Bisiii

Basel Committee on Banking Supervision

Consultative Document Proposal to ensure the loss absorbency of regulatory capital at the point of non-viability
Issued for comment by 1 October 2010 August 2010

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ISBN print: 92-9131-837-X ISBN web: 92-9197-837-X

Contents
Section 1: Introduction..............................................................................................................1 Section 2: Background..............................................................................................................3 Section 3: Proposal and an explanation of the mechanism......................................................4 Explanation of the elements of the proposal ...................................................................5 Section 4: Potentialimpact of the proposal on incentives ........................................................8 Common stockholders.....................................................................................................8 Capital instrument buyers................................................................................................9 Annex: Common questions and answers regarding the proposal..........................................10

Proposal to ensure the loss absorbency of regulatory capital at the point of non-viability

Proposal to ensure the loss absorbency of regulatory capital at the point of non-viability
Section 1: Introduction
In the December 2009 consultative document Strengthening the resilience of the banking sector 1 , the Basel Committee on Banking Supervisionnoted that “[the Committee] continues to review the role that contingent capital and convertible capital instruments should play in the regulatory capital treatment. The Committee intends to discuss specific proposals at its July 2010 meeting on the role of convertibility, including as a possible entry criterion for Tier 1 and/or Tier 2 to ensure loss absorbency, and on the role of contingent andconvertible capital more generally both within the regulatory capital minimum and as buffers.” This consultative document outlines a proposal to enhance the entry criteria of regulatory capital to ensure that all regulatory capital instruments issued by banks are capable of absorbing losses in the event that a bank is unable to support itself in the private market. During the recent financial crisis anumber of distressed banks were rescued by the public sector injecting funds in the form of common equity and other forms of Tier 1 capital. 2 This had the effect of supporting not only depositors but also the investors in regulatory capital instruments. Consequently, Tier 2 capital instruments (mainly subordinated debt), and in some cases non-common Tier 1 instruments, did not absorb lossesincurred by certain large internationally-active banks that would have failed had the public sector not provided support. In order for instruments to be treated as regulatory capital, the Committee considers it a precondition that such instruments are capable of bearing a loss. Three options exist to ensure this outcome: 1. Develop national and international bank resolution frameworks that enablelosses to be allocated to all capital instruments issued by internationally active banks that have reached the point of non-viability. Try to identify systemically important banks and prohibit them from including Tier 2 instruments in their regulatory capital. Require that all regulatory capital instruments include a mechanism in their terms and conditions that ensures they will take a loss at the...