BSP ready for 2nd phase of Basel III reforms

The Bangko Sentral ng Pilipinas (BSP) is preparing to implement the second phase of reforms pertaining to capital ratios under the Basel III agreement aimed at addressing the weaknesses of the international banking industry that were made evident during the global financial crisis. BSP Deputy Governor Nestor Espenilla III told reporters at the central bank's Annual Reception for the Banking Community last Friday evening that monetary authorities are set to implement Basel III in stages after issuing the guidelines on the risk-based capital adequacy framework that would help Philippine banks comply with the higher capital standards late last month. “Our idea is to try to phase-in Basel III this year. But as I said, it will be in stages," he stressed. He explained that the BSP could implement the second phase involving capital ratios within the first half of the year once the minimum capital ratios for banks under Basel III are finalized. “Internationally, the discussions are still not quite clear, so we are in a way dependent on that. So if these discussions are finalized, let's say in the first quarter, then there's a very good chance we can make our second (phase) before the first half," Espenilla said. Last month, the BSP adopted new criteria for capital instruments after issuing a moratorium on the fund-raising activities of banks until December 31 last year as part of the central bank's commitment to continuously institute reforms that would promote a stronger banking system. Under the revised framework, the BSP adopted the Basel III criteria for inclusion of non-common equity components in banks' capital base as basis for determining capital instruments that could be counted as regulatory capital by Philippine banks starting January 1. Basel III redefines ‘bank capital’ The Basel III agreement revised the existing international capital standards under Basel II and involves changes to the definition of bank capital. Under Basel III, the definition between Tier 1 and Tier 2 capital was retained. But Tier 1 capital was subdivided into ‘common equity’ and ‘additional going-concern capital components,’ while the subcategories of Tier 2 capital were removed. Tier 1 capital is considered as the more reliable form of capital consisting largely of shareholders’ equity and retained earnings as ‘Core capital’ and common stock known as ‘capital securities’. Tier 2 capital is the second most reliable form of financial supplementary capital, comprised of undisclosed reserves, revaluation reserves, general provisions, hybrid instruments, and subordinated term debt. Under Basel II, banks’ qualifying capital consisted of Tier 1 – divided into ‘Core capital’ and ‘Hybrid Tier 1’ – and Tier 2 including upper and lower categories that could contribute up to 100 percent of the amount of Tier 1 capital to form a bank’s capital base. Common equity as majority of bank’s capital base The BSP explained that Basel III requires that majority of the capital base must be in the form of common equity elements and sets out minimum criteria for instruments to qualify in each of the sub-categories of capital. It added that the new guidelines state that instruments included in additional going-on concern capital and Tier 2 capital must not be governed by conditions that give the issuing bank an incentive to redeem the instrument, such as increases in coupon or dividend rates in the event that the instrument is not called at a pre-determined date thereby reducing its ability to absorb losses. Furthermore, the new guidelines provide that bank-issued capital instruments under Basel II classified as Hybrid Tier 1 capital must no prospectively comply with Basel III criteria for additional going-concern capital in order to qualify as Tier 1. Likewise, Lower Tier 2 capital under Basel II must now comply with criteria for Tier 2 capital to qualify as Tier 2 under Basel III. Under the new guidelines, the BSP would no longer allow the new issuance of capital instruments to be included in the Upper Tier 2 capital. Old standards to new standards Philippine banks were allowed to follow the definition of capital under Basel II wherein bank-issued capital instruments such as unsecured subordinated debt that qualified as Hybrid Tier 1 or Hybrid Tier 2 or Lower Tier 2 capital. The BSP said eligible capital instruments under Hybrid Tier 1, Hybrid Tier 2 or Lower Tier 2 capital based on existing regulations that were issued as of December 31 last year would continue to be recognized under their respective categories until such time that further guidance is issued by the central bank. “For now, we focus on redefining the capital primarily to allow banks, those who want to raise capital, to already issue [instruments] based on the new standards rather than the old standards," Espenilla explained. He pointed out that it is a good time for banks to raise capital with the recent rating outlook and rating upgrade from Moody's Investor Service as well as Standard & Poors. “And since the market now is pretty good for the Philippines with upgrade and everything, it will be a lost opportunity if they cannot take advantage of this good period," he added. Minimum ratios and liquidity standards Under the Basel III standards, banks would be required to hold Core Tier 1 capital of 4.5 percent, up from 2.0 percent under previous agreements. In addition, a further capital conservation buffer' would be required, bringing the total ratio of capital to assets that banks must hold to 7.0 percent. Banks would have less than five years to comply with the minimum ratios – 4.5 percent common equity and 6.0 percent Tier 1 – and until January 2016, to meet the buffer requirements. Tier 1 capital, whose definition has been narrowed by the Basel committee, includes common equity and perpetual preferred stock. Banks are currently required to have common equity equal to 2.0 percent of total assets and 4.0 percent Tier 1 capital. The committee also gave banks until the end of 2017 to comply with the tighter definitions of capital and said that a new short-term liquidity standard wouldn’t be implemented until the beginning of 2015. While a separate long-term liquidity rule has been shelved under pressure from the banking industry, the short-term rule was expected to go into effect earlier. The two liquidity rules would require banks to hold enough cash and easily cashable assets to meet liabilities. – MRT/KBK, GMANews.TV