BANKING CRISES could be averted by paying bonuses to bank staff and dividends to shareholders through a form of debt that converts to capital if the bank runs aground, according to a senior official at the Bank of England.
Andrew Haldane, executive director for financial stability at the Bank of England, said contingent convertible securities, or CoCos, which convert automatically to capital when triggers are breached, could be used as a means of reducing risk at banks.
This would make banks “much more resilient and less likely to fail” and incentivise bankers to reduce risk, he said in a speech to the Institute of International and European Affairs in Dublin.
“In the good times you get paid and in the bad times your debts are diluted so you bear the downside risk of your actions,” he said.
“That will make those shareholders in banks and staff in banks much more risk sensitive, much less likely to bet the ranch next time around.”
Paying staff in CoCos would help create a market for them, he said. If UK banks had paid bonuses and half their shareholders’ cash dividends by way of CoCos, their capital levels would have been much higher and “may have averted the crisis”.
When a bank starts to get in trouble, it would be bolstered by the conversion of some debts to capital and the market discipline from trading in these securities would create an early warning signal of six to nine months.
“You get a bank that automatically recapitalises itself if it falls onto stony ground,” he said.
Large banks that were “too big to fail” should be required to hold more capital and “put more aside for a rainy day” to choke off the supply of credit during a boom.
The financial system had been put at risk by the biggest banks devoting a greater proportion of their balance sheets to doing business with each other. This gave rise to an “increasingly dense” web of interconnections that made large institutions too big to fail.
“We know that when those big guys go down the collateral damage is that much greater because they are connected to the whole world,” said Mr Haldane.
