Who’s afraid of Basel 3? Not crisis-hardened PH bankers

MANILA, Philippines—The global economic turmoil that led to the collapse of Lehman Brothers in September 2008 and the near bankruptcy of several large financial establishments in the United States alone had prompted authorities in the West to rethink government regulation in light of how these institutions tended to operate.

Authorities saw the need to put in place stringent and effective regulations if they hoped to avoid a similar crisis in the future.

As a result, regulators around the world have agreed to establish a set of enhanced guidelines to regulate financial institutions, especially banks. The recent crisis highlighted flaws in bank regulations, which had far-reaching and damaging effects.

Basel 3

A series of guidelines had already been drawn up and approved by the group of governors and heads of supervision—the oversight body of the Basel committee on banks. The group meets regularly at the headquarters of the Bank for International Settlements (BIS) in Basel, Switzerland.

The latest set of guidelines for regulating banks, known as Basel 3, calls for the tightening of capital requirements for banks. The objective is to ensure that banks have sufficient buffer to absorb shocks, including credit losses arising from loan defaults.

It has been agreed that the set of reforms in capitalization requirements will be phased in over the next few years.

The previous set of reforms, known as Basel 2, required banks to maintain an amount of capital equivalent to at least 8 percent of their risk-exposed assets, such as funds disbursed as loans.

Under Basel 3, this requirement has been tightened so that more than half of the minimum required capital must be of high quality. Specifically, of the 8-percent capital adequacy ratio (CAR), 6 percent should be core or “Tier 1” capital, which includes common equity and other high-quality capital like retained earnings. Moreover, of the 6 percent, 4.5 percent should be common equity.

This means that under Basel 3, banks should rely more on high-quality capital to absorb losses rather than capital of inferior quality, such as funds raised through sale of bonds. Compared with bonds, equity is considered to be of a higher quality because it does not create debt for a bank.

“A key element of the new definition of capital is the greater focus on common equity, the highest quality component of a bank’s capital,” the Basel 3 capitalization framework released by the Basel Committee on Banks states.

Implications

The draft of the Basel 3, which was released last December, has elicited talk about its potential impact on banking systems in various parts of the world.

In the United States and other industrialized countries, most of which are still trying to recover from the recent crisis and the recession it spawned, the requirement for banks to put up more capital has raised the question on their ability to do so. Some banks are reportedly hard-pressed to raise additional capital to cover potential losses, while even others face the threat of collapse due to the capitalization requirement.

Some argue that if this were to happen, then the enhancement of bank regulation through Basel 3 would have served no purpose.

But according to the Basel Committee on Banks, this is the reason why the group is gradually phasing in the requirement for compliance over the medium term. The committee expects banks worldwide to be able to slowly work on the requirements and build up capital without compromising their integrity and avoid the risk of collapse.

Philippine case

The Bangko Sentral ng Pilipinas wants to implement Basel 3 earlier than 2015—the year set by the international committee for compliance. The BSP believes that the local banking industry is healthy enough to adopt the internationally accepted standards early on.

For instance, while the minimum capital adequacy ratio (CAR) is set at 8 percent internationally, the BSP requires banks in the Philippines to maintain a CAR of at least 10 percent at all times.

According to BSP Deputy Governor Nestor Espenilla Jr., head of the bank supervision unit of the BSP, local banks are far better off than their counterparts in the West. In fact, he said, the Philippines do not have to make significant adjustments to comply with Basel 3.

Espenilla cited the latest data from the BSP, which showed that the average CAR of the country’s banking system stood at 15.2 percent as of the first semester of 2010.

He said all sub-sectors of the country’s banking system have CARs exceeding the 10-percent minimum requirement.

The universal and commercial banks (U/KBs) sub-sector has a CAR of 15.37 percent, while that of thrift banks is at 12.04 percent. Also, the rural banking sub-sector’s CAR stands at 18.95 percent, while the cooperative banking group has 17.16 percent.

Basel 3 is intended for banks in the West, Espenilla said, where the recent global economic crisis originated. When Asia went through its own painful financial crisis over a decade ago, regional regulators learned their lessons well—lessons central bankers in the West are only starting to discover.

Since the Asian financial crisis of the late 1990s, bank regulation has significantly improved in the Philippines and in neighboring countries, observers said.

Philippine bankers do not even see any problem with the requirement to maintain higher-quality capital, Espenilla said.

“Most [major players in the Philippine banking industry] are already complying with the proposed higher standards,” Espenilla told the Inquirer.

He said that, based on reports submitted to the BSP, most banks already maintain core capital higher than what Basel 3 requires.

For instance, BDO, the country’s largest bank in terms of resources, is estimated to have posted a Tier 1 capital equivalent to 10 percent of its risk-exposed assets as of end-2010.

Other top banks in the country likewise have reported double-digit figures for their Tier 1 capital ratio.

Metrobank reported that the ratio of its core capital to risk-exposed assets stood at 11.4 percent, while its total CAR hit 16 percent by the end of last year. Bank of the Philippine Islands reported a core capital ratio of 13.86 percent during the same period.

Meantime, as of the end of the first semester last year, Land Bank of the Philippines and Development Bank of the Philippines reported core capital ratios of 10.4 percent and 14 percent, respectively.

Thrift banks

Even thrift banks in the country have comfortable levels of high-quality capital, industry players said. Pascual Garcia III, president of PS Bank and one of the leading members of the Chamber of Thrift Banks (CTB) in the country, told the Inquirer that most of the players in the Philippine thrift banking sector are enjoying comfortable levels of core capital even before the Basel 3 was drafted.

“Compared with their counterparts [in industrialized countries], Philippine banks are strong,” Garcia said.

He said most thrift banks in the country would not find the Basel 3 requirement of maintaining 6-percent core capital a problem.

In the case of PS Bank, Garcia said, its core capital stands at about 10 percent of its risk-exposed assets.

Espenilla said the outlook for the country’s banking sector, at least for 2011, is quite positive.

Bank profits are expected to rise again this year, while capitalization levels are seen to remain healthy, he said.

Data from the BSP showed that as of the end of the third quarter of 2010, collective net income of universal and commercial banks in the country has reached P62 billion, while thrift banks collectively posted P1.8 billion.

Meanwhile, total resources of the country’s banking sector stood at P6.8 trillion as of end-October last year, rising by 8.6 percent from the previous period’s level of P6.2 trillion.

But Espenilla admitted that the rate of growth in net income of banks could slow down this year due to base effects. He noted that 2010 profit growth rates were unusually high due to the stark slowdown of the economy in 2009, brought on by the global financial crisis.

“If 2010 was a great year, 2011 will be a good year,” the central bank official said.

Aurelio Montinola III, president of the Bankers Association of the Philippines (BAP), said in an earlier interview that 2011 could be expected to be another favorable year for Philippine banks.

Montinola said the lending business would be profitable, while demand for loans, amid a growing economy, would likely grow by almost 10 percent this year.

The regulator and captains of the banking industries all agree that local banks have gone a long way since the Asian financial crisis of the 1990s, so much so that any regulatory reform being pushed in the West may only be considered redundant in the Philippines.