Basel III Implementation Approaches in Southeast Asia

Basel III, introduced by the Basel Committee on Banking Supervision (BCBS) in 2010, is widely seen as a response to the failure of the current regulations to stem the global financial crisis of 2007-08. It is changing the way banks manage their risks, as the new regime seeks the adoption of a more rigorous regulatory stance towards the key components of strategic, risk and financial management such as derivatives’ and systemic risks, statutory capital, leverage, liquidity, and cyclicality. Basel III requires further evolution of a risk management framework into a more robust one, in many ways providing a solid rationale for true enterprise risk management, which involves covering all risks to the business.

Increased capital requirements because of Basel III sent ripples around the globe with some major banks going to the market with new stock issuances as early as late 2010. Although being confident in banks’ ability to meet the new capital requirements due to historically high capital adequacy ratios (CAR) , national regulators in the key regional markets already formulated their approach to implementation of Basel III. In general, the regulators adopted a balanced approach, carefully sizing up implementation requirements against the capabilities of financial institutions and giving preference to measures that would insure overall capital adequacy and ability to withstand cyclical downturns.

Singapore: Systemic Risk Recognised

On 28 December 2011, the Monetary Authority of Singapore (MAS) released the proposed amendments to MAS Notice 637 on Risk Based Capital Requirements for Banks Incorporated in Singapore to implement Basel III. The framework in Singapore will apply to banks at both consolidated and stand-alone level. The minimum Common Equity Tier 1 (CET1) ratio is set to reach 6.5% by 2019, which is 2.0% higher than the BCBS’ CET1 ratio. MAS will require Singapore-incorporated banks to meet international minimum capital adequacy requirements from 1 January 2013, two years ahead of the BCBS 2015 timeline. Such accelerated approach also means that from 1 January 2013, Singapore-incorporated banks will meet a minimum CET1 CAR of 4.5%, Tier 1 CAR of 6.0%, and Total CAR of 8.0%.

In line with the BCBS requirements, MAS will introduce a capital conservation buffer of 2.5% above the minimum capital adequacy requirement, the leverage ratio of 3.0%, as well as some other regulatory adjustments and deductions: goodwill and other intangible assets as well as deferred tax assets (DTA) deduction from CET1 instead of Tier 1, recognition of the hedge cash flow reserve in the calculation of CET1 capital, and credit valuation adjustment (CVA) calculation. Another important feature of Basel III implementation in Singapore is recognition of systemic importance of all domestically incorporated banks, because of their substantial retail presence. Consequently, 2.0% will be included into total CAR ratio, bringing it to 10.0% to cover for systemic risks. Gradual phase-in of the capital conservation buffer will raise the ratio to 12.5% by 2019.

Philippines: Fast-track Adoption for Statutory Capital

The Bangko Sentral ng Pilipinas (BSP), the country’s central bank and regulator of the financial services industry, circulated a draft of Basel III requirements for universal and commercial banks, including its subsidiaries and quasi-banks in January 2012. BSP requested the banks to implement BCBS requirements for statutory capital, including cleanup and deduction clauses in full by 1 January 2014, in contrast with BCBS recommended staggered timeline and gradual phase-out of ineligible capital instruments. According to BSP, the minimum CET1 ratio will be set 6.0%, total Tier 1 capital will be 7.5%, and total CAR 10%. A capital conservation buffer of 2.5% will be applied, bringing the total CAR to 12.5%.

There are two special features of the current phase of Basel III implementation in the Philippines:

  1. Tier 2 capital definition. 
  2. A specific deduction of equity investments in non-financial entities.

While defining Tier 2 capital, BSP chose to clearly specify preferred stock as the only type of instrument, allowable under this category. This is narrower than the definition proposed in BCBS requirements.

BSP also required the banks to review the equity investments specifically in ‘non-financial allied undertakings and non-allied undertakings’ and deduct them in full from the common equity Tier 1 ratio. The main reason for such a stringent approach is that major Philippine banks are linked with some of the biggest country’s holding companies. It is not uncommon for such banks to have investments in other (non-financial) entities of the holding. These investments may be a source of a significant systemic risk. At this time BSP chose to concentrate on capital definition and cleanups, however, other aspects of the Basel III implementation, such as leverage, liquidity and the countercyclical buffer, will also be also covered in separate regulations likely to be announced later in the year.

Malaysia: In Line with BCBS Approach

Bank Negara Malaysia (BNM) fully supported the implementation of Basel III reform measures to strengthen the capital and liquidity standards for banking institutions in the country. The regulator chose to implement the reform package in accordance to the globally-agreed levels and timeline, with a gradual phase-in of the standards beginning 2013 until 2019. The guidelines on Basel III implementation, issued in December 2011, address the enhancement of definition of capital and strengthening of its quality, as well as implementation of the leverage and liquidity ratios.

The minimum CET1 ratio will reach 4.5%, while total Tier 1 capital will be fixed at 6.0%, and total CAR at 8% by 2015. The gradual introduction of the capital conservation buffer will bring the total CAR target for Malaysian banks to 10.5% by 2019. Considering the industry feedback, BNM plans to issue concept papers outlining the rules and mechanisms to implement the new capital buffers (countercyclical and capital conservation) by 2014. The regulator will also clarify existing supervisory processes and risk management requirements before the new requirements are implemented.

Challenges of Basel III Implementation

Comparison of selected approaches, selected by the regulators, indicates their continued confidence in banks’ ability to meet Basel III standards. For instance, both Singapore and Philippines chose an accelerated approach to implementation of the new total capital requirements. At the same time, regulators leave some room for further discussions on such components of Basel III framework as specific risks’ calculations and liquidity ratios. The latter were of a significant concern for the banks in southeast Asia.

The challenge with implementation of the liquidity coverage ratio (LCR) and net stable funding ratio (NSFR) lies in the low levels of government debt in the region. This means an absence of high-quality assets needed to meet the minimum required levels for both LCR and NSFR. For example, Singapore has a significant shortfall of government debt relative to the size of the domestic banking industry. Such a situation can actually create new risks, instead of mitigating currently existing ones.

When the volume of government securities in the market is not sufficient, banks may take in more foreign currency denominated debt, thus increasing both currency and sovereign risks. Regional regulators may need to continue dialogue with the Basel Committee to recalibrate some of these ratios to better reflect both regional business and risk contexts.

 

Footnote 1.  Total CAR for Indonesian and Philippines banks is currently around 17.0% and around 14.2% for Malaysian banks.

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