BANKS’ NEW CAPITAL STRUCTURE

Q.WHY DOES THE REPORT FOCUS ON LOSS-ABSORBING DEBT?
A.Banks hold far more debt than equity. In the financial crisis that debt should have been used to absorb losses, but banks’ complexity made it difficult to decide at the time what should be written off and what should not. Instead, governments were forced to meet all debtholders’ obligations – ICB chairman Sir John Vickers said it was “staggering” how many senior bank debtholders came out whole from the crisis. In future, it wants creditors and debtholders to bear losses before any taxpayer funds are used.

Q.WHAT IS CONTINGENT CAPITAL?
A.Contingent convertible capital (co-cos) are bonds used to recapitalise a bank in a crisis. Co-co bonds will either be written off or convert to equity if, for example, a bank’s capital ratio falls below regulatory requirements. This would relieve a struggling bank of its debt obligations.

Q.HOW DO BAIL-IN BONDS DIFFER FROM CO-COS?
A.Bail-in bonds are similar to co-cos in that they can turn into equity, but the regulator decides when this conversion is triggered – usually as the bank stops being a viable entity. Bail-in debt is used to resolve a failed bank, whereas co-cos would try to revive a bank. In theory, all of a bank’s unsecured term debt could be considered bail-in.

Q.WHO SHOULD LOSE OUT FIRST IN ANOTHER CRISIS?
A.Equity holders would bear the first losses, then any co-cos would be written off or converted to equity. If the bank reached insolvency, bail-in debt would be used. If all bail-ins were exhausted, remaining creditors would be exposed to losses. Retail depositors would be the last to suffer under the ICB’s plan.