BoE questions benefits of contingent capital

1 June 2012

Britain's banking system could face further difficulties if financiers decide to sell contingent capital bonds.

That is according to a new report by the Bank of England (BoE), which has questioned the wisdom of lenders using these products to protect their business should it run into serious financial difficulties.

A number of major banks have sold these bonds - which are more commonly known as CoCos - to investors, including Credit Suisse and the Lloyds Banking Group, but the central institution has indicated that the widespread facilitation of the products may result in "wider systemic problems".

CoCos are sold to individuals on the premise that if the bank's core capital level decline below a specified level, this debt will turn into shares to provide the company with a bigger cushion against financial problems.

However, the BoE stated this means investors are incentivized to "manipulate the conversion trigger to generate a conversion or bank equity holders", while banks may opt to try and avoid such a conversion occurring.

By Tony Aynsley

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