Bank capital: Turning away from common stock

In the prevailing environment of high asset quality and soaring earnings enjoyed by many banks, they and other financial institutions are finding that regulatory capital needs typically exceed the economic capital they require to run the business efficiently.

"There is an increasing sensitivity to the difference between economic capital and regulatory capital needs," says Marc Jones, JP Morgan's head of origination and product development for European financials. "In order to maintain an improved return on equity, people are focusing on the hybrid instruments in order to achieve what they consider to be the optimal capital mix." Hybrids such as preference shares have the perpetual characteristics of equity and rank at the bottom of the balance sheet just ahead of common stock, but they offer investors a fixed rate of return.

Banks have been stepping up their issuance this year and in greater amounts for a variety of reasons. On the...