Profits of local banks seen taking a dive in 2014

Profits of local banks are expected to take a dive next year as companies build up capital buffers required under stricter industry regulations that will take effect in January.

The Bankers Association of the Philippines (BAP) said it believed stricter capital rules under Basel III would be a worthy long-term investment, despite their effect on short-term profitability, because these would shelter the industry from “financial storms.”

“Regulators are looking after the safety of the industry and depositors, whereas our objective is shareholder return,” Rizal Commercial Banking Corp. president Lorenzo Tan said.

He said investors in banks should expect a 1 to 2 percent-reduction in their return on assets.

“For some banks, it may even be more. Those reliant on trading gains, it may be more,” Tan said.

Tan, who heads the BAP, said the higher capital buffer requirement under Basel III would force banks to rethink their current business models to bring back returns to historical levels.

At the moment, local banks are already required to maintain a capital adequacy ratio (CAR) of 10 percent, higher than the international standard of 8 percent under previous Basel II rules.

A bank’s CAR represents its buffer against losses in case its risky assets have to be written off. This is a measure of a bank’s ability to absorb unexpected losses that may be a result of macroeconomic issues or a sudden rise in loan defaults.

Under the new rules, the BSP said the minimum 10-percent CAR requirement would be retained, but the share of common equity in the CAR would be increased.

The Bangko Sentral ng Pilipinas (BSP) said it would require banks to increase tier 1 capital to at least 6 percent of their total CAR, up from the 5-percent minimum under Basel II rules.

Tier 1 capital is made up mainly of actual shareholders’ equity in banks, manifested through common shares.

On top of the required 6 percent, local banks would also be required to set aside a 2.5-percent “capital conservation buffer,” a new component that was absent from existing rules.

To comply with the Basel III rules, banks can either increase their capital base, which would require additional investment and may dilute existing shareholders, or rein in their lending activities to reduce their risk-weighted assets.

In a speech last week, BSP Governor Amando M. Tetangco Jr. said he believed the local industry would be able to make the transition to Basel III smoothly.

Universal and commercial banks currently have an average Tier 1 CAR of over 15 percent.

BAP’s Tan, for his part, said banks would have to look at other revenue sources such as the aggressive cross-selling of other financial products to existing clients.

He said banks could also increase lending to higher-yield segments such as consumers and small businesses.