A veil of tiers
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A veil of tiers

Banks are constantly exploring new and cheaper ways of raising and using capital. After Tier 1 (shareholders' funds) and Tier 2 (debt capital) comes Tier 3 to support short-term trading positions. But only the adventurous Dutch have put Tier 3 to use. There seems to be more mileage in clever structures such as callable perpetuals. Jules Stewart reports.

Regulators are increasingly seeking to ensure that banks match their risk to the amount and quality of their capital, as well as carrying an extra cushion for low-probability events. And banks have concluded that there are advantages in fine-tuning capital use, as much for internal risk management and risk/reward measures as to satisfy the regulators.

Despite the appeal of new approaches to squeezing the most out of resources, Tier 3 capital, the latest capital instrument allowed by European Union (EU) regulators, is getting off to a slow start. Since last year, banks have been allowed to include this two-year short-term subordinated debt as part of their capital base for regulatory purposes. Previously the minimum maturity was five years. But Tier 3 capital can be used only to support a bank's trading activities, not its banking book. And so far few banks have found a good use for this highly transitory capital buffer.

Waiting for guidelines

Only the UK and the Netherlands have established a framework that includes Tier 3 instruments. Banks in other EU states are waiting for regulatory guidelines, and the Tier 3 concept will soon apply to all leading OECD countries.

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