The Italian central bank’s proposals, which were set out in a consultation paper last Friday, also bring Italy’s covered bond legal framework into line with the capital requirements directive.
At present Italian banks must have a minimum consolidated regulatory capital of €500m, a minimum total capital ratio of 9% and a minimum tier one ratio of 6% before they are allowed to issue covered bonds, or Obbligazioni Bancarie Garantite.
Under the new proposal the minimum consolidated regulatory capital would be halved and banks would need to reference their core equity Tier One ratio, instead of a total capital ratio.
This is important because core equity is not as fluffy as total capital. It’s there strictly to absorb losses and it is a tougher measure of a bank’s strength.
Core equity is essentially equity in the form of shares, and cash mainly held as retained earnings.
In other words, it doesn’t include other forms of capital such as tier one and tier two, which are not the same as equity and may not soak up losses.
But, by halving the absolute level of consolidated regulatory capital from €500m to €250m, the central bank has, at a stroke, enabled around 20 more banks to access the cheap source of long term funding that the covered bond market can provide.
The number of Italian banks that will in theory be able to access the capital markets using Obbligazioni Bancarie Garantite should rise to 55.
Though these smaller issuers may be less systemically important, and may hypothetically be required to hold less core equity, they tend to be proportionally stronger banks.
This is because smaller Italian banks are likely to be much the same as smaller Dutch and UK issuers which have tended to issue less fluffy tier one and tier two debt.
And as a consequence their core equity ratios have tended to be higher, or at least similar to their total capital ratios, which cannot be said for bigger banks.
Italy’s new covered bond proposal should therefore strengthen the OBG covered bond brand and by opening up access to a more diversified source of funding, should give people less of an excuse to be negative on Italy’s small but well-proportioned banks.