Basel Committee to look at Tier 1 capital quality
Radical changes being prepared by the Basel Committee on capital quality rules
As things stand, 50% of Tier 1 capital is supposed to qualify as 'core' equity, which is permanent, absorbs losses and gives the issuer freedom on whether to pay dividends. The rest can comprise various types of hybrid instruments, which are currently subject to a patchwork of national laws. European reforms were intended to harmonise those laws, but the crisis has prompted a focus on more fundamental questions.
"It's not about the Basel Committee versus Europe - it is yesterday's problems versus today's problems," says the regulator. "When we started this work, it was focused on hybrid instruments, but what's happening now is a much more fundamental review of what capital really is, what it's for, and what features of capital we need to see."
The boldest idea currently under discussion would be the inclusion of an anti-cyclical element to the capital regime. In the current crisis, capital requirements have increased at a time when capital is hardest to raise, intensifying the pressure on banks. Evidently, regulators have been paying attention. There is "strong support" within the Basel Committee for a plan to keep the minimum core equity requirement at 50% but to have it float upwards to a target of 75% when times are good, the regulator says. In other words, banks would be expected to make hay when the sun shines, building a large buffer of the very best quality capital,then be allowed to wind that down as the organisation suffers losses.
Thibaut Adam, head of capital markets structuring at BNP Paribas in London, says it is an interesting approach, but one that comes with problems: "The chief question would be about timing - who would decide when we were in good times or bad?"
A second bold change could be the abolition of Tier 2 capital. The regulator argues that because these instruments only absorb losses in a bankruptcy situation - and because the crisis has shown that large, systemically important banks are too big to fail - Tier 2 capital has become completely irrelevant. "If an instrument only has loss-absorbing capacity in an event that will never happen, then it has no loss-absorbing capacity for the purposes of Basel II. If these lower-quality instruments don't count for regulatory purposes, then banks will have little incentive to use them," he says.
The result will be a greater need for capital that has the same qualities as core equity. However, bankers argue that investors don't want to buy capital that is both permanent and would get written down by losses. One compromise might be to create fixed-term notes that are loss-absorbing. The regulator isn't impressed: "If there is a term limit, it obviously makes the hybrids more debt-like. It is hard to say where this dilemma will end up, but I refuse to believe banks will never be in a position to issue equity capital. Banks will have to issue these capital instruments, and ultimately there will be investors willing to buy them. It all depends on the pricing."
Only users who have a paid subscription or are part of a corporate subscription are able to print or copy content.
To access these options, along with all other subscription benefits, please contact info@risk.net or view our subscription options here: http://subscriptions.risk.net/subscribe
You are currently unable to print this content. Please contact info@risk.net to find out more.
You are currently unable to copy this content. Please contact info@risk.net to find out more.
Copyright Infopro Digital Limited. All rights reserved.
You may share this content using our article tools. Printing this content is for the sole use of the Authorised User (named subscriber), as outlined in our terms and conditions - https://www.infopro-insight.com/terms-conditions/insight-subscriptions/
If you would like to purchase additional rights please email info@risk.net
Copyright Infopro Digital Limited. All rights reserved.
You may share this content using our article tools. Copying this content is for the sole use of the Authorised User (named subscriber), as outlined in our terms and conditions - https://www.infopro-insight.com/terms-conditions/insight-subscriptions/
If you would like to purchase additional rights please email info@risk.net
More on Regulation
FCA presses UK non-banks to put their affairs in order
Greater scrutiny of wind-down plans by regulator could alter capital and liquidity requirements
Industry calls for major rethink of Basel III rules
Isda AGM: Divergence on implementation suggests rules could be flawed, bankers say
Saudi Arabia poised to become clean netting jurisdiction
Isda AGM: Netting regulation awaiting final approvals from regulators
Japanese megabanks shun internal models as FRTB bites
Isda AGM: All in-scope banks opt for standardised approach to market risk; Nomura eyes IMA in 2025
CFTC chair backs easing of G-Sib surcharge in Basel endgame
Isda AGM: Fed’s proposed surcharge changes could hike client clearing cost by 80%
UK investment firms feeling the heat on prudential rules
Signs firms are falling behind FCA’s expectations on wind-down and liquidity risk management
The American way: a stress-test substitute for Basel’s IRRBB?
Bankers divided over new CCAR scenario designed to bridge supervisory gap exposed by SVB failure
Industry warns CFTC against rushing to regulate AI for trading
Vote on workplan pulled amid calls to avoid duplicating rules from other regulatory agencies