Working Paper: CEPR ID: DP10213
Authors: Jeremy Bulow; Paul Klemperer
Abstract: We propose a new form of hybrid capital for banks, Equity Recourse Notes (ERNs), which ameliorate booms and busts by creating counter-cyclical incentives for banks to raise capital, and so encourage bank lending in bad times. They avoid the flaws of existing contingent convertible bonds (cocos)--in particular, they convert more credibly--so ERNs also help solve the too-big-to-fail problem: rather than forcing banks to increase equity, we should require the same or larger capital increase but permit it to be in the form of either equity or ERNs--this also gives some choice to those who claim (rightly or wrongly) that equity is more costly than debt. ERNs can be introduced within the current regulatory system, but also provide a way to reduce the existing system?s heavy reliance on measures of regulatory-capital.
Keywords: bail-in; bank; bank capital; capital requirements; CoCo; contingent capital; contingent convertible bond; SIFI
JEL Codes: G10; G21; G28; G32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Decline in share price (G19) | Increase in ability to raise capital (O16) |
| ERNs (R10) | Countercyclical incentives for banks (G21) |
| ERNs (R10) | Financial stability (G28) |
| ERNs (R10) | Solution to too-big-to-fail problem (G28) |
| ERNs (R10) | Credible conversion mechanism (C59) |