The Market Monitor Minding the Nation's Business
By Luis Leoncio
The local banking system is healthy overall as a result of measures the Bangko Sentral ng Pilipinas (BSP) had taken, including the imposition of a strict requirement to ensure that Philippine banks are on par with international standards. But BSP records show that not only small banks, but even those considered “too big to fail” have fallen below the regulator’s standards.
Data obtained by The Market Monitor showed that even the biggest lenders in the country have not met the Basel III requirements that the BSP has imposed since last year.
The BSP issued the new Basel III Implementing Guidelines on January 1, 2014, which stated that banks must meet specific minimum thresholds for so-called Common Equity Tier 1 (CET1) capital and Tier 1 (T1) capital, in addition to the Capital Adequacy Ratio (CAR).
These regulatory thresholds effectively move banks worldwide to rely more on core capital instruments like CET1 and T1 issues in lieu of hybrid instruments that did not fare well in the latest global crisis as far as absorbing losses.
Basel III is the global regulatory standard on bank capital adequacy, stress testing, and market liquidity risk agreed upon by the members of the Basel Committee on Banking Supervision. Under Basel III, the minimum Common Equity Tier 1 Capital Ratio is 4.5 percent, Tier 1 Capital Ratio is 6.0 percent, conservation buffer is 2.5 percent, and the minimum Total CAR is 8.0 percent.
The ability to absorb losses is central to Basel III. The BSP maintained the minimum Capital Adequacy Ratio (CAR) at 10 percent.
In addition to CAR, the new framework sets a CET1 ratio of at least 6 percent and the Tier I capital ratio is at a minimum of 7.5 percent.
The new guidelines also introduce a capital conservation buffer of 2.5 percent, which shall be made up of CET1 capital. In addition, banks that issued capital instruments from 2011 will be allowed to count these instruments as Basel III-eligible until end-2015.
Moreover, banks that are considered by the BSP as “too big to fail” or domestically systemically important banks (DSIB) will have minimum common equity Tier 1 (CET1). Ratios that are higher by 1.5 percent to 3.5 percent higher than the existing minimum of 6 percent and the capital conservation buffer of 2.5 percent.
Under these guidelines, several banks failed to make the cut as of September 30, 2014, based on the financial statements submitted to the BSP.
The data showed that three thrift banks failed to meet the BSP’s total CAR threshold, 11 thrift banks and one DSIB failed to comply with the Tier 1 CAR requirement, while 56 thrift banks and six DSIBs, including foreign offshore units, missed the common Tier 1 ratio rule.
A bank’s CAR is a measure of a its capital and financial strength. It is expressed as a percentage of a bank’s risk weighted credit exposures. It is also known as the “Capital to Risk Weighted Assets Ratio (CRAR).
Tier 1 CAR, meanwhile, is the ratio of a bank’s core or equity capital to its total risk-weighted assets. It measures financial strength from a regulator’s point of view.
Tier 1 Capital measures the bank’s ability to absorb losses without a bank being required to cease trading.
Tier 2 Capital is supplementary capital. It measures the ability of a bank to absorb losses in the event of a winding up and so it provides a lesser degree of protection to depositors.
Investopedia defined the Common Equity Tier 1 Ratio as a capital adequacy ratio that “…excludes any preferred shares or non-controlling interests when determining the calculation. This differs from the Tier 1 capital ratio which is based on the sum of its equity capital and disclosed reserves, and sometimes non-redeemable, non-cumulative preferred stock.”
Regulators use the Tier 1 common capital ratio to grade a firm’s capital adequacy as one of the following rankings: Well-Capitalized, Adequately Capitalized, Undercapitalized, Significantly Undercapitalized, and Critically Undercapitalized, it said.
A well-capitalized bank has a Common Equity Tier 1 ratio of 6 percent or more and does not pay any dividends that would affect its capital base, while those considered adequately capitalized are those with Common Equity Tier 1 Ratio of 4 percent or more.
Undercapitalized banks are those with Common Equity Tier 1 Ratio below 4 percent while those significantly undercapitalized are those with Common Equity Tier 1 Ratio below 3 percent.
A bank is considered critically undercapitalized if it has a Common Equity Tier 1 Ratio below 2 percent.
Banks “ranked as Undercapitalized or below are prohibited from paying any dividends or management fees. In addition, they are required to file a capital restoration plan.”