Published by El Nuevo Herald on June 07, 2013
There is a big controversy in the U.S. over the banks too big. Some propose to remove its implicit subsidy reducing them in size. Others propose to increase its Legal Reserve and properly design a convertible contingent bond issuing (CoCos).
European banks recently authorized by the European Banking Authority (EBA), launched a bond issue of 5,000 million euros, of which most have been called CoCos Bonds.
There are normal convertible bonds, where the buyer has the option to "convert" these bonds into shares at maturity. The Bonds CoCos have no such option. Automatically converted into shares when the capital of the issuing institution starts to drop to a preset limit.
Of course, for a bank issuing CoCos Bonds, this is big business. Banks in the U.S. are under scrutiny from regulators that require a healthy relationship capital -assets.. When capital starts to fall and the market value is less than 9%, usually a CoCo bond becomes in share, thereby increasing the bank's capital, which thus avoids a possible federal intervention.
The advantage of a buyer CoCos Bond is, interest usually perceived is higher under risk. Obviously, the disadvantage is that such conversion in shares is enforced. In other words, investors in CoCos bonds becomes a shareholder when the share of the company that sold you the CoCo, falls.
Supporters of the "too big to fail" theory say that the big banks, for his great capacity, provide more valuable services. The reality is, these banks for being federally guaranteed, offer a safer investment to depositors. Based in this safety, big Banks pay less interest to the public that small banks to attract customers, who are forced to pay more interest than larges given their lack of collateral.
Those who support the thesis that big banks should disappear too, believe that these financial institutions have received excessive protection and have taken advantage to deliberately profit.
Those who argue that banks too big should continue, are proposing two solutions to prevent its collapse: 1) Issuing CoCos Bonds to offset a fall in capital. 2) increase the legal reserve to 20%. From early 2012 this reserve is 10% for banks with more than 79.5 million in deposits and 0% for time deposits.
There are 29 banks in the world, of which 8 are Americans considered "systemically important." This means that their failure would cause serious trouble to the economy.
We are suggesting that banking procedures should be more flexible to promote greater competition and thus ensure that we'll have more access to credit, and in this way, also invigorating the economy.
And certainly, the CoCos Bond issuing could be a double-edged sword. Indeed, some entities with calculated insolvency, may be involved in the process.
Benjamin F. DeYurre
Economist and Journalist.
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