European Union banks are accused of inflating the value of their high-risk debt

Thursday, June 27, 2024 - 19:09
Point Trader Group

The European Union's banking supervisory authority on Thursday accused banks in the bloc of possibly inflating the value of their high-risk debt used to plug capital gaps in crises.

Banks began issuing so-called additional Tier 1 AT1 bonds, also known as conditional convertible bonds or CoCos, to boost capital after the global financial crisis, according to Reuters.

The bonds are converted into shares or are written off if the bank's capital levels fall below a certain level.

The recent period witnessed disputes between debt buyers and banks, the most recent of which was when the value of Credit Suisse bonds amounting to $17 billion was written off to zero, when the troubled lender was forced to merge with UBS, which led to lawsuits being filed.

The European Banking Authority indicated that it investigated how banks issued AT1 bonds. It presented its findings in a report on Thursday that included new models to better standardize information about AT1 bonds and more accurately reflect their value.

The aim of the directive is to limit the scope for banks to make ad hoc adjustments when issuing AT1 bonds.

The authority said: “Some provisions could be better drafted because, as originally proposed, they may introduce uncertainty in relation to regulatory provisions – for example in relation to the effectiveness/implementation of the loss absorption mechanism, or they may increase the already high complexity of “Sukuk.”

Differences were noted between the book value of bonds recorded on the bank’s balance sheet under accounting rules, versus the nominal value.

She added that "measuring additional Tier 1 capital instruments for control purposes using book value-accounting value is necessary to prevent overestimation or underestimation of the total capital available to cover losses."

“To calculate and report regulatory capital ratios, it is essential that capital instruments consistently reflect their actual loss-absorbing capacity,” she continued.

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