Loan loss buffers of banks decline

Loss buffers of banks declined at the end of March following the implementation of stricter regulations on debt securities qualified as capital that took effect at the start of the year, the Bangko Sentral ng Pilipinas (BSP) said.

Industry capitalization levels, however, remained well-above the minimum prescribed by the BSP—a testament to the health of the local financial sector.

Documents released by the BSP showed universal and commercial banks’ average capital adequacy ratio (CAR) stood at 15.45 percent. Including the books of subsidiaries, banks’ CAR stood at 16.35 percent in March.

Both levels were lower than the solo and consolidated CARs of 16.5 percent and 17.65 percent, respectively, recorded in end-December. The latest report on capital was the first since the new rules took effect.

“The December 2013 ratios were calculated under the previous prudential regime,” the BSP said, explaining the dip. Under existing regulations, banks need to maintain CAR levels of only 10 percent.

Banks’ CARs, a measure of capital they have relative to risk-weighted assets such as loans and investments, serve as buffers for potential losses from defaults.

At the start of the year, Basel 3 regulations on capital took effect, which meant debt securities issued by banks that under previous rules qualified as a lower kind of capital that could augment their CARs were no longer recognized by regulators.

Fitch Ratings, in a report late last month, estimated that there were P120 billion in banks’ tier-2 notes outstanding when Basel 3 rules took effect. So far, P50 billion in Basel 3-compliant notes have been issued. The rest, the rating firm said, “must eventually be replaced.”

Basel 3 rules dictate that if banks want to continue issuing debt securities, these notes need to have loss-absorbency features to make them act more like real equity capital.

“Loss absorbency refers to the ability of bank-eligible capital instruments other than common equity to behave and act in the same way common equity shares at the point where the bank takes losses and becomes non-viable,” the BSP said.

Simply put, this means holders of tier 2 notes lose either part or their entire investment if a bank shuts down. The main goal of these rules is to protect the bank’s clients and the public, not the firm’s shareholders and investors.

Also under Basel 3 rules, so-called “non-allied undertakings” such as benefit pension funds, goodwill and other intangible assets would also be deducted from a bank’s capital.