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BERLIN, March 19 (Reuters) - Germany is preparing to offer its banks favourable tax treatment on a special type of hybrid bond, aligning German rules with those in other European countries and opening the door to billions of euros in new debt issuance.
German banking association BDB said it had information pointing to a decision soon from Berlin authorities, saying it had become an urgent matter for banks seeking to bolster their balance sheets and that a delay risked putting the country's financial sector at a competitive disadvantage.
"It is urgently necessary that German authorities create legal certainty for the additional core capital quickly," BDB head Michael Kemmer said in a statement on Wednesday.
German banks have waited to issue so-called Additional Tier 1 (AT1) capital until the national tax treatment was clear, unlike some banks in other EU countries who have come to market in the expectation that rules would be decided in their favour.
Deutsche Bank alone plans to issue at least 5 billion euros ($7 billion) of AT1 capital, which can include contingent capital instruments known as CoCos, before the end of next year, paving the way for other banks.
German property lender Aareal Bank has said it seeks to repay the 300 million euros in state aid it received in the financial crisis by issuing AT1 instruments later in the year.
Banks in Britain, France, Switzerland, Denmark and Belgium have all issued AT1, after they laid the needed regulatory groundwork. Italy and the Netherlands are also in the process of changing their legal frameworks.
AT1 bonds can convert into shares, be temporarily written down, or get wiped out if a bank's capital falls below a set level.
Investor demand for AT1 issues has been high, allowing banks to raise cheap capital to fortify their balance sheets and improve their leverage ratios. Banks have been especially keen to raise new capital ahead of a balance sheet check underway by the European Central Bank.
Under the bank safety framework known as Basel III, banks can raise 1.5 percentage points of their 6 percent Tier 1 capital ratio using AT1.
Bankers and investors expect German banks to use the structure set by French banks, where if bank regulatory capital falls below a certain threshold, bondholders lose their investment. But investors still have the potential to recover those losses should the bank return to health.
According to JP Morgan, Deutsche Bank's AT1 requirement is almost 13 billion euros while Commerzbank may need to raise almost 2.5 billion euros in AT1 capital.
Total European issuance of AT1 capital is likely to reach 31 billion euros in 2014, JP Morgan analysts estimate, based on a peer group of 25 European banks. Researchers at Citibank expect European banks to issue around 20 billion euros in AT1 capital.
A spokeswoman for the German Finance Ministry said that final discussions on the tax status of the AT1 instruments were ongoing but declined to comment further.
$1 = 0.7189 Euros Reporting by Klaus Lauer in Berlin and Helene Durand in London; Writing by Thomas Atkins; Editing by Anthony Barker