Across The Border

Hong Kong banks hoard capital as they await new Basel rules

Local lenders likely to be more affected than larger Hong Kong banks, due to lower capital levels and less expertise

PUBLISHED : Sunday, 06 August, 2017, 1:35pm
UPDATED : Sunday, 06 August, 2017, 10:02pm

Banks in Hong Kong, and indeed the world, are still waiting for new global rules to be finalised, and as a result, hoarding cash rather than returning it to investors, or making use of it in more profitable ways.

Last week, Standard Chartered’s board chose not to issue a dividend, for the fourth half yearly period running and cited the finalisation of the Basel 3 regulations as a major factor.

While uncertainty prevails as to the form the final rules will take, however, analysts suggest that the more locally focussed Hong Kong banks may be more affected than international banks.

The rules come from the Basel Committee on Banking Supervision, an organisation that brings together regulators from 28 countries, and is seeking to standardise the ways in which banks assess the riskiness of their assets, and so the amount of capital they must hold to remain stable.

“The rules are an attempt to stop banks playing the system by using their own models when they assess their capital levels,” said Keith Pogson, senior partner for financial services at EY.

The particular controversy lies in the capital floor, which would restrict the amount banks’ own weighting of the risk of their assets could differ from standardised levels.

Even the name given to the new regulations is disputed, with some players referring to it is as the finalisation of Basel 3 reforms (first agreed in 2010), others as Basel 3.5 or Basel 4.

They do, at least, succeed the Basel 1 agreements from 1988 and Basel 2 from 2004. The new rules were meant to be finalised in 2016, but disagreement between banks and regulators from different jurisdictions has pushed the date back to this year.

Where there is agreement, is that most analysts expect the new system will require banks to hold more capital than they currently do.

HSBC, for example, said with its interim results that it had a common equity tier 1 ratio (a key measure of capital strength) of 14.5 per cent well above its target range of the upper end of between 12 and 13 per cent, even after a series of share buybacks.

Ratings agency Fitch, however, said in its analysis of the bank’s performance that they felt this ratio had peaked and that “higher risk-weighted assets due to Basel revisions will lower [HSBC’s] capital strength.”

Similarly Standard Chartered’s CET-1 ratio was 13.8 per cent, also above its target.

But in a statement to the Hong Kong and London stock exchanges, group chief executive Bill Winters said a reason for not returning capital to shareholders by means of a dividend was that “clarity may emerge over the coming months regarding current regulatory uncertainties, including the capital implications of the finalisation of Basel III”.

It’s not only the big international banks in Hong Kong that will be affected when the new rules finally arrive.

“While the changes are not yet finalised, some of the more local Hong Kong banks will be more affected as they start with a lower capital position,” said Kwon Il-Dong, a partner at financial services consultancy Oliver Wyman in Hong Kong.

The CET-1 ratio of Bank of East Asia, for example, is approximately 1.2 percentage points lower than Standard Chartered, and 4 percentage points lower than HSBC at the end of 2016.”of course it has different requirements from HSBC and Standard Chartered.

Meanwhile, analysts at CLSA “estimate that Bank of China Hong Kong could see the largest reduction in CET1 from Basel 4,” they wrote in a recent report (though BoC HK does have a vast capital buffer to use up).

There will also be a lot of internal changes that banks will have to make due to the changes, and I don’t think they are fully prepared for them, though until the rules are finalised it is hard for them to know what to prepare for
Kwon Il-Dong, a partner at Hong Kong financial services consultancy, Oliver Wyman

“There will also be a lot of internal changes that banks will have to make due to the changes, and I don’t think they are fully prepared for them,” said Kwon, “though of course until the rules are finalised it is hard for them to know what to prepare for.”

“Again I feel the larger international banks are likely to be able to respond more quickly than their local competitors.”

There are also ways in which banks in Hong Kong will have to adjust to the new regulations that differ from their competitors elsewhere.

“There are two main things that will affect banks in Hong Kong particularly,” said EY’s Pogson.

The first was the banks will have to use international ratings agencies when assessing risk, rather than local ratings agencies.

And because the local ratings agencies assess the credit risks of large corporates in a different way from Fitch, Moody’s and S&P, they tend of offer higher ratings, which local banks will then use.

“This means that banks in Hong Kong will have to measure risk differently from local banks when lending to corporates in places like China, India or Indonesia, and so put them at a disadvantage,” said Pogson.

The other difference is with regards to property.

“The new rules will mean the banks will have to give a higher risk weighting to mortgage assets than they do currently,” said Pogson.

This is the case even though property default rates are extremely low in Hong Kong by international standards.

This will further increase the capital that Hong Kong banks must hold, though the precise form remains uncertain as this is a key sticking point to the global negotiations between American and European banks and regulators.