* Examining a step-up, step-down bond -source
* Bondholders take haircut if core Tier 1 below 7% -source
(Adds quote from source, background)
By George Hay, Columnist, Reuters Breakingviews
LONDON, Oct 14 (Reuters) - Barclays is working on a new capital instrument that would allow it to meet regulators' capital demands without issuing equity, a person familiar with the situation told Reuters Breakingviews.
The UK bank is examining a debt instrument that has been dubbed a "step down, step up" bond. If the bank's core Tier 1 ratio fell below 7 percent, holders would suffer a haircut of as much as 30 percent.
The bond is one of several options being investigated by British banks to raise capital if the Financial Services Authority demands that they hold additional buffers to protect themselves from future crises. Emerging markets lender Standard Chartered launched a rights issue on Oct. 13 to raise $5.2 billion, after expenses, to strengthen its capital reserves.
The bond being examined by Barclays differs from so-called contingent convertible bonds because it does not convert into equity. It also allows the bond's value to be written up if the bank recovers and starts paying dividends again.
"The issue is how to make this kind of instrument acceptable for investors", the source told Reuters Breakingviews.
"But regulators are also waiting for Basel (Committee on Banking Supervision) to define what is acceptable as capital."
Barclays declined to comment.
The Basel Committee, which sets global bank rules, wants banks to maintain a core Tier 1 ratio of at least 7 percent. Below this level, they would have to curtail dividends and bonus payments.
The Basel Committee also wants banks to hold a counter-cyclical buffer of up to 2.5 percent. Meanwhile, regulators are also considering imposing capital demands for banks that are deemed too big to fail.
DIAMOND SAYS ENOUGH EQUITY
At the end of June, Barclays had a core Tier 1 ratio of 10 percent. This could fall to 8.7 percent by 2011, according to analysts at KBW.
Barclays' incoming Chief Executive Bob Diamond recently told a Bank of America Merrill Lynch conference that the bank did not need to issue new equity capital as things stood.
"Of course we have a lot of work to do to adapt to the new Basel framework," he said. "But from what we know and we can see today, we believe we have enough equity capital, and it is not our intention to turn to our shareholders for more."
Investors have shown interest in Barclays' proposed new instrument, the person familiar with the situation said.
Under its current structure, the bond does not comply with Basel proposals, which demand that instruments absorb losses on a permanent basis in order to count towards capital ratios. However, the Basel Committee and the Financial Services Authority, which regulates UK banks, are debating whether to adapt their proposals.
Italian bank Intesa SanPaolo sold on Sept. 23 a 1 billion euro perpetual bond that has similar characteristics to Barclays' proposed instrument.
It is not clear whether Intesa will be allowed to include the bond in its core capital ratio. (Editing by Will Waterman)