Hong Kong banks could shave billions of dollars from the minimum regulatory capital safety nets they will be required to hold against credit risk under the new Basel II Capital Accord, according to Maurice Ewing, executive director of Emerging Markets Risk Advisory. 'On a model asset portfolio totalling HK$159.6 billion, minimum regulatory capital required under the existing accord amounts to $8.73 billion. Under the standardised approach in the new accord, this will drop to $5.96 billion - a 32 per cent decrease,' Mr Ewing said yesterday. Savings might be even higher under the more sophisticated Internal Ratings Based (IRB) credit risk calculations allowed in the new accord, he added. At present, most Hong Kong banks hold more regulatory capital in the form of cash and liquid assets than is required under the existing Basel Accord, which sets a minimum at 8 per cent of risk-adjusted assets. By releasing this surplus regulatory capital to support bigger loan portfolios, they will be able to increase earnings and raise key performance ratios such as return on capital. However, Mr Ewing said the final outcome for total regulatory capital required under the new accord - which will be phased in from the end of 2006 - would depend on how the Hong Kong Monetary Authority implemented the new provisions. As the banking watchdog, the authority requires local banks to comply with the existing capital accord guidelines and has indicated that it will expect them to adopt the new requirements, while leaving open which of the three approaches to use. The global accord, developed by the Bank for International Settlements' Basel Committee, aims to impose regulatory capital requirements on internationally active banks and may be adopted in regional or local banking markets at the discretion of local supervisors. 'The final capital relief under the new accord will also depend on how much additional capital will have to be set aside under the new requirement to provide for operational risk,' Mr Ewing said. 'But since operational risk capital requirements will be higher for bigger banks, Hong Kong's predominantly smaller banks are likely to emerge, overall, with a lower total regulatory capital requirement under the new accord.' A key driver of the lower capital requirements will be reduced risk weightings attached to mortgage loans. At present, mortgage loans attract a risk-weighting for the purpose of calculating regulatory capital of 50 per cent. However, under the new accord's standardised approach this drops to 35 per cent. If the IRB method that allows banks to set their own risk weightings is used, it may fall to as little as 14 per cent. 'Which approaches local banks finally adopt will ultimately be market-driven,' Mr Ewing said. 'Shareholders will want to see their banks maximising returns on capital - and generally this will be achieved by adopting one of the internal ratings-based approaches to calculating risk, and the advanced measurement approach to calculating operation risk.'