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April 15, 2013

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Basel III poses new set of hurdles for banks

April 15, 2013, Monday | Print Edition

FOREIGN banks have significantly invested in China after a ban on taking local deposits was lifted in 2007. They now enjoy healthy returns, with 114 locally incorporated or branch status banks in China and a total of 339 branches. On top of the bricks and mortar investment, foreign banks also face new pressure from local Basel III implementation.

The Chinese Banking Regulatory Commission (CBRC) released an updated set of capital management rules in June of 2012, which require all banks in China to comply with Basel III.

The revised rules represent an important evolution in the regulatory regime in China and will require significant investments in resources, systems, processes and risk management for all banks in China. Not all foreign banks are convinced that they will need to fully localize Basel implementation here in China. However, the rules do apply to all, and in many instances, CBRC's rules are on a more accelerated timeline than those in a foreign bank's home jurisdiction.

As of January 1, all foreign banks - incorporated and non-incorporated branches - need to capture detailed data elements and calculate quarterly capital adequacy using a complex new set of risk weighted asset calculations determined by the CBRC in conjunction with revised definitions of eligible capital.

Banks can either use standardized (basic) approaches or they can apply to use advanced approaches. Further, all banks need to implement CBRC interpretations of Basel III liquidity risk rules and report quarterly metrics such as the liquidity coverage ratio, which must be above 100 percent and comply with the CBRC's tighter leverage ratio of 4 percent. China also has tacked on a unique rule on provisioning. It requires all banks to take the higher of 150 percent of non-performing loans or 2.5 percent of total loan assets as a provision.

Moreover, foreign banks must begin work on another requirement known as the internal capital adequacy assessment, which must be run and submitted to CBRC on an annual basis beginning in 2014. The CBRC regulations on that require all banks to have a systematic process in place for assessing their overall China capital adequacy in relation to their risk profile and business strategy, and to have a plan in place to maintain capital levels that must be signed by local boards of directors.

Navigating the new complex set of Basel rules and options available will require foreign banks to prepare detailed implementation plans, leverage global tools and templates and make decisions on implementation. They should also be conducting capital impact analysis of these new regulations on their asset growth plans. For example, by measuring the impacts on the business line level, or even product level, banks can steer away from capital intensive businesses and products in China.

Some foreign banks are already floating close to the minimum capital adequacy requirement of 10.5 percent, and the worry is they may need additional capital if their growth plans are aggressive.

However, the implementation of these regulations should not be seen only as a burdensome cost. There are ways that banks can gain advantage and business benefits over their foreign and even local peers. For instance, banks can invest in developing local credit risk models to help them more accurately price risk in the China market. Such investments are already paying off for some banks, especially in unsecured personal lending.

These same models might also be used one day to calculate capital adequacy under the advanced approach for local Basel, known as the internal rating-based approach.

Another potential benefit of developing a strong local Basel program and team is to tap into less costly talented staff to support global Basel risk modelling, validation and other analytical type projects.

Repatriating profits

The current non-performing loan ratios for most foreign banks are quite low and net interest margins are healthy.

However, Basel III implementation may impact their ability to repatriate profits back to headquarters if their capital levels fall below the minimum requirement.

Based on KPMG's annual survey on the mainland banking industry, net profit growth, interest income growth and non-interest income growth have all demonstrated strong performance, with increases of 109 percent, 57 percent and 27 percent, respectively, from 2010 to 2011.

But even with numbers like this, can the foreign banks continue to gain market share and increase their profitability in China, given new Basel III regulatory pressure?

Compared with foreign banks operating in the United States, foreign banks operating in China occupy a miniscule 2 percent market share in terms of total assets, versus 15 percent in the US. They also have a higher cost-to-income ratio, compared with their local peers.

New challenges are on the horizon for foreign banks in China, such as smaller economies of scale and increasing competition from local banks, lower benchmark interest rates pressuring margins and the new Basel III regulations.

Our view at KPMG is that the institutions that can intertwine local Basel regulation with advanced techniques like risk-based pricing may not only cover the costs of implementation but also reap substantial gains.

Finance Special


 

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