After the weekend’s meeting of Group of 20 finance ministers, questions over how banks fund themselves have again come to the fore.

European banks in particular are under the spotlight because of concerns over how they will meet finance ministers’ calls for much bigger and better capital buffers against shocks. Analysts have warned these pressures could lead to a fresh round of capital raising.

At the core of the concerns is the future of the near $450bn market for tier one debt in Europe and the US. Of this figure, European and UK banks account for $283bn and US banks $161bn. European banks are felt to be too dependent on hybrid debt which, as the crisis has unfolded, has not proved loss-absorbing enough to act as a buffer against shocks.

Hybrid securities are subordinated debt instruments, which have equity-like features, but which count as loss-absorbing tier one capital.

On Sunday, the Group of Central Bank Governors and Heads of Supervision, the oversight body of the Basel Committee on Banking Supervision, met to review a comprehensive set of measures to strengthen the regulation, supervision and risk management of the banking sector to reduce the risk of a repeat of the crisis.

They agreed banks should raise “the quality, consistency and transparency of the tier one capital base” and that the predominant form of tier one capital must be common shares and retained earnings.

European banks have typically relied much more than their US counterparts on hybrid debt. European banks’ ratio of equity made up of issued ordinary shares to assets at the end of 2008 was 2.5 per cent against 3.7 per cent in the US, according to data Citi analysts cite from the International Monetary Fund.

Analysts say one reason for the difference is that in some cases European banks’ shareholder bases have not been conducive to capital raisings and instead have relied on hybrid capital.

There is uncertainty over the speed and degree to which banks could be forced to shift away from using hybrid capital as part of their funding as regulators do not want banks to be forced to rein in lending.

“The really surprising thing is that banks continue to issue tier one bonds,” says Matt King, global head of credit products strategy at Citigroup. “If regulators have now agreed that tier one capital in future should consist predominantly of common equity, this risks being a wasted effort – especially when they generally have plenty of that tier one capital in the first place. We can only presume that banks are hoping that the rules won’t change that much, and that they’ll be able to fight to minimize the change in the role of tier one.”

On Monday, Spain’s Banco Bilbao Vizcaya Argentaria launched plans to sell €1bn of five year mandatory convertible bonds.

Just over a week ago Société Générale launched what it claimed to be the first institutional investor targeted euro-denominated tier one bond issue since before the collapse of Lehman Brothers in September 2008. According to Dealogic European banks have sold $9bn so far this year in hybrid debt and US banks $1.5bn.

Investor confidence in the hybrid debt markets has been shaken in recent months after banks failed either to call bonds back as expected or stopped paying coupons on the debt in response to regulator pressure.

But banks are changing the structure of hybrid debt. SocGen’s €1bn perpetual so-called innovative tier one bond was sold with the offer of a 50 per cent increase to the initial credit margin, should it not be called by the bank after 10 years. This is a much bigger compensation than investors would have received pre-credit crisis. The order book filled in 20 minutes.

Richard Thomson, a senior financial analyst within Henderson Global Investors’ Credit Alpha team said the market was looking for new forms of capital for banks.

“Potential new forms of capital for banks are being considered such as convertible bonds where conversion would be mandatory in situations where a bank was in need of capital. The problem may be finding investors that are willing to buy into these instruments.”

In July the UK’s West Bromwich Building Society swapped some of its subordinated bonds into so-called profit-participating deferred shares. The move was part of a scheme by the Financial Services Authority to develop a more loss-absorbing capital instrument for UK building societies, offering more flexibility in terms of their core tier one capital.

Huw Van Steenis, banking analyst at Morgan Stanley, says there could be a move towards banks issuing more longer-term debt. “These changes will mean there is still a vibrant market for senior debt as well as hybrids. The key will be on the quality of capital in banks’ capital structures, that is more equity, and hybrids with better loss absorbing characteristics.

On the other hand, tier two is viewed by investors and regulators as having less loss-absorbing characteristics and so will be far less relevant going forward,” Mr Van Steenis says.

Mr King says: “There is a concern that the hybrid market could be orphaned if there is increasing focus on common equity as a percentage of tier one capital for banks.”

The regulatory reforms in the wake of the crisis are changing the way investors assess bank risk. “Investors now realise that they need to look at more ratios to assess whether a bank has sufficient capital,” said Mr Thomson. “In the past, European banks and investors have been more focused on tier one capital levels as opposed to leverage ratios such as tangible equity to assets. That was clearly inadequate.”

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