question on Basel II: Scope and capital definition

[Liming]

Dear David,

In reference to above title from page http://www.bionicturtle.com/learn/article/basel_ii_scope_and_capital_definition/

Can you please explain why some hybrid debt securities and short-term subordinated debt securities can be counted as eligible capital under Basel II ? why not long-term debt since they are not to be repaid soon?

Can you also kindly elaborate on the meaning of "covenant limiting payment if impairs bank's capital requirements"?

Thank you!


Cheers
Liming

 

[David Harper CFA FRM]

Hi Liming,

I am not sure of the logic that enters the maturity criteria for Tier 3, Note the original maturity must have been at least two years. Here is from Basel:

49(xiv). For short-term subordinated debt to be eligible as Tier 3 capital, it needs, if circumstances demand, to be capable of becoming part of a bank’s permanent capital and thus be available to absorb losses in the event of insolvency. It must, therefore, at a minimum:
• be unsecured, subordinated and fully paid up;
• have an original maturity of at least two years;
• not be repayable before the agreed repayment date unless the supervisory authority agrees;
• be subject to a lock-in clause which stipulates that neither interest nor principal may be paid (even at maturity) if such payment means that the bank falls below or remains below its minimum capital requirement.

Re: elaboration on covenant: I am sorry, I don't understand the context?

David

 

[Liming]

Dear David,

Thank you for your 49(xiv) from Basel, which is very helpful! Just to double check abut the last point which concerns the lock-in clause. Does it mean that a bank can postpone its interest or principal payment if such payment may impair the capital status of the bank in question, ie. less equity capital, falling below its capital adequacy ratio requirement?

Thanks

Cheers!
Liming
04/10/2009

 

[eddfung]

To my understanding, in Canada, the banks do offer some debts with strange conveneta that they may defer to pay you interest and principal if that weakens the cap ratio and that may convert the debt into preferred shares. They are generally offered in a better return and lower credit rating. I did not know what that really means before studying FRM.

eddfung