subordinated term debt in tier 2

Discussion in 'P2.T7. Basel II & Regulatory' started by ajsa, Oct 8, 2009.

  1. ajsa

    ajsa New Member

    Hi David,

    In the screencast, subordinated term debt is in tier 2, but short-term subordinated debt is also in tier 3. Could you explain?

  2. David Harper CFA FRM

    David Harper CFA FRM David Harper CFA FRM (test) Staff Member

    Hi ajsa,

    Subordinated debt is in the so-called "lower Tier 2" (i.e., max of 50% of Tier 1 as opposed to max of 100% of Tier 1 for the regular "upper" Tier 2). In regard to the difference between Tier 3, I have to reference the source Basel. You'll note the Tier 3 requires an original maturity of > 2 years but lower Tier 2 requires orginal maturity > 5 years (and I myself do not understand the maturity logic ...)

    APPENDIX: Basel "Lower: Tier 2
    (e) Subordinated term debt: includes conventional unsecured subordinated debt capital instruments with a minimum original fixed term to maturity of over five years and limited life redeemable preference shares. During the last five years to maturity, a cumulative discount (or amortisation) factor of 20% per year will be applied to reflect the diminishing value of these instruments as a continuing source of strength. Unlike instruments included in item (d), these instruments are not normally available to participate in the losses of a bank which continues trading. For this reason these instruments will be limited to a maximum of 50% of Tier 1.

    BODY: 49(xiv). Base Tier 3 (Market risk only)
    For short-term subordinated debt to be eligible as Tier 3 capital, it needs, if circumstances demand, to be capable of becoming part of a bank’s permanent capital and thus be available to absorb losses in the event of insolvency. It must, therefore, at a minimum:
    • be unsecured, subordinated and fully paid up;
    • have an original maturity of at least two years;
    • not be repayable before the agreed repayment date unless the supervisory authority agrees;
    • be subject to a lock-in clause which stipulates that neither interest nor principal may be paid (even at maturity) if such payment means that the bank falls below or remains below its minimum capital requirement.

  3. ajsa

    ajsa New Member

    Hi David,

    How should we understand "original maturity"? If we have 2 subordinated bonds both of which will mature in next month, one is 5 year bond and the other is 2 year bond and all else are equal. should they be treated differently?

    Also the bank is the issuer of the bond (ie debt on its balance sheet), rather than banks holding the bond in its book. is it correct?

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