MANILA, Philippines - While most Asian banks have still to fulfill regulations under the Basel II framework set by the Bank for International Settlements (BIS), consultative papers on new regulations have been circulated by the Basel Committee for Banking Supervision since late 2009, seeking the thoughts of banks worldwide.
Bankers, including those domiciled in Asia, must submit their proposals or reactions by the first semester of 2010.
“These proposals represent a major and ambitious overhaul of the existing regulatory regime, and are made in response to the recent global financial crisis,” Citibank NA (Citi) said in its February report of Asia Macro View.
The final standards will be released end 2010, with implementation by end 2012.
Citi believes that Basel III will require banks to hold more equity capital, and maintain more liquidity.
Other broad implications are: earnings will be smoother/less cyclical due to the shift to expected loss (EL) provisioning; banks will also be subject to greater regulatory intervention, including potential constraints on divided payment; and, net result will be lower and less cyclical return on equity (ROE).
But Citi is not too concerned about the ability of the Asian banks in general to deal with a new environment.
“In Asia (ex-Japan), capital levels are higher to start with, liquidity is generally strong given low loan/deposit ratios and reliance on deposit funding (as opposed to wholesale funding), and business mix is predominantly in basic banking without much complex derivative, structured, off-balance sheet activities,” the report said.
The average equity Tier 1 ratio of Asian banks under Basel 3 is estimated at nine percent compared to 7.1 percent for Australia, 5.7 percent for Europe and 3.4 percent for Japan.
The reported average Asia Tier 1 under Basel 2 stood at 10.7 percent, while the average equity Tier 1 under Basel 2 is 10.
Philippine banks are estimated to be within the Asian average, as of June 2009.
“We believe this level for Asia should be sufficient to clear future regulatory minimum levels, based on four-percent minimum and two- to three-percent capital buffer,” the report indicated.
Banks in the countries of Indonesia, Thailand and Pakistan are well capitalized and have strong liquidity.
“Markets that we think are more problematic are Taiwan and Malaysia,” Citi said.
Both markets have relatively low equity Tier 1 ratios and relatively high leverage ratios. Malaysia in addition has relied heavily on hybrid capital to bolster Tier 1 capital and there seems to be significant amounts of goodwill that is hidden from view at the financial holding company (FHC) level.
Taiwan in addition has a fairly poor history of credit costs, which could hurt the sector under EL provisioning. This is further compounded by the sector’s low profitability, which amplifies the earnings sensitivity to provisions.
Korea is a borderline case, dragged down by low capital ratios and high loan/deposit ratios (potentially more vulnerable to new liquidity standards).
The impact on ROE from raising equity Tier 1 is likely to be limited. Since Asian banks are generally well capitalized, we do not anticipate significant capital raising pressure, except in a few specific cases.
However, Citi said that banks that may be under ROE pressure are Malaysia’s Public Bank, and Chinatrust, Chang Hwa Bank and First, all Taiwan banks.
Banks to watch are Hana, OCBC, CIMB, Maybank, KBFG, Bank of Baroda, and Sinopac.
Likewise, strictly applying the average 10-year credit cost as the future level of EL provisions, the report said that ROEs that could be most impacted are Taiwan (7.2 percentage points), Malaysia (negative 4.7 percentage points) and Korea (negative four percentage points). The least impacted markets are Singapore, Pakistan and China.
The proposed Basel III framework introduces two new measures for liquidity risk — the liquidity coverage ratio (LCR) and the net stable funding ratio (NCR).
The LCR ensures that there are sufficient high quality liquid assets to help the bank survive a 30-day stress scenario. The NCR encourages banks to reduce duration mismatch on the balance sheet.
The broad implications are that banks will need to carry more liquidity in future and less reliance on wholesale funding (impact on banks with high loan/deposit ratios).
“We find that liquidity appears to be high across the region. The range for our liquid assets ratio is Hongkong and China at the high-end (51 to 56 percent), and Korea and Thailand at the low end (negative 30 percent),” the report added.
Loan/deposit ratios are generally below 100 percent, with the exception of Korea. Even in Korea, the regulator has recently demanded that the banks reduce their loan/deposit ratios to below 100 percent by 2013.
“Qualitatively speaking, if the new Basel 3 liquidity standards were to be an issue for Asia, Korea would come across as being most vulnerable, in our view,” Citi said.