Following the Financial System Inquiry recommendations, the Australian Prudential Regulation Authority (APRA) is on a course to increase bank capital levels.
The logic is simple: a stronger buffer capital net will lead to a more resilient system. Yet its implementation is tricky at best; and deceptive at worst.
As highlighted before, there is no agreed yardstick to measure capital levels. The reason is that every capital asset class has its own risks and costs, which cannot be inferred without subjective assumptions. There is as much art as science behind this issue. Notwithstanding, APRA still seems to prefer unilateral regulation, disregarding the bank industry concerns.
Yet, a new class of convertible bonds — the so-called Equity Recourse Notes (ERNs) — seems to come to the rescue, promising to avoid taxpayer-funded bailouts without the heavy-handed and costly regulations on the private sector.
ERNs (similar to other contingent convertible bonds) are issued as a debt liability, yet its currently-due payments can be easily converted into equity shares in times of financial distress, therefore saving taxpayer funding to the ailing bank.
The vital difference between ERNs and other contingent convertible bonds is on the timing of conversion. The latter is decided by the regulation authority, which generates uncertainty and political fiddling; whereas the former has its conversion trigger clearly pre-defined as a percentage of the bank’s share price at the moment of the bond issuance.
The real benefit of ERNs is in their possible market-oriented solution with low financing costs, but with buffer features of equity-like assets.
The Australian financial watchdog should embrace the newcomer, allowing banks to use these novel convertible bonds to meet higher capital levels. And hear the refreshing winds of change: not more regulation, not less regulation, but a better regulation environment for a safe and thriving Australia.
Home > Commentary > Opinion > A possible market solution to appropriate bank capital levels
A possible market solution to appropriate bank capital levels
Following the Financial System Inquiry recommendations, the Australian Prudential Regulation Authority (APRA) is on a course to increase bank capital levels.
The logic is simple: a stronger buffer capital net will lead to a more resilient system. Yet its implementation is tricky at best; and deceptive at worst.
As highlighted before, there is no agreed yardstick to measure capital levels. The reason is that every capital asset class has its own risks and costs, which cannot be inferred without subjective assumptions. There is as much art as science behind this issue. Notwithstanding, APRA still seems to prefer unilateral regulation, disregarding the bank industry concerns.
Yet, a new class of convertible bonds — the so-called Equity Recourse Notes (ERNs) — seems to come to the rescue, promising to avoid taxpayer-funded bailouts without the heavy-handed and costly regulations on the private sector.
ERNs (similar to other contingent convertible bonds) are issued as a debt liability, yet its currently-due payments can be easily converted into equity shares in times of financial distress, therefore saving taxpayer funding to the ailing bank.
The vital difference between ERNs and other contingent convertible bonds is on the timing of conversion. The latter is decided by the regulation authority, which generates uncertainty and political fiddling; whereas the former has its conversion trigger clearly pre-defined as a percentage of the bank’s share price at the moment of the bond issuance.
The real benefit of ERNs is in their possible market-oriented solution with low financing costs, but with buffer features of equity-like assets.
The Australian financial watchdog should embrace the newcomer, allowing banks to use these novel convertible bonds to meet higher capital levels. And hear the refreshing winds of change: not more regulation, not less regulation, but a better regulation environment for a safe and thriving Australia.
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