High-growth markets face bank capital setback

Banks from emerging economies are likely to experience hurdles when it comes to raising bank capital internationally, S&P says, but syndicate bankers think otherwise.

While most rated Asia-Pacific banks will be able to meet Basel III capital requirements within the stipulated time frames without reducing assets, there are some that will struggle.

According to Standard & Poor’s, banks operating in high-growth systems such as China and India will likely face challenges in replenishing capital.

Domestically, the depth and size of these countries’ investor base are lagging behind those in developed systems and internationally, they have a limited track record of cross-border issuance while the liquidity of securities is low, the rating agency said in a report released on Wednesday.

“Banks in high-growth countries such as India and China are poised to venture into both the domestic and global markets for Tier 1 and Tier 2 securities,” Naoko Nemoto, analyst at S&P said in the report.

“In our opinion, they will face more challenges to tap the global market given their limited track record of cross-border issuance of capital instruments and relatively low stand-alone credit profiles compared to those in the developed market.”

Also, regulatory frameworks differ across countries, making it difficult for market participants to assess the risk of such Tier 1 and Tier 2 securities , Nemoto added.

Japan, for example, is a special case. The country’s resolution framework aims to minimise any disruption to the financial system through preemptive recapitalisation of solvent banks.

“In Japan, the preemptive capital infusion does not hit the trigger of the non-viability clause of hybrid securities, and the non-viability trigger occurs only if the bank is in a position of negative net worth,” Nemoto said.

Elsewhere, India has proposed bail-in of creditors as one of its many options for the resolution of distressed financial institutions, although it is not a pre-requisite for using other instruments. A bail-in forces creditors to bear some of the burden by having part of the debt they own written off.

While the proposal provides a cohesive framework to manage future financial crises, legislative and political challenges could impede its execution, S&P warns. In China, the resolution framework has not even been revealed yet.

West and East differ

Asia-Pacific governments generally give banks and their obligations a high level of support, and the resolution framework and non-viability trigger — when investors could lose all their money if the regulators decide the bank cannot survive — are not similar to the Western countries.

In Europe and the US, Basel III-compliant hybrid securities carry a contingent clause that relies on the bail-in power of regulators, which is statutory. In Asia-Pacific, the non-viability language is contractual — a written agreement between banks and bondholders — meaning the regulators have no power impose a bail-in scenario.

“It is mandatory in the US and EU as these governments are not keen on using tax payers money to save banks’ creditors,” Nemoto said. “In Asian countries, we expect the governments will provide some sort of support to banks without having creditors take losses.”

 However, the resolution regime in Asia is still work-in-progress, highlight bankers. There is a strong push for jurisdictions in the region to move towards a statutory framework where a proposed bail-in is imposed as opposed to contractual one.

Still more to come

Despite the setbacks, syndicate bankers are still confident that Asia Pacific is going to see more bank capital issuance from the region’s banks.

China, the world’s second largest economy after the US, is likely to drive a bulk of the dollar-denominated Basel III hybrid bond volumes as the country’s local banks look to shore up cheaper forms of funding.

“There has not been any issuance from China because there’s no framework but that doesn’t mean there won’t be any demand for these securities, especially when investors are chasing return,” Alan Schmoll, debt capital markets director at Bank of America Merrill Lynch, told FinanceAsia.

“There’s no doubt that there are going to be differences across various jurisdictions but that means that investors need to learn those nuances on a case-by-case basis,” he added. “I don’t think that in itself affects the demand for the securities.”

The mainland’s top five banks have obtained approvals last year to issue a combined Rmb270 billion ($43.5 billion) worth of Basel III-compliant bonds from 2014 to 2016. The banks are Agricultural Bank of China, Bank of China, Bank of Communications, China Construction Bank and Industrial and Commercial Bank of China.

While that includes issuance in both onshore and offshore markets, BofA Merrill believes that a quarter of that approved total will be issued in the latter market.

Without the mainland banks, syndicate bankers estimate another $3 billion to $5 billion of supply will come from Hong Kong, Korea, Singapore and Thailand. Indian financial institutions, which have been actively raising bank capital domestically, could also be potential Basel III-compliant capital candidates in the international market.

“I think all the jurisdictions that are looking to issue in Asia are all relatively safe and investors are taking the view that the region’s banking system is going to be stable for the next five years,” a Hong Kong-based syndicate banker said. “It’s just a case of how much yield you want to chase.”

“The performance that we are going to see over time is going to be in some of the more high-yielding jurisdictions like Greater China,” the syndicate banker added.

Asia-Pacific dollar-denominated Basel III Tier-2 bond volume has reached $8.7 billion with nine deals year-to-date, according to Dealogic data.

Although the bankers tend to be more bullish on the future of bank capital issuance, S&P highlights the importance of greater transparency of each bank’s health as well as more clarity over the treatment of such hybrid securities and banks’ resolution schemes. “[This] will support the issuance of these hybrid capital banks in emerging markets, targeting a broader range of investors,” Nemoto said.


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