CAMBRIDGE WINTER CENTER
for Financial Institutions Policy
Five Principles to Make “Contingent Capital” More Like Capital and Less Contingent
The Cambridge Winter Center has submitted a comment on the Basel Committee on Bank Supervision’s “Proposal to Ensure the Loss Absorbency of Regulatory Capital at the Point of Non-Viability.”
The “Basel Proposal” relates to hybrid securities issued by banks that are not common equity, but nevertheless have traditionally qualified for regulatory capital treatment. The proposal contemplates requiring “that all regulatory capital instruments include a mechanism in their terms and conditions that ensures they will take loss at the point of non-viability.” That mechanism would involve writing off the principal amount of capital securities issued by a distressed bank, and possibly offering their holders, in exchange, shares of common equity.
In essence, then, the proposal could give life to “contingent capital” instruments -- securities issued by banks that would function like debt in good times, but automatically convert into common equity during bad times.
Cambridge Winter’s analysis suggests that the Basel Proposal has real merit, but that policy-makers should adopt five principles to ensure that such new capital securities do not simply replicate the myriad flaws of existing bank hybrid instruments.
NOW MORE ABSORBENT!
August 25, 2010
The Basel Committee’s proposal on loss absorbency might give life to so-called “contingent capital” instruments. It should adopt five principles to cleanse the concept of the deep flaws of the traditional bank preferred market.
