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Backgrounder on Hybrid Tier 1 Capital

12.23.2005

The BSP’s risk-based capital adequacy framework tries to ensure that banks have sufficient amount of capital to serve as buffer for losses that would arise from their business activities.  In the framework, financial instruments may be included in banks’ capital base if their loss absorption characteristics mimic that of a common equity.

Hybrid capital instruments are one such example. These instruments have equity-like features that would enable them to absorb losses much like a common equity. Some of these features are:

1.      Long maturity 

Hybrid capital instruments are perpetual.  They are redeemable by the issuer only, subject to BSP approval.  Moreover, such redeemed hybrid capital instruments should, unless the bank’s risk-based capital ratio remains more than adequate after redemption, be simultaneously replaced with issues of new capital, which is neither smaller in size nor of lower quality. 

2.      Subordination 

In the event of bank liquidation, the holders of hybrid capital instruments gets paid only after the depositors, other creditors, and holders of capital instruments which are of lower quality have been paid in full.    

3.      Non-cumulative 

Dividends or coupons that could not be paid in a financial year as a result of poor business performance may not be recovered in subsequent years.

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