THE ANNOUNCEMENT BY the 43% UK state-owned Lloyds Banking Group last month that it was replacing existing so-called hybrid debt securities with a new form of regulator-prescribed debt called contingent capital has highlighted the task regulators face in aligning their own interests in reducing the sector’s reliance on the lender of last resort with the fostering of a market-led solution that works for all. The UK’s Financial Services Authority became the first of the most important global bank regulators out of the blocks last month in proposing this new form of capital, which has the prime objective of allowing banks to self-medicate in times of distress, rather than requiring governments to inject new equity as a last resort. Contingent capital is a security that looks and acts like a bond. However, it converts into common equity when the issuing bank’s core tier 1 ratio falls below a specified level, in Lloyd’s case 5%, a level seen as a crucial inflexion point in terms of a bank’s ability to absorb further losses in a distressed market.
It’s an attempt by regulators to reform an asset class that has proven to be unfit for purpose.