Banks get tips on how to beef up their capital adequacy ratio

Instead of struggling to raise additional capital, commercial and universal banks could beef up their capital adequacy ratio (CAR) if their borrowers get positive credit ratings from external credit rating agencies.

Under the provisions of the Basel II Convention, having a portfolio of borrowers with a positive credit rating by external credit assessment institutions (ECAI) could help banks boost their CAR.

According to Philippine Ratings Services Corp (Philratings) president Cayetano W. Paderanga, the risk weights in calculating the CAR of banks were based on credit ratings of an external rating agency under Basel II.

Basel II is a set of proposals revising Basel I to make regulatory capital requirements more risk sensitive. Paderanga explained that the standards set by Basel II was reflective of all, or at least most, of the risks banks were exposed to and prescribe not only a risk-based capital framework, but an entire risk-based supervisory framework.

Paderanga explained that current risk weighting now was 100 percent for most of the existing exposures. Under the Basel II, the risk weight stays at 100 percent if the exposure is unrated.

To improve their CAR, Paderanga said banks with CAR of already close to 10 percent (the minimum required by the Bangko Sentral ng Pilipinas) could resort to encouraging their creditworthy borrowers to be rated by ECAIs so the risk weight could go lower than 100 percent.

"For instance, a loan exposure with PRS Aaa rating may have a risk weight of as little as 20 percent, and could thus improve the CAR of the bank," Paderanga explained. "Consequently, the borrower can ask for a lower interest rate as the bank will need lower capital to cover the corresponding exposure," he added.

"Some rated entities have realized lower interest rates on their rated obligations, as much as 200 basis points lower than their unrated obligations," Paderanga said, adding that "credit ratings could also enhance its (the borrower’s) access to new sources of funds and to new markets."

The Monetary Board of the BSP earlier approved the risk-based capital adequacy framework which would take effect on July 1, 2007, to align the existing Basel I-compliant framework with the new Basel II standards.

Based on the provisions approved by the BSP, the MB decided to maintain the present minimum overall capital adequacy ratio (CAR) of banks and quasi-banks at 10 percent.

However, consistent with Basel II recommendations, the MB also approved major methodological revisions to the calculation of minimum capital that universal banks, commercial banks and their subsidiary banks and quasi-banks should hold against actual credit risk exposures.

This is where the quality of banks’ loan portfolio would become critical in calculating their actual CAR.