Global banking supervisors are taking a harder look at banks, including pushing for banks to have a sufficient cushion of high-quality capital. The proposed new ruling by the Basel Committee is expected to take effect in 2012, which means banks will have to raise the quality of their Tier-1 capital. On the domestic front, although Malaysian banks are still on solid financial ground, preparations are ongoing as they brace for the changes ahead. Bank Negara Malaysia, in response to email questions from The Edge, says that while the proposed rules are still at a consultative stage and are too premature for adoption, banks have been urged to take into account these international developments in their capital management strategies.  

The Edge: How will the new capital requirements for banks change the local banking landscape?
Bank Negara: The recent financial crisis in the advanced economies has brought to the surface some fundamental gaps with respect to the quality of capital held by banks as buffers against unexpected losses. This has prompted the Basel Committee to undertake a holistic review of the existing regulatory capital framework.

The proposals contained in the consultative document issued in December 2009 have signalled a clear focus on common equity and reserves as the core component of regulatory capital, moving forward, towards promoting financial stability and the long-term resilience of the banking system.
In Malaysia, following the bank’s announcement to implement Basel II in 2008, significant improvements have been observed in banking institutions’ capital and risk management practices in meeting the more stringent requirements under the new capital framework. Malaysian banks have built up sizeable capital buffers over the years. Their capital management strategies have also remained conservative, with more than 80% of total capital base in the form of common equity and reserves. Furthermore, Malaysian banking institutions maintain lower leverage ratios, at an average of 13 times, which is well below that of most financial institutions in developed economies.

Nevertheless, the new capital requirements may lead to some review of the overall funding strategies as well as the dividend policies of banking institutions to manage the potentially higher cost of raising capital and increased shareholders’ expectations.  

What are the developments so far on the new capital requirements for banks? Are there banks in the country that are already adopting the new capital requirements?
Malaysian banks are well capitalised with the core capital ratio of the banking system at 13.1% at the end of last year. Based on our periodic stress tests, there is little pressure for banking institutions to raise fresh capital at this point in time.

The new proposals on regulatory capital will, however, become relevant as banking institutions seek to fund their new growth plans in the future. Bank Negara is in discussion with the banking industry to assess the implications of the new capital requirement proposals. The proposed rules are still at a consultative stage and are too premature for adoption at this stage. Nevertheless, the banks have been urged to take into account these international developments in their strategic plans and capital management strategies.

How will this impact banks’ acquisition mode, given that financing will be an issue?
Malaysian banks are expected to continue to explore regional expansion opportunities. However, the growth and expansion strategies, as well as the funding strategies, going forward, would need to consider developments in regulatory requirements. As capital instruments, in particular the hybrid Tier-1, will no longer take its similar current form. Managing the cost of new acquisitions requires banking institutions to effectively manage the implementation of their investment strategies. Given the growth potential of Malaysia and the region, investor demand for bank issuances is expected to remain positive. In addition, it is anticipated that new capital instruments, which comply with new global standards, will emerge and this will add value to the vibrancy of the domestic capital markets.

How much voice do central banks in the developing world have in terms of the new guidelines to be imposed?
The events of recent years have contributed to reshaping the mandate, composition and structure of the international groups and standard setting bodies, such as the G20, the Financial Stability Board and the Basel Committee on Banking Supervision. In addition to membership in the main committees, representation at the working group levels of the Basel Committee has also been extended to emerging economies through their regional groups, such as EMEAP, the Executives’ Meeting of East Asia-Pacific Central Banks. The policy formulation process is now more inclusive, with the representation of central banks and regulatory agencies from the emerging economies. This helps to ensure that the new policy measures take into consideration the broader implications for emerging economies. It would also contribute towards a more consistent and coordinated implementation of the new standards at regional level.

How far have local banks complied with Basel II?
The Revised Risk Weighted Capital Adequacy Framework, or Basel II, has been implemented in Malaysia since January 2008. It comprises the Standardised Approach for credit risk, the Basic Indicator Approach, the Standardised Approach and the Alternative Standardised Approach for operational risks, and the Standardised Approach and Internal Models Approach for market risks. In December 2009, the bank announced the final calibration of the Internal-Ratings Based (IRB) approach for credit risk, which is available for adoption from January 2010. All 11 banking institutions that were granted conditional approval in 2009 to directly migrate to the IRB approach from Basel I, are making significant progress towards full compliance and are all expected to implement the IRB approach at the conclusion of this year. In particular, considerable efforts have been made to strengthen the robustness of internal models used for the risk estimation process, integrating these internal systems with the bank’s day-to-day business operations as well as enhancing the IT and data infrastructure to support the risk management processes.     

Does the FRS139 Recognition and Measurement of Financial Instruments require banks to mark to market their loans as well?
FRS139 provides an option for banks to designate loans at fair value through profit or loss (that is to apply the fair value option) subject to conditions specified under the accounting standards and guidelines on financial reporting that have been issued by the bank. Banking institutions that intend to apply this option are expected to have established a robust governance structure, risk management systems and related risk management policies and procedures. This will include the requirement for regular independent model validation and an independent monitoring function.

This article appeared in Corporate page of The Edge Malaysia, Issue 792, Feb 8 – 14, 2010