With greater need to set aside loss reserves once corporate restructuring picks up speed, Korean banks are tapping into the merits of contingent convertible bond issues to bolster capital and prepare for potential risks ahead.

Contingent convertible (CoCo) bonds that can be converted into equity if pre-specified trigger event occurs has been popularly used for crisis management in the banking sector such as in the 2007-2008 financial crisis to allow quick capital injection to prevent bankruptcy or systematic collapse of a financial institution.

According to financial industry sources on Tuesday, a number of local lenders are scheduled to issue CoCo bonds this year. State-run Korea Development Bank (KDB) in need of recapitalization as the major creditor to most of troubled shipbuilders and shipping companies mulls CoCo bond issue worth 700 billion won ($600 million) in May. Among major commercial banks, Shinhan Bank and KEB Hana Bank are rolling out CoCo issues each in 300 billion won and 200 billion won, respectively, in June. State-invested Industrial Bank of Korea (IBK) is planning another 600 billion won issue within the year following 400 billion won issue in April.

The bonds have appeal to both investors and issuers. They yield higher returns than standard bonds and do not affect share prices. Moreover, the bonds serve as a form of capital.

Banks are required to boost their capital adequacy ratio to 11.5 percent to meet the Basel III guideline by 2019. Most of them have kept up capital at near the BIS adequacy ratio of 11.5 percent. But about 10 percent of the earlier CoCo issued under the Basel II regulation is being counted out as capital every year.

The BIS capital ratio for Shinhan Bank and KEB Hana Bank stood at 15.0 percent and 15.3 percent, respectively, as of the first quarter this year. And the BIS ratio for the state-run lenders KDB and IBK were each at 14.2 percent and 12.51 percent, respectively, as of the end of 2015.

Banks also may be turning to CoCo issues to ready ammunition for bigger loss reserves against insolvent loans and bonds once restructuring of ailing companies kicks off.

By Park Yoon-ye

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