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Asia-Pac banks sail through Basel III transition

Most banks in the region, having emerged from the global financial crisis relatively unscathed, are well on track to meet the stricter capital requirements.

Asia-Pacific countries are phasing in Basel III rules not quite uniformly but most banks in the region, having emerged from the global financial crisis relatively unscathed, are well on track to meet the stricter capital requirements under varying challenges.

When Basel III was conceived as an international regulatory response to the 2007-2008 financial crisis, banks in the Asia-Pacific region were in a healthier state than their peers in Europe and North America, due to lessons governments and companies had learned from another crisis in Asia in the late 1990s.

Now, while most regulators in the Asia-Pacific are still in the process of rolling out Basel III rules, major lenders in the region appear well covered, with the common equity Tier 1 capital ratios of select large Asia-Pacific banks ranging from 7.50% to 56.81% as of August 8, according to data compiled by SNL Financial.

“Most of the regulators have laid out pretty clear rules about what they expect in terms of the amount of capital and the timing of those capital requirements for all their banks. Most of them use the Basel standard implementation timetable. In certain cases, they have raised the capital requirements, and in certain cases, they have made the implementation timetable a bit shorter. But generally speaking, as far as the capital requirements go, all the Asian regulators have, to my knowledge, put out pretty clear rules in terms of what they expect their banks to hold,” Gene Fang, a vice-president and senior credit officer at Moody's, told SNL.

Under a timeframe set by the Basel Committee on Banking Supervision, banks have until 2019 to have common equity Tier 1 ratios of at least 7%, Tier 1 capital ratios of at least 8.5%, total risk-based capital ratios of at least 10.5% and leverage ratios of at least 5%, including an additional capital conservation buffer of 2.5%, if applicable.

Most Asia-Pacific countries are making a transition to the new framework in phases and the incremental approach has given Asia-Pacific banks plenty of time to prepare for the advent of Basel III.

“If you look at the fact that there has already been something like US$35 billion, probably more by now, of Basel III securities that have been issued by banks in Asia, excluding Japan and Australia, that gives you some evidence that the banks themselves have prepared for the capital requirements and are actively trying to manage their capital structures to meet those requirements,” Fang said.

The learning curve for banks is steeper in some countries, such as the Philippines, which implemented Basel III in January in one step. Specific rules also vary from country to country. Minimum common equity Tier 1 ratios in Asia-Pacific can be anywhere between 4.5% and 6.5%, excluding the additional 2.5% requirement, with the Philippines and Singapore on the higher end of the range, and Malaysia and Thailand on the lower end, Moody's said in April. Countries also interpret what constitutes common equity Tier 1 capital differently — Malaysia and Singapore have stricter rules, which do not fully recognize unrealized gains for the category.

Stricter Australian rules                                       

Australia is among the countries applying Basel III guidelines more strictly. By global standards, banks in the countries are well capitalised, according to Lachlan Colquhoun, head of market analysis at East & Partners.

But the reported common equity Tier 1 ratios of the top four Australian banks — National Australia Bank, Commonwealth Bank of Australia, Westpac Banking and Australia & New Zealand Banking Group — are relatively low at 8.33% to 8.82% as of August 8.

The CEO of Commonwealth Bank of Australia estimated that the bank's Tier 1 capital ratio would be as high as 12.7% under rules in Canada or Europe, The Australian reported in February. In response to such complaints, the chairman of the Australian Prudential Regulation Authority said at the time that regulators’ focus on banks' loss-absorbing capabilities and a conservative way of measuring mortgage risks are why Australian banks' capital ratios are lower than those of their global peers. The top four banks may have to raise A$23 billion to comply with tougher capital requirements, following an inquiry by the authority in July, according to UBS estimates.

A key concern for Australian banks is how the stricter capital rules will affect their dividend payments and loan growth. “The impact on [Australian banks], and elsewhere, will be the extent to which Basel III [standards] will limit both their ability to distribute dividends to shareholders — and we have had a recent period of special dividends which shareholders have enjoyed — and also the ability to expand credit,” Colquhoun told SNL.

For ANZ, Basel III created a different headache. An overseas expansion push left the bank with stakes amounting to A$4.1 billion in various banks in Asia as of September 30, 2013, which do not count toward Tier 1 capital. “Does this mean that, to meet the capital requirements, ANZ is going to have to unwind what was an early part of its pan-Asian strategy? The jury is out on this, but we are watching this one closely,” Colquhoun said.

China a risk to Hong Kong, Taiwanese banks

Hong Kong banks are also in good shape. “They have fewer risks, have better asset quality and loan books, and they are quite stable overall,” Jonathan Cornish, managing director and head of North Asia banks at Fitch Ratings, told SNL.

Yet, a major risk to lenders in the city is the impact of a slowdown in China as Hong Kong banks are becoming increasingly exposed to the market. “If China continues to slow down, if that is something that either they need to do or the government asks them to do, then that will have a knock-on effect to the operating environment in Hong Kong,” Cornish said.

In addition, a possible rate hike in the US would hit a large number of Hong Kong banks relying on US dollar funding while triggering an outflow of funds to the US, he said.

Taiwanese banks similarly have built sizable capital buffers. At the end of 2013, the average Tier 1 capital ratio of Taiwanese banks was 9.1%, and only 13 out of 47 banks on the island at that time did not have enough capital to meet the 2019 target ratio of 8.5%, including the extra 2.5% buffer, according to BNP Paribas. As Taiwanese banks do not have much subordinated debt, Basel III rules, such as a new core equity ratio requirement, will not pose major challenges for them, an analyst said.

“I think there is not too much concern, as half of the 13 banks' Tier 1 capital ratios were above 8%,” the analyst said.

Like their Hong Kong peers, however, Taiwanese banks are seeking to expand their business in China, which may force them to raise more capital in the coming years.

Chinese banks in fundraising rush

In China, banks have been busy tapping markets to raise funds to boost capital buffers as asset quality and profitability weaken, although their reported capital metrics do not cause alarm yet.

The country's top lender, Industrial & Commercial Bank of China, in August sought to issue Rmb20 billion of Basel III-compliant bonds in the largest offering of such securities in the local market, The Wall Street Journal reported on August 4. As of August 8, ICBC had a common equity Tier 1 ratio of 10.88%, the second-highest level among China's five largest banks by assets.

“A couple of the banks are looking to raise Basel III capital recently and [there are] very large transactions. In that case it indicates progress, I think it's certainly true that the banks are actively going out there raising capital and this is generally good progress,” said Fang at Moody's.

Chinese banks are in a fundraising rush to counter a range of risks. Underscoring a cautious outlook for them, particularly in asset quality and profitability, none of the viability ratings of Chinese banks are rated higher than BB by Fitch.

“We think that there are pressures on capitalization because there are a number of things, such as whether or not asset quality is properly reported, whether all of the risk weights on exposure are appropriately classified,” Cornish said. “In our view, we still look for improvements [in Chinese banks] to mitigate other risks in the system. They have definitely room to increase their capital in order to provide further buffers for potential losses.”

Economic challenges for Japanese, South Korean banks

Turning to other parts of Asia, Cornish said Fitch has a stable outlook for the ratings of all banks in Japan, which the rating agency thinks will meet Basel III requirements comfortably. A major source of uncertainty in the country, however, is the impact of Prime Minister Shinzo Abe's stimulus measures, or Abenomics, which provided a significant boost to markets and, consequently, to banks' earnings.

“The uncertainty going forward will be whether or not Abenomics continues to be positively affecting the market. If that proves to be unsuccessful, then there is a scope for correction in the market and that would be negative for the earnings of the banks and for their future prospects,” Cornish said.

The Japanese market still remains stagnant, and banks have been seeking growth overseas, marking a strategic shift that may eat into their capital. “What we are monitoring is whether or not there will be a material change in their risk appetite. If there is, then we will expect banks to use their capital [as] buffers against any potential losses through their increasingly risky portfolios. It's still a bit too early for us to tell what risks the Japanese banks are having,” Cornish said.

The common equity Tier 1 ratio of Mitsubishi UFJ Financial Group, the largest Japanese banking group by assets, was 11.25% as of August 8, while Japan Post Bank Ltd. topped the list of all major Asia-Pacific banks selected by SNL, with a ratio of 56.81%.

It is a somewhat similar story for South Korean banks. Fitch has a stable outlook for South Korean banks, which are expected to take Basel III requirements in stride. But the rating agency is less optimistic about the country's economic growth, a lingering risk for lenders in the country, along with the deteriorating financials of some large corporate borrowers.

“Those challenges are economic in nature. You've probably seen the government has announced a few policies trying to stimulate growth prospects there. They have an aging population, like Japan, which is going to also add as a headwind toward growth prospects,” Cornish said.

Some countries falling behind

The situation in the southern part of Asia is more mixed. Banks in Thailand will likely have little trouble meeting Basel III requirements, but some countries in Southeast Asia are far behind in switching to Basel III. In Myanmar, Laos, Vietnam, Brunei and Cambodia, banks are still operating under Basel I, according to an April presentation by Moody's.

Meanwhile, India is pressing ahead with Basel III at a time when state-owned banks, which make up about 70% of the country's banking system, are struggling to boost capital amid rising bad debt.

“Currently, their Tier 1 ratios already appear relatively low. [Business itself is] not necessarily profitable enough for them to continue to generate capital internally. They also have asset quality problems, which continually require high provisioning. So I think those Indian banks probably face lots of challenges in terms of raising additional capital in order to meet the higher and higher Basel III requirements,” Fang said.

As a way to preserve capital, public sector banks in India are cutting lending to riskier companies, the country's Mint reported Aug. 11.

Their peers in other countries may be better capitalized but regulatory compliance is still a growing burden for them, with tougher rules constantly introduced as the implementation of Basel III progresses. One thing banks are pressed to tackle now is replacing old Basel II securities with those compliant with new guidelines.

“For those to go away, you have to replace those with new capital, and finally they have these capital buffers they get phased in. Looking at all of that, you can prepare for it, but you have to prepare to meet higher and higher hurdles. I think the banks are aware of that, but that doesn't necessarily make it easy,” Fang said.

Moody's said in April that about US$44 billion of legacy securities were held by 60 rated banks in Asean countries and India, which will become callable or mature through the end of 2017.

Also, any unforeseen shocks could easily throw banks off balance. “You don't know what might transpire between now and then, whether or not there would be other problems to impact the banks,” Cornish said.

How far will regulators go?

For Asia-Pacific banks already in compliance with global Basel III guidelines, the question may be how far local regulators want to go in tightening rules within the broad framework.

“The main thing is [that] banks are trying to maintain capital levels above what the guidelines are for the minimum Basel III requirements and pretty much they are already at that point. So, it's a matter then of local regulators determining how liquidity would be calculated [by] them and the Basel committee determining how liquidity would be calculated, and whether or not they will be compliant with the required timeframes,” Cornish said.

In the coming years, for example, regulators may need to decide whether to impose additional capital requirements on domestic systemically important financial institutions, he said. Currently, there are five global systemically important financial institutions in Asia — Mizuho Financial Group, Sumitomo Mitsui Financial Group, Mitsubishi UFJ Financial, Bank of China and ICBC.

There are other areas Asia-Pacific regulators need to work on. The Monetary Authority of Singapore recently issued a consultation paper to revise its leverage ratio rules in line with the latest guidelines of the Basel committee. Under Basel III, the leverage ratio is calculated as Tier 1 regulatory capital divided by adjusted on- and off-balance-sheet assets, with a 3% recommended minimum. Off-balance-sheet components include future exposure to derivatives, standby letters of credit and underlying assets of outstanding covered bonds.

Regardless, banks are well-placed to adapt to any new rules. Moody's said on August 11 that Singaporean banks will have little trouble meeting the threshold, which will become a requirement by January 2018, thanks to their conservative risk management and relatively small exposure to capital markets.

“[We] are all beginning to see these other requirements getting clarified from the regulatory perspective,” Fang said.

Harish Mali contributed to this article.

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