BSP okays new rules on hybrid capital instruments

The Bangko Sentral ng Pilipinas (BSP) has approved a new regulation allowing banks to issue a hybrid capital instrument with equity-like features.

The Monetary Board (MB) approved the guidelines last week, effectively recognizing hybrid Tier 1 capital instruments as eligible Tier 1, otherwise known as the core regulatory capital of a bank.

The MB said the guidelines it approved were based on the minimum features recommended by the Basel Committee for this kind of capital instrument. 

The Basel Committee is the leading international body promoting convergence of capital standards and bank supervisory practices worldwide. 

BSP Governor Amando M. Tetangco said the issuance of hybrid Tier 1 capital would require prior MB approval. He said the MB has also set a maximum limit of 15 percent of total Tier 1 capital to prevent banks from becoming over-reliant on the instrument.

"These amendments to the capital framework are aimed at providing banks with alternative ways to strengthen their capital base," Tetangco said. He said it would help banks prepare for the eventual adoption of the Philippine Financial Reporting Standards (PFRS) and Philippine Accounting Standards (PAS) by end-2005 and the Basel 2 by 2007.

Tetangco explained that hybrid Tier 1 capital instruments had equity-like features that would make acceptable as Tier 1 capital. "They may be in the form of unsecured subordinated debt or preferred shares with step-up feature."

Hybrid Tier 1 instruments, Tetangco said, are perpetual or without maturity. They are also non-cumulative which meant that dividends or coupons that could not be paid in a financial year as a result of poor business performance may not be recovered in subsequent years.

Unlike normal preferred shares, preferred shares considered to be hybrid Tier 1 would have a coupon rate step-up feature that would require the bank to pay a higher dividend rate upon non-exercise of the call option. 

"The step-up rate should, however, be moderate and allowed only after a minimum of 10 years and only once during the entire life of the instrument," Tetangco said.

This step-up feature would also apply to hybrid Tier 1 issued in the form of debt instruments.

However, Tetangco said hybrid Tier 1 capital must be available to absorb losses of the bank on a going concern basis.  "This is one of the central requirements that set it apart from other debt securities and that give the instruments equity-like features," he said.   

The instrument must be unsecured and subordinated to the claims of the depositors, general creditors and holders of Lower and Upper Tier 2 capital instruments, Tetangco explained further.

Hybrid Tier 1 capital instruments were "callable" but only at the initiative of the issuer (and not of the holder) after a minimum of five years from issue date. 

The BSP regulation also provided that hybrids may be called even earlier under certain well-defined circumstances. For example, if there is a change in treatment of the tax instrument due to a change in tax laws or regulations. 

"These early redemptions would also require prior approval of the MB because there must be simultaneous replacement with issues of new capital which are neither smaller in size nor of lower quality than the original issue," Tetangco said.

Tetangco said the MB has to determine whether the bank already has capital that is more than adequate to its risks.  

Meanwhile, to maintain appropriate distinctions among the qualifying capital categories within the risk-based capital framework, the BSP has likewise fine-tuned the minimum requirements for eligible Upper and Lower Tier 2 unsecured subordinated debt instruments.

The hybrid Tier 1 instruments, like upper and lower Tier 2 instruments, may be denominated in Philippine peso or in foreign currency. 

But Tetangco said the MB was not inclined to allow banks in the case of peso denominated issuance of hybrid Tier 1, upper Tier 2 and lower Tier 2 instruments, to swap the proceeds into foreign currency for the purpose of investing in foreign currency denominated instruments.

While there is no substitute for traditional core capital such as equity, Tetangco said the BSP has decided it would recognize that international practice has evolved to accommodate more innovative eligible capital instruments that are potentially more cost efficient from an issuer standpoint.