Asian banks also feeling heat of Basel III regulatory obligations

Banks around the world are finding that rapidly evolving regulatory changes are taking up a good amount of their attention.

While more acutely felt in Europe and the US, given the impact of the Global Financial Crisis (GFC) in these regions, changes are being increasingly felt among banks operating in Asia as well.

Changes in the regulatory frameworks following the GFC are leading to considerable changes in business models of these banks in Asia - both in the Asian offices of global institutions, as well as domestic Asian players.

The most pervasive of these changes is the implementation of the norms commonly known as Basel III.

Asian centres have been closely involved in Basel Committee discussions - Australia, China, Hong Kong, India, Indonesia, Japan, the Republic of Korea and Singapore are all members of the Basel Committee on Banking Supervision (BCBS). Many countries in Asia are implementing components of Basel III even as regulators in Europe and the US contemplate the start dates and the banks that should be subject to these norms.

Indeed, many Asian countries have already put regulations in place to phase in the Basel III requirements from the beginning of this year. In some cases (notably China, India and Singapore), there will only be a few deviations from the Basel III timetable and with higher minimum capital requirements than are set out in Basel III.

While there is general agreement on the capital standards, there are however important differences in implications for Asia when compared with the West. These lie in the relative priorities of some elements of the regulatory changes within Asia; particularly in the areas of liquidity and the centralised clearing of over-the-counter (OTC) derivatives.

Yet, the 'Basel' story in Asia is not just about Basel III but also very much about Basel II. Many banks in Asia have only implemented either the standardised approach or have not implemented Basel II at all.

Only Australia, Hong Kong, India, Japan, Korea, New Zealand and Singapore have already implemented Basel II in full, including allowing banks to apply for the use of their own internal ratings based (IRB) models to calculate capital requirements for credit risk.

Banks in countries where Basel II is not implemented, or where only the standardised approach to credit risk is used, are faced with additional challenges. Basel II imposes conservative and broad-brush risk-weightings for some key components of a banks' portfolio such as trade finance, SME lending and infrastructure finance.

It has been suggested that these higher risk weights may discourage banks from lending to these sectors. The cost of borrowing may also be higher to borrowers than the historical loan-loss experience; and the availability of such finance may be limited.

There are two important questions being voiced with regard to implementation of the emerging regulatory norms in Asia.

The first relates to whether the requirements are too focused on specific issues in the Western world, and the extent to which Asian regulators should have more discretion to modify the requirements to better suit the realities of their specific marketplace.

Second, many Asian banks have higher and better quality capital compared to those in the West, and can easily meet the new requirements at this particular point of time.

There could however be potential constraints in the coming years, given the relatively high economic growth rates in Asia when compared to Europe and the US. Capital growth will need to keep up with balance sheet growth in these Asian banks.

Banks that are considered as Global Systematically Important Banks (G-SIBs) will have additional capital surcharges imposed. Most of the G-SIBs have extensive Asian operations. China, Australia, HK and Singapore have imposed additional surcharges on domestic SIBs as well.

On the liquidity front, most Asian members of the BCBS and many other Asian jurisdictions have already announced - or are expected to announce - that they intend to implement the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR) with some modifications to reflect local circumstances.

The LCR is designed to strengthen the ability of banks to withstand adverse shocks. It requires banks to hold sufficient high quality liquid assets to meet a severe cash outflow for at least 30 days.

The NSFR is a structural measure, intended to ensure that banks have a degree of matching between their stable funding such as capital and long-term debt instruments, retail deposits and more than one year maturity wholesale funding, and their medium and long-term lending.

The issue of availability of sufficient stable deposits remains a question, as stable deposits tend to grow in line with GDP while the growth of lending may be significantly higher.

It is clearly not going to be straightforward for banks doing business in the region to meet all the new requirements. This is particularly so when one considers that many of the economies and of course financial markets in the region are still developing.

International banks operating in Asia face particular challenges as they juggle home and host country requirements and face issues on funding and suggestions of pressure to incorporate locally. There are continuing moves towards the 'localisation' of the operations of foreign banks in some Asian jurisdictions.

Other unresolved questions include the ability of Asian banks to supplement their equity capital with the new-style subordinated debt under Basel III, such as contingent convertible bonds (CoCos), which are untested in the Asian context. The G20 and the FSB have also made clear their determination to introduce greater standardisation of derivatives.

An exhaustive study was recently done by the global KPMG Financial Services Centers of Excellence to gauge the regulatory pressure that banks are facing across US, Europe and Asia. The results show an increase in the Regulatory Pressure Index for Asia across several areas over the past three years.

What also emerges quite clearly is that the regulatory pressures on reform in Asia are increasing, particularly in areas related to capital, liquidity, systemic risks, traded markets, and financial crime and tax.

Remuneration, which remains a hot topic in Europe and US, is less of an issue in Asia.

Accounting and disclosure and customer treatment remain relatively low pressure in Asia, certainly compared to the West.

To date, we have seen a strong level of commitment in the Asia Pacific region - among members of the Basel Committee and non-members alike - to implement Basel III and associated regulatory reforms.

Indeed, at this point of time, a number of Asia Pacific jurisdictions are ahead of the US and Europe in formalising these requirements.

There are areas which are more contentious and less easily implementable in Asia - such as the liquidity and OTC derivatives reforms - and it is likely that we will see less commonality of approach in these areas. For certain, there are likely to be continued significant differences from jurisdiction to jurisdiction.

Get The Business Times for more stories.