William Dudley wasn't the first regulator to endorse the idea of allowing banks to convert debt into equity if they need capital in a pinch, but the president of the Federal Reserve Bank of New York has gone further than any other policymaker in making the case that "contingent capital" is key to averting another banking crisis.

While there are less-complex proposals out there, like simply requiring large banks to hold more capital, Dudley worries that when bad loans begin piling up, even well-capitalized banks can find themselves with thin buffers and few options for raising capital. They wouldn't have such worries if debt could be automatically converted into equity in the event of a capital crisis.

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