Given the large dividends and bonuses paid out by banks historically, distributing in CoCos could increase banks’ capital base materially. Consider UK banks. Imagine that 50% of bonuses had been paid in CoCos rather than cash from 2000 to 2006. By 2007 at the start of the crisis, UK banks’ capital ratios would have been around 1 percentage point higher (Chart 11). Had 50% of dividends in addition been CoCoed, and assuming CoCos counted as Tier 1 capital, capital ratios would have been 3 percentage points higher. That is roughly £ billion, or around the amount of external capital UK banks raised during the crisis. Second, CoCo payouts potentially better align risk-taking incentives among staff and shareholders than cash or even equity payouts. The crisis demonstrated all too visibly some of the downsides of equity-based remuneration. One is the temptation to gamble for resurrection when poised on the brink, given the gambler’s option embedded in equity. A second is the perverse incentive not to seek external equity because of the dilutive impact it might have on managerial wealth. Both of these adverse side-effects were evident at Bear Stearns and Lehman Brothers. Remunerating management in CoCos removes this temptation, in much the same way as would credibly loss-absorbing sub-ordinated debt.21 In peacetime, management is no longer offered the upside of equity, only the downside. The asymmetry of payoffs embedded in peacetime bonus packages – “heads I win, tails society loses” – is neutralised somewhat by paying in CoCos.
Also see “The Riksbank’s inquiry into risks on the Swedish housing market,” 2011, and “Financial imbalances in the monetary policy assessment”, article in the Monetary Policy Report, July 2013. 7  See Andersen, A.L, Duus C. and Lærkholm Jensen T., “Household debt and consumption during the financial crisis: Evidence from Danish micro data”, Working Papers 89, 2014, Danmarks Nationalbank, Dynan, K.,” Is Household Debt Overhang Holding Back Consumption?”, Brookings Papers on Economic Activity, 2012, and Mian, A. Rao, K. and Sufi, A., ”Household Balance Sheets, Consumption, and the Economic Slump”, Quarterly Journal of Economics 128(4), pp. 1687–1726, 2013. 6  BIS central bankers’ speeches  Figure 7 The relationship between indebtedness and the development of consumption among Danish households during the financial crisis Per cent 4  4  2  2  0  0  Change in -2 consumption between 2007 and 2009, in relation -4 to income in 2007  -2  -6  -6  -8  -8  -10  -4  0  50 100 150 200 250 300 350 400 450 500 550 600 650 700 Debt-to-income ratio in 2007  -10  Source: Andersen, A.L, Duus C. and Lærkholm Jensen T., “Household debt and consumption during the financial crisis: Evidence from Danish micro data”, Working Paper, Danmarks Nationalbank. One hypothesis argues that highly indebted households particularly increased their indebtedness before the crisis with the aim of increasing consumption, based on, for example, optimistic expectations.