Fitch Ratings comments today in a special report that a combination of regulatory change, strong bank growth and a favourable market environment have resulted in substantially greater issuance of capital securities - hybrid instruments and subordinated debt - by emerging market ("EM") banks in 2006.

International public placements of such securities in 2006 to date are up 48% to USD13 billion and issuance has also become significantly more diversified both geographically and by issuer. "Before 2005, the EM hybrid market was dominated by Asian, in particular Korean, banks," says James Watson, Senior Director in Fitch's Financial Institutions group. "However, Brazilian institutions were major issuers in 2005, and in 2006 the largest volumes have come from Hungary, India and Kazakhstan. Banks from Russia and the Gulf Co-operation Council countries have become major suppliers of subordinated debt."

The adoption by many EM bank regulators of rules that allow hybrids and subordinated debt, in line with the recommendations of the Basel Committee, to qualify as regulatory capital has been a catalyst for issuance across EMs. Implementation of Basel II could put pressure on capital ratios as a result of higher charges for commercial lending, foreign currency government debt and operational risk, and thereby also contribute to future issuance.

"Strong organic bank growth has been a key factor driving EM banks' supply of capital securities, with expansion running ahead of internal capital generation in Kazakhstan, Russia and India in particular," notes Mr. Watson. "Growth has also been high in Turkey and the Gulf, but from a starting point of more comfortable capital ratios." Acquisitions, more active capital management and long-term funding requirements have also contributed to issuance.

A favourable global market environment, characterised by high liquidity, generally low interest rates and strong investor demand for higher-yielding instruments has also facilitated placements. A further factor has been generally strong EM performance, as Asian banks have recovered from the crisis of 1997-1998, Brazilian and Turkish country risks have reduced since 2003 and Russian, Kazakhstani and Gulf banks have benefited from the favourable impact of high oil and other commodity prices on their operating environments. Domestic market infrastructure has also had a major influence on international supply, with strong local investor bases absorbing most issuance in South Africa and Chile, and also playing a role in India, Brazil, Korea and Kazakhstan.

Foreign bank ownership, combined with more modest growth rates, has tended to constrain issuance in Central and Eastern Europe, although foreign-owned banks have issued in Latin America. Domestic government and private shareholders have used capital securities to avoid equity dilution and thus retain control.

Ratings of capital securities reflect the degree of their subordination and the probability of payment deferral, the latter based on both the issue structure and the stand-alone financial strength of the bank. Equity content of hybrid issues by Asian and Latin American banks has generally been high.