Coco bonds

Could contingent convertible bonds, or Cocos, stop a bank failing? Some regulators believe so. Cocos are just like normal bonds (IOUs) for as long as the bank holds enough capital to satisfy regulators it is solvent. However, should a bank’s safety fund fall too far, the Coco bonds would convert into shares. So say a bank has own funds (including shareholders’ equity) of £50m and risk-weighted assets (including £20m of Coco bonds) of £200m. Its capital ratio is (50/200) x 100% or 25%. But were the Coco bonds converted, this ratio becomes (70/180) x 100%, or 39%. Fine, but a sudden conversion of Cocos into equity at a troubled bank could start a fire sale of the bank’s shares. That would finish the bank off anyway.

• See Tim Bennett’s video tutorial: Bond basics.

MoneyWeek magazine

Latest issue:

Magazine cover
Walking out on the banks

The UK's best-selling financial magazine. Take a FREE trial today.
Claim 3 FREE Issues
Shale gas 'fracking' promises to transform Britain's energy market. Find out what it is, what it means, and how to invest.

More from MoneyWeek

The problem with the Bank of England

Fracking: Nine reasons not to get carried away

Five small-cap stocks worth a flutter

This Dutch company could help us tame floods

ScreenHunter_01 Mar. 25 09.51

Get the latest tips and investment opportunities from MoneyWeek magazine: Claim 3 FREE Issues HERE