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         V. The definition of capital


Proposal To Issue A Supplement To The Basel Capital Accord To Cover Market Risk

V. The definition of capital

19. The April 1993 proposal invited comment on the possibility of allowing banks to issue short-term subordinated debt subject to a lock-in clause (so-called "tier 3 capital") to meet a part of their market risks. The Committee has decided to adopt an approach whereby eligible capital will consist of shareholders' equity and retained earnings (tier 1 capital), supplementary capital (tier 2 capital) as defined in the 1988 Accord, and short-term subordinated debt (tier 3 capital). Tier 3 capital will be subject to the following conditions:
  • it should have an original maturity of at least two years and will be limited to 250% of the bank's tier I capital that is allocated to support market risk;
  • it is only eligible to cover market risk, including foreign exchange risk and commodities risk;
  • insofar as the overall limits in the 1988 Accord are not breached, tier 2 elements may be substituted for tier 3 up to the same limit of 250%;
  • it is subject to a "lock-in" provision which stipulates that neither interest nor principal may be paid if such payment would mean that the bank's overall capital would then amount to less than its minimum capital requirement.
In addition, a significant number of member countries are of the opinion that the principle in the present Accord that tier 1 capital calculated on a consolidated basis should represent at least half of total eligible capital should be retained, i.e. the sum total of tier 2 plus tier 3 may not exceed total tier 1. However, the Committee has decided that any decision whether or not to apply such a cap on the use of tier 3 capital should be a matter for national discretion. All countries will continue to maintain the principle that total eligible tier 2 is limited to a maximum of 100% of the total tier 1 elements.


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