The following will be discussed in this chapter: Regulating bank capital adequacy, what is capital adequacy, regulations, 5C’s of credit, regulatory capital, tier 1 capital, tier 2 supplementary capital, revaluation reserves.
Session: SEVEN MBF-705 LEGAL AND REGULATORY ASPECTS OF BANKING SUPERVISION OSMAN BIN SAIF Summary of Previous Session • General Types of Bank Regulations • Privacy Regulations • Anti-money laundering and anti-terrorism regulation • Community re-investment regulation • Deposit account regulation • Deposit insurance regulation • Consumer protection Summary of Previous Session (Contd.) • Interest on demand deposits • Lending Regulations – Consumer protection – Debt collection – Credit cards – Lending limits • Central bank regulations • Regulation of bank affiliates and3 holding Agenda of this session • • • SECTION 2: REGULATING BANK CAPITAL ADEQUACY – What is Capital Adequacy – Regulations – 5C’s of Credit Regulatory Capital – Tier Capital Agenda of this session (Contd.) • General Provisions • Hybrid Debt Capital Instrument • Sub-ordinated term debt • Different international implementations • • SECTION 2: REGULATING BANK CAPITAL ADEQUACY CAPITAL ADEQUACY • • Capital requirement (also known as Regulatory capital or Capital adequacy) is the amount of capital a bank or other financial institution has to hold as required by its financial regulator This is usually expressed as a capital adequacy ratio of equity that must be held as a percentage of risk-weighted assets CAPITAL ADEQUACY (Contd.) • • • These requirements are put into place to ensure that these institutions not take on excess leverage and become insolvent Capital requirements govern the ratio of equity to debt, recorded on the right side of a firm's balance sheet They should not be confused with reserve requirements, which govern the left side of a bank's balance sheet in particular, the Regulations • • A key part of bank regulation is to make sure that firms operating in the industry are prudently managed The aim is to protect the firms themselves, their customers and the economy, by establishing rules to make sure that these institutions hold enough capital to ensure continuation of a safe and efficient market and able to withstand any foreseeable problems Regulations (Contd.) • • The main international effort to establish rules around capital requirements has been the Basel Accords, published by the Basel Committee on Banking Supervision housed at the Bank for International Settlements This sets a framework on how banks and depository institutions must calculate their capital 10 Regulatory capital • In the Basel II accord bank capital has been divided into two "tiers" , each with some subdivisions 20 Tier capital • Tier capital, the more important of the two, consists largely of shareholders' equity and disclosed reserves This is the amount paid up to originally purchase the stock (or shares) of the Bank (not the amount those shares are currently trading for on the stock exchange), retained profits subtracting accumulated losses, and other qualifiable Tier capital securities 21 Tier capital (Contd.) • In simple terms, if the original stockholders contributed $100 to buy their stock and the Bank has made $10 in retained earnings each year since, paid out no dividends, had no other forms of capital and made no losses, after 10 years the Bank's tier one capital would be $200 Shareholders equity and retained earnings are now commonly referred to as "Core" Tier capital, whereas Tier is core Tier 22 Tier (supplementary) capital • Tier capital, or supplementary capital, comprises undisclosed reserves, revaluation reserves, general provisions, hybrid instruments and subordinated term debt 23 Undisclosed Reserves • Undisclosed reserves are not common, but are accepted by some regulators where a Bank has made a profit but this has not appeared in normal retained profits or in general reserves 24 Revaluation reserves • • A revaluation reserve is a reserve created when a company has an asset revalued and an increase in value is brought to account A simple example may be where a bank owns the land and building of its headquarters and bought them for $100 a century ago A current revaluation is very likely to show a large increase in value The increase would be added to25a General provisions • • • A general provision is created when a company is aware that a loss may have occurred but is not certain of the exact nature of that loss Under pre-IFRS accounting standards, general provisions were commonly created to provide for losses that were expected in the future As these did not represent incurred 26 losses, regulators tended to allow them to Hybrid debt capital instruments • • They consist of instruments which combine certain characteristics of equity as well as debt They can be included in supplementary capital if they are able to support losses on an on-going basis without triggering liquidation Sometimes, it includes instruments which are initially issued with interest obligation (e.g Debentures) but the same can later be converted into capital 27 Subordinated-term debt • • Subordinated debt is classed as Lower Tier debt, usually has a maturity of a minimum of 10 years and ranks senior to Tier debt, but subordinate to senior debt To ensure that the amount of capital outstanding doesn't fall sharply once a Lower Tier issue matures and, for example, not be replaced, the regulator demands that the amount that is qualifiable as Tier capital amortises (i.e 28 Subordinated-term debt (Contd.) • The remainder qualifies as senior issuance For this reason many Lower Tier instruments were issued as 10yr noncall year issues (i.e final maturity after 10yrs but callable after 5yrs) If not called, issue has a large step - similar to Tier thereby making the call more likely 29 Different International Implementations • Regulators in each country have some discretion on how they implement capital requirements in their jurisdiction 30 Different International Implementations (Contd.) • For example, it has been reported that Australia's Commonwealth Bank is measured as having 7.6% Tier capital under the rules of the Australian Prudential Regulation Authority, but this would be measured as 10.1% if the bank was under the jurisdiction of the UK's Financial Services Authority This demonstrates that international differences in implementation of the rule can vary considerably31in their Summary of this session • • • SECTION 2: REGULATING BANK CAPITAL ADEQUACY – What is Capital Adequacy – Regulations – 5C’s of Credit Regulatory Capital – Tier Capital 32 Summary of this session (Contd.) • General Provisions • Hybrid Debt Capital Instrument • Sub-ordinated term debt • Different international implementations 33 THANK YOU 34 ... Regulation of bank affiliates and3 holding Agenda of this session • • • SECTION 2: REGULATING BANK CAPITAL ADEQUACY – What is Capital Adequacy – Regulations – 5C’s of Credit Regulatory Capital – Tier... ratio of at least 6%, a combined Tier and Tier capital ratio of at least 10%, and a leverage ratio of at least 5%, and not be subject to a directive, order, or written agreement to meet and maintain... implementation of the rule can vary considerably31in their Summary of this session • • • SECTION 2: REGULATING BANK CAPITAL ADEQUACY – What is Capital Adequacy – Regulations – 5C’s of Credit Regulatory