In response to the 2007 eurozone and US debt crises, the Basel Committee on Banking Supervision in 2010 introduced Basel III with a view to regularising standards on bank capital adequacy and market liquidity risk. The unprecedented speed with which Basel III was introduced was an attempt to stem the growing dissatisfaction with how banks were regulating themselves and to regain market confidence. While the aims of Basel III can be lauded, criticism on its viability in regions not affected by the European and US debt crises brings to the fore questions as to whether such standards would have counter-productive results.
In Malaysia, the capital adequacy framework, which is meant to be in line with Basel III, is published by Bank Negara Malaysia (BNM). Despite Basel III setting the common equity ratio (CER) plus capital conversation buffer as seven percent, the current CER in Malaysia is well above this minimum with most banks being at nine-and-a-half percent. Additionally, the capital adequacy framework issued by BNM shows that BNM has projected that the minimum CER and minimum tier 1 capital is to be met by 2016, and the respective buffers to be gradually phased in by 2019; in line with the Basel III timeline. BNM has also imposed several other measures which go beyond that required under Basel III.
While banks in Malaysia should not have difficulties in meeting the CER, meeting the liquidity requirement would be more challenging. Malaysian key industry players have questioned the applicability of Basel III in Asia since the risk weighted assets of European banks are between 20% to 30% as opposed to between 50% to 60% in Asia. The application of Basel III is also argued to be biased against developing countries given that the western economy requires its banks to deleverage while Asian banks still have liquidity and appetite for funds, and imposing such limitations across the board may have a negative impact resulting in curtailment of growth in the region. The increase in compliance costs would also hit the smaller banks in Asia the hardest.
Under the CAF, unrealised fair value gains of financial instruments (which are classified as available for sale) were allowed recognition as regulatory capital subject to some prudential filters: (i) available-for-sale reserves for equity and debt instruments in relation to common equity tier 1 (CET1) capital would be subject to a 55% haircut; and (ii) the fair value gains for loans will not be recognised in any tier of capital. While some have criticised these adjustments as overly-conservative compared to those prescribed under Basel III, BNM has responded that this prudential view was taken on the basis that unrealised gains of financial instruments, and in particular loans and debt instruments for which an active secondary market does not exist, lack permanence which may quickly become unrealised losses when adverse events occur.
Going over and beyond Basel III, BNM has also provided that investments in the ordinary shares of subsidiaries and unconsolidated financial/insurance/takaful (Islamic insurance based on Shariah principles) affiliates be fully deducted in the calculation of CET1 capital. Although such treatment may disadvantage banking institutions which directly own other banking and insurance/takaful subsidiaries, BNM is not convinced that allowing the flexibility provided for under Basel III is consistent with the principle of avoiding double-counting of capital. On the other hand, the Central Bank seeks instead to address the multiple gearing of capital within financial groups and the broader financial system for which BNM has provided for this deduction to be gradually phased in over five years.
In addition to the above, BNM has imposed as part of the CAF several other measures which go beyond Basel III. Examples include: requiring that the additional tier 1 capital instruments be written-off or converted to an amount sufficient to restore the CET1 capital ratio back to 5.75% as opposed to the Basel III threshold of 5.125%; expanding the scope of the principal loss absorption requirement to include equity accounted additional tier 1 capital instruments and specifically for Islamic (Shariah-compliant) banking institutions, BNM will allow write-off for exchange-based contracts (under the Shariah principles of murabahah or ijarah) using mechanisms approved by the Shariah Advisory Committee as specified under the CAF.
It would seem, from the Malaysian perspective at least, that BNM has taken a stricter approach on Basel III which has raised some concerns that compliance would make financial products more unattractive and also curb expansion among banks in Malaysia.
Putri Norlisa Mohd Najib