BREAKINGVIEWS-FSA too weak on hybrid capital

December 11, 2009

— The author is a Reuters Breakingviews columnist. The opinions expressed are his own — 
   By George Hay
   LONDON, Dec 11 (Reuters Breakingviews) – The Financial Services Authority needs to be tougher on bank capital. The UK regulator is considering allowing banks to count their current stock of hybrid securities as part of loss-absorbing reserves for another decade, and potentially longer. Such a grandfathering goes against the FSA’s policy goal of improving the quality of bank capital.
   Hybrid securities pay interest and have a par value like debt but are supposed to lose value like equity if the issuer gets in trouble. In the recent crisis, though, the existing hybrid issues were seen, by investors and governments alike, as insecure capital — not sufficiently permanent and with dividends that could not easily be cut.
   The FSA has responded by leading the charge for contingent convertibles — debt instruments that automatically convert into equity if certain triggers are met. These so-called CoCos allowed Lloyds Banking Group <LLOY.L> to kill two birds with one stone. The bank raised 7.5 billion pounds in capital while at the same converting its stock of unloved hybrids.
   If it wanted to, the FSA could force all UK banks to follow suit, by announcing that after next year non-compliant Tier 1 securities would not be recognised as loss-absorbing. But although its latest consultation will improve hybrid quality, it contains a get-out clause. Banks will be allowed to count the offending securities as Tier 1 capital until 2020, and then in a reduced capacity until 2040. They can even keep issuing new non-compliant hybrid debt until the end of next year.
   The FSA has reasons for being timid. It may not want to overburden bank investors. They could already be asked to help UK banks raise 33 billion pounds of extra capital to meet new adequacy standards for trading books and securitisations. Other reforms will require even more. The regulator also may not want to get too far ahead of EU nations, or of the Basel Committee, the sector’s global regulator.
   But the FSA has already shown it is willing to take a lead on critical reforms — it unilaterally published views on new liquidity buffers ahead of the Basel group. It should get tougher on capital as well.
   — The Financial Services Authority has proposed allowing UK banks to hold current Tier 1 capital instruments which do not comply with its new rules for ten years after the guidelines become official at the end of next year.
   — Under new proposals put out to consultation on Thursday, hybrid capital held by banks — such as permanent interest-bearing shares (PIBS) and preference shares — must meet new standards on permanence, flexibility of payments and loss absorbency from Dec. 31, 2010 to be eligible as Tier 1 capital.
   — However, instruments issued before Dec. 31, 2010 will remain eligible as Tier 1 capital until Dec. 31, 2020, and will afterwards still be allowed to count as a declining proportion of Tier 1 capital until 2040.
   (Editing by Edward Hadas and David Evans)
Friday, 11 December 2009 10:21:38RTRS [nGEE5BA0PY] {EN}ENDS

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