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Banks wait for diversified capital

New Delhi, Nov. 20: Banks are gearing up for a new three-tier capital adequacy regime with a wide array of instruments, including hybrid ones.

Union finance minister P. Chidambaram has asked the Reserve Bank of India (RBI) to come out with the Tier III norms early so that banks have sufficient time to raise additional capital to meet Basel II requirements.

The RBI has adopted Basel norms on the lines of the European banking system. While Indian banks are able to tap Tier I and Tier II capital to meet the Basel norms, Tier III capital has not yet been introduced here.

Tier II capital refers to supplementary capital comprising undisclosed reserves and subordinated debt instruments. Tier I capital, on the other hand, consists of statutory reserves and revenue.

Under Basel II, the capital requirements are more risk-sensitive. Banks are required to hold capital not only for credit and market risk but also for operational uncertainities. They also need to hold capital for concentration and liquidity risks.

Sources said a significant part of the meeting of public sector bank chiefs with the finance minister was dedicated to ways and means to raise additional bank capital.

Bankers are keenly awaiting a definition of Tier III capital by the RBI. “The extent to which RBI allows mixing of debt and equity for raising hybrid capital will be of particular significance,” a banker said.

Executives of banks and financial institutions will discuss the costs and benefits of introducing hybrid capital in a conference to be held soon under the aegis of the Indian Banks Association and JP Morgan.

“Hybrid capital promises to provide an important source of non-dilutive, tax-efficient, and relatively low-cost fund for domestic banks. This is especially true for public sector banks,” a banker said.

Hybrid capital combines the features of both debt and equity. Like debt, hybrid capital does not dilute the ownership of existing shareholders and is often structured to provide tax-deductible payments. Like equity, hybrid capital absorbs operating losses.

Since the Bank of International Settlements (BIS) released the guidelines for hybrid capital in 1998, global banks have adopted the instrument in the face of growing pressure from shareholders to maintain and improve returns, while conforming to the demands of regulators to maintain healthy balance sheets.

Analysts feel hybrid capital is important since some of the domestic banks are already constrained by limited headroom to raise additional Tier I capital comprising deposits, reserves and investment fluctuation reserve (IFR).

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