Push for ‘Contingent Capital’ Has Momentum

By Emily Flitter

 

 

A regulatory drive to force large, systemically risky banks to issue “contingent capital,” a new type of instrument that allows institutions to quickly convert debt to equity under stressful circumstances, is gaining momentum. Federal Reserve Board Chairman Ben Bernanke became the latest policymaker to discuss such a plan at a hearing Thursday, in a sign the idea, which was considered radical as recently as last year, has become increasingly mainstream. In theory, such a debt instrument would allow a bank to quickly raise capital if a crisis occurs, lowering the risk that the government would have to bail it out. During the hearing, Bernanke said regulators are still working on capital standards that would be “calibrated to the systemic importance of the firm.” “Options under consideration in this area include requiring systemically important institutions to hold aggregate levels of capital above current regulatory norms or to maintain a greater share of capital in the form of common equity or instruments with similar loss-absorbing attributes, such as ‘contingent’ capital that converts to common equity when necessary to mitigate systemic risk.” Observers said regulators are certain to make contingent capital part of new capital rules. “The plan is going to be part of the rewrite of capital rules in the Basel II accords,” said Karen Shaw Petrou, managing director of Federal Financial Analytics. “You’ll see a plan out by year-end. There is a determination to find a way of putting contingent capital into the Tier 1 capital base going forward. That’s why everyone’s talking about it.”

 

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