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CA-2.1.5

Tier 2 capital shall consist of the following items:

(a) Current interim profits which have been reviewed as per the ISA by the external auditors;
(b) Asset revaluation reserves which arise from the revaluation of fixed assets from time to time in line with the change in market values, and are reflected on the face of the balance sheet as a revaluation reserve. Similarly, gains may also arise from revaluation of Investment Properties (real estate). These reserves (including the net gains on investment properties) may be included in Tier 2 capital, with the concurrence of the external auditors, provided that the assets are prudently valued, fully reflecting the possibility of price fluctuation and forced sale. A discount of 55% must be applied to the difference between the historical cost book value and the market value to reflect the potential volatility of this form of unrealised capital;
(c) Unrealized gains arising from fair valuing equities:
(i)  For unrealized gross gains reported directly in equity, a discount factor of 55% will be applied before inclusion in Tier 2 capital. Note for gross losses, the whole amount of such loss should be deducted from the Tier 1 capital;
(ii)  For unrealized net gains reported in income, a discount factor of 55% will apply on any such unrealized net gains from unlisted equity instruments before inclusion in Tier 1 capital (for audited gains) or Tier 2 capital (for reviewed gains) as appropriate. This discount factor will be applied to the incremental net gains related to unlisted equities arising on or after January 1, 2008;
(d) Banks should note that the Central Bank will discuss the applicability of the discount factor under paragraph (c) above with individual banks. This discount factor relating to CA-2.1.5(c)ii may be reassessed by the CBB if the bank arranges an independent review (which has been performed for the bank's systems and controls relating to FV gains on financial instruments) and meets all the requirements of the paper 'Supervisory guidance on the use of the fair value option for financial instruments by banks' issued by Basel Committee on Banking Supervision in June 2006;
(e) Banks applying the IRB approach for securitisation exposures or the PD/LGD approach for equity exposures must first deduct the expected loss (EL) amounts subject to the corresponding conditions in paragraphs CA-6.4.4 and CA-5.7.13, respectively. Banks applying the IRB approach for other asset classes must compare (i) the amount of total eligible provisions, as defined in paragraph CA-5.7.7, with (ii) the total expected losses amount as calculated within the IRB approach and defined in paragraph CA-5.7.2. Where the total expected loss amount exceeds total eligible provisions, banks must deduct the difference. Deduction must be on the basis of 50% from Tier 1 and 50% from Tier 2. Where the total expected loss amount is less than total eligible provisions, as explained in paragraphs CA-5.7.7 to CA-5.7.10, banks may recognise the difference in Tier 2 capital up to a maximum of 0.6% of credit risk-weighted assets. The provisions in excess of 0.6% of credit risk-weighted assets will be deducted from the risk-weighted assets of the related portfolio to which these provisions relate;
(f) Hybrid instruments, which include a range of instruments that combine characteristics of equity capital and debt, and which meet the following requirements:
•   They are unsecured, subordinated and fully paid-up;
•   They are not redeemable at the initiative of the holder or without the prior consent of the CBB;
•   They are available to participate in losses without the bank being obliged to cease trading (unlike conventional subordinated debt); and
•   Although the capital instrument may carry an obligation to pay interest that cannot permanently be reduced or waived (unlike dividends on ordinary shareholders' equity), it should allow service obligations to be deferred (as with cumulative preference shares) where the profitability of the bank would not support payment. Cumulative preference shares, having the above characteristics, would be eligible for inclusion in Tier 2 capital. Debt capital instruments which do not meet the above criteria may be eligible for inclusion in item (g);
(g) Subordinated term debt, which comprises all conventional unsecured borrowing subordinated (with respect to both interest and principal) to all other liabilities of the bank except the share capital and limited life redeemable preference shares. To be eligible for inclusion in Tier 2 capital, subordinated debt capital instruments should have a minimum original fixed term to maturity of over five years. 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 (f) above, 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 capital. Subordinated debt instruments must also satisfy the conditions outlined in paragraphs CA-2.1.2 (a), (f), (h), (i), (j), CA-2.1.3 and CA-2.1.4; and
(h) Loan loss provisions held against future, presently unidentified losses and are freely available to meet such losses which subsequently materialise. Such general provisions/general loan-loss reserves eligible for inclusion in Tier 2 will be limited to a maximum of 1.25 percentage points of credit risk-weighted risk assets. Provisions ascribed to identified deterioration of particular assets or known liabilities, whether individual or grouped, must be excluded.
Amended: October 2013
Amended: April 2013
Amended: April 2011
Apr 08