Basel 3 poser for banks

The Star

The Basel 3 proposals, which will be fully implemented by the end of 2012, may affect the capital level of some Malaysian banks, leading them to cut back on dividend payouts and raise fresh capital, analysts said.

Although the proposals remain vague as they are still at an early stage of development, analysts expect that the proposals would broadly require banks to hold more equity capital and liquidity, strengthen their capital buffers and subject banks to greater regulatory intervention, including potential constraints on dividend payments.

Citi Investment Research, in a note, observes that although banks in Asia, excluding Japan’s, are generally well capitalised, banking markets like Taiwan’s and Malaysia’s have relatively low equity tier-1 capital and relatively high leverage ratios.

RAM Rating Services Bhd’s Promod Das ... ‘Basel 3 would be the next quantum leap.’

It notes that Malaysia relies heavily on hybrid capital to bolster tier-1 capital and there seems to be significant amounts of goodwill hidden at the financial holding company level.

“Since Asian banks are generally well capitalised, we do not anticipate significant capital raising pressure, except in a few specific cases. We think a handful of banks’ equity tier-1 ratios may fall below our assumed 7% minimum by 2011 – Malaysia’s Public Bank Bhd (PBB) is one of them. These banks may face pressure to either reduce dividends and/or raise fresh capital,” Citi Investment Research said.

“Knowing the future level of minimum requirement will be critical. As an example, if we set the minimum equity tier-1 ratio to 8% instead of 7%, then many more banks may potentially fall into the capital raising zone, including OCBC, CIMB and Maybank,” it added.

BNP Paribas, in a research note, reckons that the key reforms of Basel 3, among others, would focus on how capital base is being defined.

In this respect, the report said a key proposal would be that the predominant form of tier-1 capital must be common shares and retained earnings.

The phasing out of innovative capital securities, the exclusion of minority interest from equity tier-1 and the addition of unrealised gains and losses towards equity tier-1 would be among other key proposals, according to BNP Paribas.

The minimum capital requirement has not been calibrated but is set to be raised from the current 4% for tier-1 and 8% for capital adequacy ratio, the report said.

BNP Paribas analyst Ng Wee Siang said a stringent application of these proposals would drag down the tier-1 ratios of banks and that Public Bank would be the most affected given its existing low equity tier-1, while the impact on other Malaysian banks would be manageable.

This may cause Public Bank to scale back on its dividend payout while the impact on its tier-1 ratio is large enough to bring it down to 6.7%, the lowest among BNP’s coverage universe.

This, Ng said, was not surprising given Public Bank’s aggressive move in recent years to increase the efficiency of its capital structure by returning equity capital to shareholders and replacing it with non-equity tier-1 capital.

“In the event the minimum tier-1 ratio is raised, Public Bank will have no choice but to scale back on its aggressive dividend payout (a minimum 80%),’’ Ng said, adding that the broader impact would be that banks would have less flexibility to undertake financial engineering to boost their return on equity (ROE).

As capital buffers are being built up, ROE would fall and this may over time have an impact on banks’ valuations, according to Ng.

He also reckoned that the proposed reforms would have zero impact on Hong Leong Bank (HLB) given the bank’s clean balance sheet with zero innovative and non-innovative hybrid securities.

Post adjustments, HLB’s tier-1 ratio would stand head and shoulders above that of its peers, Ng said.

Promod Dass, RAM Rating Services Bhd head of financial institution ratings, said Malaysian banks were well capitalised and had survived the global financial crisis without a dent in their capital position.

“The adoption of Basel II has revolutionised risk management culture and mindset of banks by setting up rigorous risk and capital management requirements designed to ensure that a bank holds capital appropriate to the risk it exposes itself to through its lending and investment practices. Basel 3 would be the next quantum leap,” he said.

Based on the rating agency’s analysis, Dass noted that domestic banks’ current level of common equity as a proportion of risk-weighted assets was still at a comfortable level.

As at end-December 2009, the banking industry’s average overall risk-weighted capital adequacy ratio and tier-1 capital adequacy ratio stood at a healthy 14.7% and 13.3%, respectively (end-December 2008: 12.6% and 10.6%).

Dass said that although the new capital rules to be set by Bank Negara could necessitate the raising of new, costlier capital for certain banks, RAM believed that the approach taken by the bank regulator would be pragmatic.

“It is important to realise that these proposed capital measures will be onerous for banks but will ensure that the Malaysian banking sector has enough might to continue riding through financial tsunamis,’’ he said.

Malaysian Rating Corp Bhd vice-president and head of financial institution ratings, Anandakumar Jegarasasingam, feels that in terms of meeting the enhanced capital requirements, the Malaysian banking sector is on a relatively better footing than some other developed markets as banks’ shareholders’ funds account for about 80% of tier-1 capital.

That said, at this point, it is reasonably expected that the minimum required regulatory capital ratios (tier-1 and total capital ratios) would increase significantly once these proposals are firmed up, according to Anandakumar.

He said one of the barriers for local banks in implementing Basel 3 was that the need to have a strong capital buffer was overlooked in their search for higher ROE.

“This is the biggest challenge for Malaysian banks given the predominance of banking stocks on Bursa Malaysia and the resulting high dividend expectations,’’ he added.

HSBC Bank Malaysia Bhd chief risk officer Paul Norton said the challenges might be in the form of granularity for the new reporting requirements which may require system investment costs.

He added that for the overall banking industry, if banks needed to set aside very substantial sums to meet liquidity, this might hinder the availability of these funds to support lending.

Ernst & Young financial services leader for Malaysia, Gloria Goh, is of the opinion that should the regulator in Malaysia set the implementation of Basel 3 proposals at an appropriate time, there would probably be many banks taking prompt action to review and raise their tier-1 capital to meet the new requirements.

“This could also result in the forced merger of some of the smaller banks as they may not have the capabilities and capacity to do it alone. As for the larger banks, the biggest challenge would be to balance the sudden cost increase and how such costs could be effectively managed,’’ she said.

Although the framework might pose some challenges to banks, OCBC Bank (M) Bhd country chief risk officer Choo Yee Kwan said bank regulators could exercise “national discretion” with respect to the timing of implementation, and in making revisions to certain prescribed areas.