A. Adoption of Basel III and Regulations.
The implementation of Basel III, the new regulation developed by the Basel Committee on Banking Supervision in response to the 2007–2009 financial crisis, was a lengthy process in Armenia, concluding only in 2022. Basel III introduced new rules for the structure of banks' capital and assets, aiming to enhance the stability of the banking system by increasing both the quantity and quality of liquid assets. This regulation found its local and adapted reflection in "Regulation 2" on the "Regulation of Banks' Activity, Main Economic Normatives of Banking Activity," issued by the Board of the Central Bank of Armenia (CBA) and periodically amended.
B. Subordinated Loans as a Capital Element for Banks.
Regulation 2 provides banks the opportunity to attract subordinated loans under specific rules for capital replenishment. Subordinated loans can supplement banks' Tier 2 capital if they meet the specific requirements outlined in the regulation. For example, such loans must have a minimum term of five years, and early repayment requires CBA approval. In the event of financial distress, these loans may be converted into equity, transferring business risk to the lenders and acting as financial buffers for struggling banks.
C. Opportunities for Issuing Subordinated Bonds.
A review of international experience reveals that the market for subordinated bonds is currently experiencing significant growth, driven by the expansion of the private credit market and investors' search for higher returns. This presents a new opportunity for Armenia to attract foreign (and domestic) direct investments through the issuance of subordinated bonds by banks. To realize this potential, the current regulations should be adapted to accommodate the issuance of such bonds, which are particularly suited to these conditions. Additionally, it is worth considering the issuance of bonds without principal repayment, whose terms could align with those of shares and serve as primary capital (core or additional) for banks.
D. Simulation of Subordinated Bond Issuance.
Simulations conducted by our company indicate that uncertainties surrounding the timing, terms, and conversion process of subordinated bonds may deter banks from making decisions to issue subordinated debt. Furthermore, the publicity associated with such bonds could be seen as an unnecessary burden for banks in managing their financial condition. Lastly, the CBA’s broad discretionary powers in prohibiting early repayment may be viewed as a significant disincentive, particularly for smaller investors.
E. Conclusion.
The issuance of subordinated bonds offers a new opportunity to activate Armenia's capital market, including the attraction of foreign investments. To make these debt instruments appealing to foreign (and local) investors, it will be necessary to adapt the regulations governing subordinated loans and limit the regulator's broad discretion over repayment terms.
Author: Got Margaryan (Mr)
Managing Partner, Legelata Legal and Tax