We propose a new form of hybrid capital for banks, Equity Recourse Notes (ERNs), which (1) ameliorate booms and busts by creating counter-cyclical incentives for banks to raise capital, and so encourage bank lending in bad times; (2) help solve the too-big-to-fail problem; and (3) reduce the regulatory system’s reliance on accounting measures of capital. ERNs avoid the flaws of existing contingent convertible bonds (cocos) -- in particular, they convert more credibly. Future required increases in bank-capital should be permitted to be in the form of either equity or ERNs.
