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12 | October 2010 | ifr special report FIG


Unanswered questions


The publication last month of the Basel Committee’s core capital requirements provided much-needed clarity on some aspects of the debt side of the bank capital market. But others, especially the role of contingent capital, still await elucidation. While key aspects of the new regulatory landscape are yet to be revealed, market participants are beginning to make assumptions about how the market will look in future. Matthew Attwood reports.


“The second phase will establish how the entire capital structure should look in future, and that I think is when we’ll know more about the debt instrument components like hybrid Tier 1 and contingent capital of whatever form.”


D


espite the fanfare attendant on the Basel Committee’s latest promulgation on September 12, for many involved in the bank capital market it was just the first phase of revelation about the new regime. Common equity, or core Tier 1, will be increased from 2% to 4.5% while the total Tier 1 ratio will be raised from 4% to 6%. That leaves 1.5% to be filled by non- equity paper, most probably hybrids. The market will have two years from January 2013 to accomplish this – an achievable task for most banks. A 2.5% capital conser- vation buffer composed entirely of common equity, rather than a proportion of contingent capital as some had hoped, will be introduced between 2016 and 2019. While that buffer is not mandatory, banks without it will be constrained in terms of dividend and other payments, meaning there is an effective 7% minimum Core Tier 1 requirement. Several market participants have related a rumour, circulating prior to the Basel Committee’s announcement, that the Core Tier 1 requirement was going to be 7.5% rather than 7%. The extra half a per cent was to be devoted to a hybrid component within the capital conserva- tion buffer, it said. The assumption is this was dropped for purity’s sake. “That release on September 12 was really just about core capital,” said one DCM banker. “The second phase, the one we’re waiting for now, will establish how the entire capital structure should look in future, and that I think is when we’ll know more about the debt instrument


components like hybrid Tier 1 and contingent capital of whatever form.”


Too big to answer He, and many others, say the biggest development in that respect will be the too big to fail buffer. “That’s coming from a completely different work-stream at Basel, but it’s expected to converge at the Seoul meeting later in the year. At the moment it’s an x% on the diagram and that x% is completely unpredictable.” Many equity analysts are predicting that the buffer will be large, potentially adding another 2% to 4% to the existing require- ments for systemically important banks, with hybrid or contingent capital likely to be permissible.


“The whole exercise has been about raising the capital requirements of banks very significantly, but in a way that achieves two things: differential application to different classes of banks and market confidence,” said a banker active in the capital solutions field for financial institution clients. “You’ve got a minimum level that the market will surpass easily – the rest is expressed in buffers. So you don’t have the calamity of banks falling into a breach situation with all the panic that would entail. The term buffer is used simply to help the market believe it can be breached without disaster. Yes, it’s a question of semantics but for good reason: to instil confidence.” Many in the market agree that debt-like capital instruments will have a key role to play. It is likely that 1.5% of the total Tier 1 ratio will come in hybrid format, while


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