citi bank- US41

Bank of America Corporation42

J.P. Morgan Chase & Co.43

Barclays Group US Inc.43

HSBC North America Holdings Inc.44

Capital Instruments And Capital Resources In Banks Balance Sheet46

CoCos as solution against banking crises: Complete contracts48

CoCos as origin of banking crises: Incomplete contracts53

CHAPTER 5: CONCLUSION74

REFERENCES78

APPENDIX A.89

A.1. Proof of Lemma 189

A.2. Expected distress costs89

A.2.1. Complete contracts90

A.2.2. Incomplete contracts90

A.3. Proof of Lemma 391

A.4. Proof of Proposition 392

A.5. Robustness results94

CHAPTER 01: INTRODUCTION

Background of the Study

CoCos have recently been issued by several investment banks. Banks have good reason to take a lot of leverage because they are lending businesses. Their equity investors expect a 20% return on their shares. But banks get to borrow only slightly more cheaply than the rate at which they lend to their customers. The difference between the rate at which the bank borrows and lends is called the "net interest margin" and may be as little as 1%. How can we turn a 1% ...