If you had asked bankers and policy makers a year ago what "contingent capital" was, most would have responded with a blank stare. Then capital-raising options began drying up as the financial crisis deepened and now, suddenly, the stewards of the banking system are touting this once-fringe idea as a key to avoiding more government rescues.

What is contingent capital? In short, it's a debt instrument that a bank could quickly convert into equity in a time of crisis, theoretically reducing the need for a bailout. Treasury Secretary Tim Geithner, Fed Chairman Ben Bernanke, and William Dudley, the president of the Federal Reserve Bank of New York, have all voiced strong support for the idea, with Dudley making it the centerpiece of a speech at a conference of international bankers.

Implementing it, though, might be easier said than done. There's no widespread agreement on whether the conversion would be triggered by a drop in book value, share price, or some other event entirely. And there are no guarantees that fixed-income investors who issued the debt would be much interested in becoming shareholders.

Still, with regulators - and the public - wary of bailouts, the push is on to include contingent capital in any rewrite of the Basel II accords.

Contingent capital isn't really an option for small banks, however, since most don't raise money by issuing debt. So what's a troubled small bank to do, other than pass the hat around the boardroom?

One big idea that could gain steam in 2010 is raising capital through the creation of a "bad-bank" subsidiary, says Kenneth Moore, a partner at Reitner, Stuart & Moore in San Luis Obispo, Calif. Under that scenario, a bank would shift nonperforming assets into a newly created bad-bank funded largely by outside investors - most likely private equity - and that cash infusion would be added to the bank's capital.

For now, Moore is advising banks in need of capital to consider establishing bad-bank subsidiaries and to be ready to act if and when regulators get comfortable with the structure.

One warning, though: setting up a bad bank can be expensive. "Private equity will want a significant return on their investment," Moore says. "We're hearing 15 to 25 percent."

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.