Basel Committee Proposal to Ensure Loss Absorbency of Regulatory Capital at Point of Non-viability

In its December 2009 consultative document ‘Strengthening the Resilience of the Banking Sector’, the Basel Committee on Banking Supervision noted it would 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 capital.

The Committee has now issued for consultation a proposal based on a requirement that the contractual terms of capital instruments will allow them at the option of the regulatory authority to be written off or converted to common shares in the event that a bank is unable to support itself in the private market in the absence of such conversions. This proposal should also help to reduce a source of moral hazard, seen by some as an underlying cause of the current financial crisis and a potential cause of future crises.

Nout Wellink, chairman of the Basel Committee and president of the Netherlands Bank, noted that “as a precondition for being treated as regulatory capital, an instrument must be capable of bearing a loss if the issuing bank is unable to support itself in the private market. In seeking to ensure this outcome, the proposal in this consultative document is an important element of finalising the Committee’s package of measures to strengthen the resilience of the banking sector.”


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