Banks Should Favor Equity Capital Over Hybrid Debt, BOE Says
Banks should revert to using equity to cushion against losses rather than the so-called hybrid debt they increasingly adopted before the credit crisis, the Bank of England said in its Financial Stability Report today.
The U.K.’s biggest lenders sold hybrid securities including subordinated notes as a cheaper way of meeting regulators’ capital requirements than issuing shares. Because the securities rank senior to equity in the event of a default, they’re less effective at buffeting against losses, and their value fell in the past two years as investors shunned hard-to-value assets.
“Subordinated debt should not feature as part of banks’ contingent capital plans,” the Bank of England said in the report. “Capital needs to be permanently available to absorb losses” and “the only instrument reliably offering these characteristics is common equity,” it said.
Regulators globally are considering ways banks can strengthen their ability to weather a future economic crisis, after financial institutions lost or wrote down almost $1.5 trillion since 2007, according to data compiled by Bloomberg. One of the proposals of authorities around the world is a return to using equity as capital, rather than forms of subordinated, or junior, debt.
U.K. banks need “higher-quality buffers consisting of common equity,” and the amount of capital a lender holds should reflect the impact its “distress or failure could have on the system as a whole,” according to the Bank of England report payday loan.
Britain’s central bank also said it supports the idea of lenders being required to set more capital aside when the economy is growing.
Buybacks and Exchanges
U.K. banks including Barclays Plc and Royal Bank of Scotland Group Plc have already started reorganizing their capital along the lines the Bank of England is suggesting, buying back or exchanging their subordinated debt to boost the levels of core Tier 1 capital, consisting mainly of equity and cash reserves. They do this by buying the notes back at a discount, booking a gain.
Barclays invited holders of its undated subordinated 7.7 percent bonds to swap the notes for new, more-senior securities on June 22, while RBS repurchased $12 million of notes due 2014 the next day, Bloomberg data show. Holders of Lloyds Banking Group’s subordinated bonds in pounds and euros agreed to swap about 66 percent of the securities for new senior debt in April.