Canadian bank regulators are taking the lead among global regulators in terms of setting the requirements for contingent capital that would convert to common equity when a bank gets into financial trouble, says Fitch Ratings.
The rating agency notes that the Office of the Supervisor of Financial Institutions (OSFI) has taken the position that explicit triggers for the conversion of subordinated debt and preferred stock to common equity should be incorporated into the terms of non-viable contingent capital (NVCC) in order to be included in Tier 1 and total capital ratios.
“OSFI officials noted again this week at investor conferences that the NVCC regulatory framework offers a clear and unambiguous view of how recapitalization of banks can take place in a distress scenario. By requiring explicit contractual terms detailing triggering events for conversion of ‘bail-inable’ securities, OSFI believes that the need for weakly capitalized banks to receive taxpayer support in such a scenario will be reduced,” it says.
In taking its position, Fitch says that OSFI has moved ahead of their global counterparts. “The Canadian regulator expects to provide final guidance on the size of the resolution buffer to be maintained by banks in the next few months,” it notes. “The amount of outstanding capital that is not NVCC-compliant will be reduced over the next few years as Canada moves toward full implementation of Basel III capital standards.”
While new forms of NVCC instruments will be issued by Canadian banks, Fitch says that it will continue to look to core equity capital as the primary source of loss-absorbing protection for creditors in a bank stress scenario. Additionally, its approach to notching ratings for banks’ subordinated bond and preferred stock issues has not been changed, it notes.
“As NVCC-compliant security structures are finalized, Fitch will focus on the potential for unintended consequences resulting from the addition of new types of NVCC-compliant securities in bank capital structures,” it adds.