One can only welcome ECB’s rethinking on CoCos. They make banks’ capital structures unnecessarily complicated and create hidden risks.
CoCo, or Contingent convertible bond, is a type of bond issued by a bank that can be converted into equity if some bad event happens, see Wikipedia.
CoCos are one of these things that sound fantastic in theory. When a bank fails, losses can be spread to creditors rather than taxpayers and in the process providing capital, exactly when the bank needs it.
The problem is the real world, as well argued by Charles Goodhart on VoxEU, Are CoCos from Cloud Cuckoo-Land?
They increase complexity and they are most likely to be triggered when the financial system is already in a state of (near) crisis. Therefore, they may just end up spreading misery to other, yet surviving, financial institutions.
As Charles said it
Would it not just be simpler and easier to raise equity capital requirements directly, rather than go through this more complicated rigmarole?
© All rights reserved, Jon Danielsson, 2019