February 22, 2008

Comments on the CEBS "Draft Proposal for a Common EU Definition ofTier 1 Hybrids"
Japanese Bankers Association
We are an industry association that represents the Japanese banking sector.
Our membership consists of 142 Japanese banks and 46 foreign banks active inJapan.
On December 7 of last year, the Committee of European Banking Supervisors(CEBS) sent out for market consultation a document entitled "Draft Proposal fora Common EU Definition of Tier 1 Hybrids."
We take this opportunity to comment on the draft proposal because some ofour member banks have offices in Europe and this proposal is considered likely
to impact the discussions on "the definition of capital (numerator)" in the context
of the regulation on capital adequacy which may take place at the BaselCommittee.
In light of the magnitude of the impact of this document, we hope that ourcomments below would assist the CEBS in its further work on this matter.
[General Comments]
This draft proposal states "...the objective of CEBS is not to create a brandnew definition for Tier 1 hybrids" (paragraph 13) and is regarded as a proposal
which intends to incorporate the 1998 Sydney Press Release (SPR) hybrid
capital principles into the Capital Requirement Directive. However, CEBS’s
interpretation of SPR and the establishment of quantitative limits partially go
beyond SPR and will rather become new requirements in effect.
We understand that CEBS’s proposal considers how to regulate banks interms of capital adequacy during normal periods to ensure that they can raise
capital under distressed conditions. However, we are concerned that theproposed new quantitative limits of hybrid capital instruments including thosecontinuously applicable after the time of issuance might lead to an increased
pro-cyclicality effect due to the decline in bank lending arising from the decreasein capital of the banks under financial distress and the lower flexibility of capitalraising by banks. Therefore, we suggest that it would be necessary for CEBS to
carefully consider its proposal in terms of financial stability.
We are aware that the Basel Committee on Banking Supervision (BCBS) is
working on the definition of regulatory capital through the research of current
practices and that it is likely to further review the definition of eligible regulatorycapital in the years to come. In light of the circumstances where the international
level playing field of capital adequacy rules is indispensable, we would like torequest CEBS to align with BCBS and take appropriate and careful steps
1

toward implementing this proposal, considering the impact on various countries,
not only in Europe, but also around the world.
[Specific Points]
We are concerned that the following specific points will go beyond SPR andwill rather become new requirements in effect. So we request that CEBS takeappropriate and careful steps toward implementing this proposal in line with theinternational discussions at BCBS.
1.

Concept of "Loss Absorption"•2.

We understand that CEBS is concerned about whether "hybrid
instruments are able to absorb losses within the bank on agoing-concern basis" (Paragraph 4, third indent in SPR) or not. However,concerning the CEBS’s statement "In the case that the Tier 1 ratio falls
below 2%, the instrument must be able to absorb losses either by
ensuring that the principal of the instrument can be partially or fully
written down; or the instrument can be converted into ordinary shares"(Paragraphs 45, 98-102), a prudential examination based on further
assessments from a practical perspective would be necessary, because
product development and business practice regarding capital
instruments vary between countries due to difference in legal andaccounting systems.

Concept of "Flexibility of Payment"•The draft proposal states "Issuers must be able to waive payments at
any time" (Paragraph 51) and "...supervisors can require banks to waive
payments at any time" (Paragraph 53): These requirements may conflictwith the contents of SPR that state "the bank must have discretion over
the amount and timing of distributions, subject only to prior waiver ofdistributions on the bank’s common stock…" (Paragraph 5, third indentin SPR). In addition, they might drive investors to question the possibilityof dividend payment of such hybrid capital instruments, which could
shrink the relevant capital markets. In light of such negative
consequences, we think that careful deliberations would be necessary.
Especially, we are afraid that the requirement: "...supervisors canrequire banks to waive payments at any time" might not prove adequate.
It is hard for supervisors, who are aware of the financial positions of a
distressed bank, to order it to waive payments since such an order couldin turn preclude additional capital raising by the bank. We are notcertain whether this requirement is valid and feasible. We would
appreciate it if CEBS would revisit this issue.

3.

Establishment of quantitative limits on Tier 1 hybrids
Regarding the following points on the quantitative limits, we would like torepeat the comment we made under "General Comments" above, i.e. theproposed limits might lead to an increased pro-cyclicality effect due to the2decrease in capital of the banks under financial distress. We believe thatthese quantitative limits need to be reconsidered carefully after examining
the practices in each jurisdiction and their possible impact on banks.
•The proposed limit that requires "...Common shares...must represent atleast...70% of the required Tier 1 capital...and at all times 50% of total
Tier 1..." (Paragraphs 60 and 61). This issue should be approached withcaution also from the viewpoint of the scope of eligible instruments towhich this limit is applied.

•The proposed limit that requires "Instruments with incentives toredeem...must not exceed 15% of total Tier 1 after deductions at anytime..." (Paragraph 61).

In addition, this limit is applied not only to common shares but also othercapital instruments (for example, convertible preferred shares). We areconcerned that this could lead to reduced flexibility for banks in raising
capital under distressed conditions, hence instability of the financial system.
We would be most grateful if CEBS would carefully reconsider this issue.

3