The Reserve Bank wants to remove certain debt instruments lenders use to raise funds which can then be deemed to meet regulatory capital levels set to avoid the event of a meltdown.
The central bank's second options and issues paper on a wide-ranging review of the system's capital framework proposes limiting common equity and preference shares as the only allowable instruments qualifying as Tier 1 capital, and long-term subordinated unsecured debt without triggers that freeze interest payments as Tier 2 capital. Other instruments would still be available for banks to use to fund their operations but wouldn't go towards the regulated capital levels.
"Given the dominance of parent entities as Tier 1 contingent debt issued by the big four banks, contingent debt appears to have been used as a substitute for ordinary shares," the Reserve Bank said. "The loss absorbing quality of ordinary shares is far greater than that provided by contingent debt, thus the quality of capital in the regime has arguably been harmed by as a result of accepting contingent debt as Tier 1 capital."
The Reserve Bank wants to complete a review of banks' capital settings by early next year, with six high-level principles: capital can readily absorb losses before they're passed on to creditors and depositors; capital requirements are set in relation to bank exposures; different methodologies to set capital needs don't create unduly different outcomes; capital requirements should be conservative compared to international lenders; the framework should be practical to administer; and the regime should be transparent.
The latest paper is seeking feedback specifically on what instruments should qualify as bank capital, which has seen a rise in the use of contingent debt after the global financial crisis and adoption of new international banking rules.
