EU watchdog plans second round of bank capital clean up

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European Union flags flutter outside the EU Commission headquarters in Brussels, Belgium June 17, 2022. REUTERS/Yves Herman/File Photo

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LONDON, July 7 (Reuters) - Major European Union banks have significantly improved the quality of their core capital, but need to clear more "legacy instruments" from their reserves, the bloc's banking watchdog said on Thursday.

Banks hold different types of capital to provide a buffer against losses, but some capital instruments they use for this purpose are more complex and higher risk than others.

Regulators worry the inclusion of these type of instruments in a bank's core capital could "infect" other parts of the safety buffer and complicate the process of winding down a troubled bank.

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Investors are also putting pressure on banks to ditch legacy instruments, which were barred from core Tier 1 capital from December 2021 under the bloc's first capital requirements regulation (CRR1).

A June 2025 deadline has been set for removing legacy instruments such as discount perpetual securities or Discos from supplementary Tier 2 capital under the EU's revised CRR2 rules.

The EU banking watchdog - the European Banking Authority - has been monitoring whether banks have been removing ineligible instruments such as subordinated hybrid equity-linked securities, or 'Cashes', from Tier 1 capital buffers.

"The stock of outstanding legacy instruments generated by CRR1 is down to a few residual, well identified instruments for a limited number of banks that we will continue to discuss with concerned supervisors," said Delphine Reymondon, a head of unit at EBA.

Banks were forced to redeem them, buy them back or stop counting them in capital buffers. Some of the residual instruments have been shifted to the lower Tier 2 category of capital.

"We will now turn our scrutiny to the new generation of legacy instruments generated by CRR2, which will mainly concern Tier 2/Discos instruments," Reymondon said.

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Reporting by Huw Jones. Editing by Jane Merriman

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