andreas dombret : in support of coco bonds op - ed by dr andreas dombret, member of the executive board of the deutsche bundesbank, published in frankfurter allgemeine zeitung, 21 february 2015. * * * one of the key outcomes of regulatory reform in the banking industry, launched in 2008, is that banks need more and more capital. to illustrate this point, the new basel iii regulatory framework requires credit institutions to hold significantly more higher - quality capital than before. in addition, global systemically important banks need to additionally strengthen their capital base so that they can bear potential losses unassisted. the idea is to enhance banks ’ resilience and avoid putting taxpayers back on the hook for banks ’ losses in future crises. although these reforms are good, they raise the question of how banks will be able to cover growing capital requirements. with this in mind, we should turn our attention to a different kind of capital instrument. known as “ contingent convertible bonds ”, or “ coco bonds ” for short, they are bonds which convert automatically from debt to equity upon a specific trigger event – for instance, if an institution is faced with insolvency or if its tier 1 capital ratio drops below a certain threshold. in such cases, coco bonds increase the bank ’ s capital buffer. this new type of bond is attractive to credit institutions for several reasons. one is that, under certain conditions, coco bonds are recognised by supervisors as capital. these conditions hinge on the category to which the capital is to be assigned and reflect, for instance, subordinated status and long - term availability of the capital. the issuing bank ’ s discretionary scope for deciding whether or not to make coupon payments to investors is a further condition. another selling point for coco bonds to banks is that interest payments on the bond are tax - deductible. coco bonds can be attractive to institutional investors as well ; owing to their particular risk, they promise superior returns to those on normal bonds – which accounts for much of their appeal to investors, particularly in the current low - interest - rate setting. so are coco bonds a “ silver bullet ” for banks? in germany at least, their importance has been marginal up to now. up until the end of last year, these bonds were issued mainly by large banks in spain, switzerland and the united kingdom. their total volume amounted to some €50 billion. only two german institutions issued coco bonds in 2014. uncertainties surrounding the

a certain extent. for those institutions that are the most heavily affected, fulfilling the basel iii requirements will undoubtedly present a challenge that should not be underestimated. yet for them as well – and let ’ s remember there is just a relatively small number of such institutions – i consider the consequences of the reforms to be acceptable. past experience teaches us that preliminary calculations tend to overestimate rather than underestimate the actual requirements. this is due, among other things, to the fact that we look at bank balance sheets as at a specific reporting date and do not take the banks ’ reactions, such as restructuring operations on the asset side, into account. however, this is where i do see considerable leeway for a number of institutions. the equity ratio of german banks and savings banks has risen by more than half a percentage point to currently 16. 2 % since september last year, which was due primarily to the reduction in risk - weighted assets. furthermore, the new rules will not come into play overnight. it is planned that all institutions shall be given longer implementation deadlines to give them enough preparation time for the transition. this will extend the period in which institutions can, for example, retain profits in order to strengthen their capital base. it may also make it easier to raise fresh capital if a favourable market environment can be expected. not least, the transitional periods also provide institutions with sufficient time to thoroughly check their business models. as the german representative in the basel committee, i will do everything i can to ensure that the transitional arrangements are 3 / 5 bis central bankers'speeches adequate. while some institutions will have their work cut out for them, the majority of german credit institutions will barely need to take any action. this applies, in particular, to small and mediumsized institutions. as i mentioned earlier, some of you in this room can probably even expect to see lower capital requirements in future. with a bit of luck, we will be able to create the first basel iii fan base here tonight. 4. don ’ t lose sight of the objective : basel iii in context with this in mind, i would now like to steer your attention away from the immediate towards the longer - term implications of the basel iii reforms. after all, this set of rules has the demanding task of laying down global standards for the banking system – possibly for many years to come. you will, of course, experience this first hand in a variety of different ways. credit institutions will, after all, either be