The Basel III rules on capital are supposed to ensure stronger banking – but in Asia's less developed markets, meeting the requirements is creating a new set of challenges. Kimberley Long reports.

MAS

In theory, Basel III compliance should have been completed by now. The deadline was set at March 31 2019, and banks were given a six-year lead time. Under the rules of Basel III, a bank's capital adequacy ratio should be at least 8%, with the common stock ratio at 4.5% and Tier 1 capital at 6% to demonstrate capital adequacy. For Asia’s developed countries, this has not proved to be too difficult an exercise, and has created a strong buffer. 

In strong economies, reaching the point of compliance has been positive. Heakyu Chang, senior director, financial institutions, at Fitch, says: “Basel III is making banks better prepared for unexpected losses. If all banks are better prepared for a stress time, the banking system would remain more solid. And hopefully, investors’ confidence would remain and banks would not face a funding problem.”

Regulator overtime

While this has meant additional work for the regulators, they have been determined to see the institutions under their authority are Basel III compliant. A Monetary Authority of Singapore (MAS) spokesperson says it has been working closely with banks in Singapore to meet the requirements, and that consistent implementation of the reforms internationally would create greater stability in the financial system. 

“The finalised Basel III standards aim to increase risk sensitivity and reduce excessive variability in banks’ risk-weighted asset computations,” the MAS spokesperson adds. “The reforms should be viewed in the context of the broader benefits of a more stable financial system, which would contribute to sustainable economic growth.

“At the same time, regulators are cognisant of the potential impact of the reforms on banks and the broader economy, as well as industry feedback on the impact on specific business lines. To this end, the Basel Committee on Banking Supervision [BCBS] has committed to an evaluation work programme to assess whether the reforms have achieved their intended objectives and identify any unintended consequences.” 

The BCBS acknowledges that moving to meet the standards has been a challenge for some countries. While the region overall fared better than the West following the financial crisis that prompted the regulatory change, divisions within the region have left some falling behind. 

A beneficial system? 

While Basel III's benefits to international banking are widely accepted, the way that the Asia-Pacific’s regulators have chosen to implement them varies. For some this has meant adopting a more stringent approach than has been outlined. 

Mr Chang says: “The regulators in Australia and New Zealand have been working on higher capital requirements recently. The new higher requirements are under draft or consultation stage. The Australian Prudential Regulation Authority [APRA] wants "unquestionably strong" capitalisation for its banks. New Zealand is similar. This may cause a significant number of Tier 2 instruments to be issued by Australia’s major banks in the next few years.” 

APRA requires the four major Australian banks – Commonwealth Bank of Australia, Westpac Banking Corporation, Australia and New Zealand Banking Group and National Australia Bank – to meet a common equity Tier 1 (CET1) capital ratio of 10.5% by January 1, 2020. Andrew Gilder, partner, Asia-Pacific banking and capital market sector leader, financial services at EY, says: “In Singapore, the regulator has generally been conservative in its application of the Basel rules, and the local banks have been raising their capital ratios since 2014. Domestic systemically important bank [D-SIBs], for example, need to meet capital adequacy requirements that are 2% higher than the BCBS rule.” 

In some countries the requirements have actually reduced the pressure. “It seems the Philippines’ regulator is easing back on its Basel III CET 1 capital requirements,” says Mr Chang. “The regulator recently reduced the D-SIB buffer by 50 basis points [bps] to 100bps for the top-tier D-SIBs, such that the minimum CET1 ratio will now be 10.5% for the largest ones. [The Philippines' banks'] capital ratios were among the highest in the Asia-Pacific region before the implementation of Basel III.” 

Compliant bond issuance 

In order to meet Basel III's capital requirements, some banks have been looking to raise funds. But challenging market conditions are putting these lenders under pressure. 

“Central banks across the globe have become markedly more dovish in recent months,” says Gavin Gunning, senior director at S&P Global Ratings. “Lower interest rates translate to increasing challenges for maintaining net interest margins and profitability, which in turn makes internal capital generation harder – 2020 is likely to be a tougher year for banks, although our current outlook is for relative ratings stability.”

When this cannot be done internally, issuing compliant bonds has been the method of choice over the past few years. Christine Kuo, senior vice-president at Moody’s, states that the ongoing issuances can be chosen for several reasons. “There have been a lot of banks issuing bonds to get up to the required capital levels. In some cases, the Basel II instruments have been maturing so there is a need to refinance them with Basel III instruments,” she says. 

Raising funds through bonds is not a failsafe solution, however. “The banks have been issuing long-term bonds, rather than shorter wholesale bonds. They could explore issuing both types of bonds to tap different parts of the investor market and better match the tenors of their assets and liabilities,” says Ms Kuo. “There is a risk that when the bonds are to be refinanced, it could be a difficult time in the capital markets with restricted access to funds.” 

Movements in Mongolia  

Developing markets have had difficulty in getting up to speed with the various iterations of the Basel rules, with some significantly behind meeting Basel III requirements. Compared with the mature banking systems of the developed countries in Asia, Ms Kuo says Mongolia and Vietnam have had a very different experience.

“The banking systems in the two markets are less advanced so need more time to get ready. Under the move from Basel I to Basel II, the capital requirement would increase. The banks in both countries have seen rapid credit growth in the past three to five years, so they need to be careful they are able to meet the requirements. They also need to factor in risk management processes, which will take up more time and resources,” she adds. 

The Bank of Mongolia (BoM) has moved its regulations to be in line with Basel II, and to meet some aspects of Basel III, such as a higher Tier 1 capital requirement for D-SIBs. A transition period of 18 months to the end of 2020 was implemented to meet this, however, the country still needs international support. Mongolia is currently under an International Monetary Fund (IMF) support regime; in May 2017, the IMF announced it would be providing the country with an additional three-year arrangement worth $434.3m, with annual reviews to check progress.

“The IMF has been very keen on the Mongolian banking system to have stability through the cycle,” says Mr Chang. “BoM has been tough on the bank’s capitalisation and asset quality. Mongolia’s banking system is in the middle of moving from Basel I to a mix of Basel II and III gradually.” 

In the September 2019 review of Mongolia, the IMF said: “More progress is needed on implementing Basel II/Basel III standards, improving asset classification, and strengthening supervisory capacity.” It also noted that any slowdown in the country's economy could cause financial instability due to inadequate capital buffers. 

Vietnam's thin buffers

In the case of Vietnam, the country is still moving towards the implementation of Basel II. Wee Siang Ng, senior director, south and south-east Asia banks, at Fitch, says the change is difficult for the banking system as it still has thin capital buffers, low profitability and under-reporting of non-performing loans. 

Mr Ng adds: “Moving from Basel I to Basel II could highlight the Vietnamese banking system’s thin capital buffers that have diminished under recent years of rapid credit growth. Capital shortfall faced by the Vietnamese banks is likely to be significant due to an increase in risk-weighted assets, driven by higher credit risk-weights and the introduction of capital charges for operational risks.”  

Even the countries with the strongest economies in the region are feeling the strain. China has been under capital pressure as its profits are insufficient to keep up with growth. Grace Wu, head of Greater China banks at Fitch, says: “Chinese banks are largely compliant with local capital requirements at the moment, but many have very limited buffers against minimum regulatory requirements.”

Problems in India 

Among the countries facing problems, India is potentially storing up the most issues as it struggles to meet capital requirements. Saswata Guha, director and team head of financial institutions for India at Fitch, says the country's state banks have been under pressure due to the decline in asset quality in recent years. Fitch estimates $7bn more in fresh equity is needed to meet the Basel III capital requirements by the end of March 2021. 

Mr Guha adds that this is not the only funding needed. “This amount is in addition to the $10bn of capital the government has budgeted to provide during financial years 2020, which will meet the state banks’ immediate capital needs but leaves limited room for growth," he says. "State banks’ access to equity markets is very weak, although the state has provided capital to them on a consistent basis. Private banks, in comparison, have had good access to fresh equity.”

He suggests there will be lower credit growth in India for the financial year 2021, based on recent results and the trends indicating the banking system is unlikely to see the 15% cacreditpital growth that was initially expected. The expected shortfall in required capital is now likely to be $17bn compared with the $25bn originally estimated by Fitch. 

Indian banks’ difficulties could also be attributed to preventative measures being enforced upon them. Rakesh Jha, group chief financial officer at ICICI Bank, says an important point is that the Reserve Bank of India (RBI) has required capital to be 1% higher than the global level defined by the BCBS, standing at 5.5% rather than 4.5%. The total requirements including capital conservation is also held 1% higher, at 11.5% compared with the global requirement of 10.5%. 

“The one big change between Basel II and Basel III is the quality of capital,” says Mr Jha. “The importance of the CET1 has gone up substantially under Basel III. Of the 11.5% of capital adequacy requirement, the equity Tier I including the capital conservation buffer has to be 8% in India. So to that extent, the requirement of CET1 is a lot more than what can be filled through the Tier 1 capital bonds.” 

There are concerns the high levels are holding back growth in India, with the RBI rejecting calls from a parliamentary panel in January 2019 to relax capital requirements to free up funds for bank lending. Removing the additional requirements could release $76bn for lending. 

TLAC requirements 

Even as Asian banks are working to meet the Basel III requirements, they are coming under pressure for the total loss-absorbing capacity (TLAC) requirements, directed at systemically important banks. From January 2019 they have been required to hold 16% of their risk-weighted assets, increasing to 18% in January 2022. 

The more developed markets are also coming under pressure: including the TLAC requirements, Japan's banks need to raise $80bn, and China's $467bn. Australia's banks need somewhere between $50bn and $60bn. “TLAC requirements are having an impact,” says Ms Kuo. “The Japanese mega-banks, the big four banks in China, and banks in Australia and Hong Kong may need to take measures. They may need to issue capital instruments in order to meet these requirements.” 

For some, this means bond issuance in countries that are already on target with the Basel requirements. Ms Kuo points to Australian banks issuing Tier 2 subordinated bonds. 

Under the rules of TLAC, China could find itself facing problems in the future as it becomes a developed economy. “China is still categorised as an emerging market for the purpose of TLAC, so does not need to comply until 2025,” says Ms Kuo. “This could be earlier if China’s debt market keeps growing. If so, an accelerated timeframe will kick in and they may look to complete in 2023 or 2024.” 

China could find itself embracing the bond market to meet its additional pressures. EY’s Mr Gilder says: “[China] has not generally issued innovative capital instruments and so it may need to do more investor education in order to meet the TLAC requirements through the issue of new securities.” 

In order to meet the mounting requirements, the Asia-Pacific region may have to develop a stronger bond market. But with this dependent on the bond market rising to the challenge, it leaves banks in Asia-Pacific walking a fine line to meet rules developed by another region’s regulators.

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