Original Research

Contingent convertible bonds as countercyclical capital measures

Francois Liebenberg, Gary van Vuuren, Andre Heymans
South African Journal of Economic and Management Sciences | Vol 20, No 1 | a1600 | DOI: https://doi.org/10.4102/sajems.v20i1.1600 | © 2017 Francois Liebenberg, Gary van Vuuren, Andre Heymans | This work is licensed under CC Attribution 4.0
Submitted: 18 May 2016 | Published: 15 June 2017

About the author(s)

Francois Liebenberg, Department of Risk Management, School of Economics, North-West University, South Africa
Gary van Vuuren, Department of Risk Management, School of Economics, North-West University, United Kingdom
Andre Heymans, Department of Risk Management, School of Economics, North-West University, South Africa


Share this article

Bookmark and Share

Abstract

Background: The procyclical nature of capital models under the Basel II Accord has been widely criticised for exacerbating lending in economic expansions and restricting lending during economic contractions. These criticisms have led regulators to employ countercyclical measures in subsequent Basel accords. One of these measures, the countercyclical capital buffer (CCB), has been proposed as an effective countercyclical measure in expansionary periods as a deterrent to excessive lending through increased bank capital requirements.

Aim: The effectiveness of the CCB during contractions is not obvious. Contingent convertible (CoCo) bonds – which are bond-like until triggered by a deterioration of a prescribed capital metric, at which point they convert into a form of equity – are explored as a supplementary countercyclical capital measure for such periods to establish whether or not they function effectively.

Setting: The analysis is undertaken using global bank CoCo data, and then applied to South African banks.

Methods: The Hodrick Prescott filter was applied to empirical historical data.

Results: The CCB functions as a good countercyclical capital measure in times of economic expansion by absorbing losses and stabilising the capital base through equity issuance.

Conclusion: The issuance of CoCo bonds – if their trigger mechanisms are designed correctly – may prove helpful to banks and the broader financial sector in times of economic contraction through the countercyclical capital properties that manifest through CoCo bonds under these economic conditions.


Keywords

contingent convertibles; CoCos; procyclicality; Basel III

Metrics

Total abstract views: 470
Total article views: 2265


Crossref Citations

No related citations found.