BSP finalizes bank capital hike under Basel III

By Lawrence Agcaoili, The Philippine Star

Posted at Dec 31 2010 10:57 PM | Updated as of Jan 01 2011 06:57 AM

MANILA, Philippines - The Bangko Sentral ng Pilipinas (BSP) has finalized the guidelines on the risk-based capital adequacy framework that would help Philippine banks comply with the Basel III agreement aimed at addressing the weaknesses of the international banking industry that were made evident during the global financial crisis.

BSP Governor Amando M. Tetangco Jr. said the adoption of the new criteria for capital instruments is part of the central bank’s commitment to continuously institute reforms that would promote a stronger banking system.

“The BSP has always expressed its broad support for the objectives of the international reforms. While they are primarily geared toward big banks, we appreciate that there are certain lessons that apply universally,” Tetangco stressed.

The BSP said the Monetary Board approved an amendment to the existing risk-based adequacy framework of the central bank to incorporate certain provisions of Basel III aimed at improving the quality of capital.

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 Jan. 1.

The Basel III agreement revised the existing international capital standards under Basel II and involves changes to the definition of bank capital.

“We would like to see out banks push the envelope when it comes to improving risk management and governance. We believe Basel III has a roles to play in this area,” Tetangco said.

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” Tier 1 capital and common stock known as Tier 1 capital securities. Tier 2 capital is the second most reliable form of financial capital supplementary capital that comprise 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 as well as Tier 2 including upper and lower categories that could contribute up to 100% of the amount of Tier 1 capital to form a bank’s capital base.

The BSP explained that Basel III states 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 reducing the instrument’s ability to absorb losses.

Furthermore, the new guidelines provide that bank issuance must prospectively comply with Basel III criteria for addition going-concern capital in order for these to qualify as Hybrid Tier 1 capital and criteria for Tier 2 capital for these to quailify as Lower Tier 2 capital.

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.

Philippine banks were allowed to follow the definition of capital under Basel II wherein banks issued capital instruments such as unsecured subordinated debt that qualified as either hybrid Tier 1, 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 Dec. 31 this year would continue to be recognized under their respective categories until such time that further guidance is issued by the central bank.

“At this point in time, the BSP is not yet making any changes to the capital structure of banks. Thus the minimum capital raios as well as the limits on the amounts that can be including as Hybrid Tier 1 and Upper and Lower Tier 2 capital are being retained,” the BSP said.

Tetangco added that the BSP is also studying other components of Basel III in order to determine how the principles are best applied to local circumstances.