Introduction of contingent capital rules under the Basel 3 framework was expected to have no small impact on South Korea's banking sector, a report by the central bank showed Monday.

Given the fact that subordinated and hybrid bonds account for around 15 percent of total equity capital among local banks, the adoption of contingent capital regulations will have no small influence on the country's banking sector, according to the Bank of Korea (BOK)'s report.

Contingent capital refers to subordinated and hybrid bonds that are automatically written down or converted into common equity capital when a trigger event happens.

Following the global financial crisis, the Basel Committee adopted in December 2010 the capital and liquidity reform plan, including rules on contingent capital, as part of the efforts to strengthen resilience in the banking sector.

Contingent capital has been believed to strengthen banks' resilience to liquidity shocks as contingent capital can automatically convert into common equity or write down loan losses under the stringent funding market situation.

Under the Basel 3 framework, subordinated and hybrid debts can be booked as additional tier 1 or tier 2 capitals only if they include clear provisions about the trigger event such as point of non-viability and going-concern conditions.

Common equity capital is booked as tier 1 capital, but other securities such as subordinated and hybrid debts are registered on the books as additional tier 1 or tier 2 capitals.

The report said that costs of funding through the subordinated bond issuance would rise as the bond yields should reflect the risk of conversion into common equity capital or writedown on loan losses, noting that it would particularly weigh on regional banks that depend more on subordinated debts.

The potential hike in funding costs in the banking sector may cause adverse effects such as the pass-through of the rising costs to financial consumers, according to the report.