Banks in the Philippines prepared to meet Basel III standards

Lenders in the Philippines are readying themselves for a further tightening of regulatory oversight, with the requirements of Basel III, as adapted by the Bangko Sentral ng Pilipinas (BSP), the central bank, due to come into effect at the beginning of next year. While the transition is not expected to be overly burdensome, the cost of greater security could be a short-term dip in profits.

The BSP requires banks to maintain a capital adequacy ratio (CAR) of 10%, already higher than the 8% mandated by the Basel II rules. While the 10% limit will be retained after January 1, the central bank has changed the mix of capital holdings to be set aside under Basel III. Lenders will be required to increase Tier 1 common equity – mainly shareholders’ equity, manifested through common shares – from the present 5% to 6% of the total CAR. The minimum Tier 1 capital ratio will be 7.5% and in addition, the BSP has told banks they must establish a capital conservation buffer, setting aside 2.5% of their funds to serve as another line of defence against any sharp reversal of fortunes.

While the Filipino banking sector has generally welcomed the strengthening of regulation, supervision and risk management that Basel III entails, lenders are aware that compliance will come at a cost. Bank chiefs have pointed out that the increased safety measures entailed under the upgraded guidelines, along with the additional monitoring units and technology, will mean a hike in expenses. Banks could also reduce their lending to meet the risk-weighted capital requirements.

According to Lorenzo Tan, president of the Bankers Association of the Philippines, while the impact of Basel III will vary across lenders, compliance will reduce expected net income generally, with investors facing a drop in return on assets of between 1% and 2% next year.

“For some banks, it may even be more,” Tan said during an address to a banking seminar in late October, noting this was particularly true for those that rely on trading gains. “We just have to find other ways to bring it back to the old level of shareholders’ return on equity.”

Adequacy rates more than sufficient

Though the additional requirements could have an effect on their bottom lines, few lenders should struggle to meet the demands made by Basel III. According to data from the BSP, universal and commercial banks have an average Tier 1 CAR of above 15%, with some, such as Landbank and BDO Unibank, topping 20%. While some lenders may be below this level, all are above the minimum requirement set by the BSP, with officials having said all universal and commercial banks should be able to step up to the standards set by Basel III.

The level of deposits and other resources upon which banks can draw for their lending activity is also on the rise. A report issued by the BSP at the end of October showed that the combined deposits, profits and retained earnings held by lenders had risen by 21% year-on-year as of the end of August.

Fewer bad loans

The move to bolster the banking sector against any sudden rise in loan defaults comes as the level of non-performing loans (NPLs) is declining. A BSP report issued at the end of October said that the gross NPL ratio for major banks fell to 2.67% as of August, down from 3.05% for the same month in 2012. There was a low or declining NPL rate across most economic sectors, said the bank, with this trend apparent in the financial intermediation, real estate, manufacturing, and wholesale and retail trade sectors, which together accounted for 62% of the total loan portfolio in August.

Though the smaller rural and co-operative banks have a higher level of NPLs – 13.26% in the case of the former and 14.22% for the latter – increases in reserves to cope with the fall-out of any loan losses mean that these NPLs have more than sufficient coverage, the BSP said.

Implementing Basel III-based standards will further strengthen lenders, and while it could lead to some short-term downturn in earnings, the result in the long run will be banks better insulated against risks that could bite far deeper into profits.

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