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Why Asian Banks are Well Positioned for Basel III

November 23, 2016

By Walter Yao

After the global financial crisis, the Basel Committee on Banking Supervision (BCBS) implemented Basel III with the goal of fostering a more resilient global banking system. Among other measures, Basel III calls for an increase in both the quantity and quality of capital that banks must hold as a buffer against unexpected losses. Under Basel III, the minimum capital ratios (including capital conservation buffer) will be effectively raised to 6.0%, 7.0%, and 10.5% for Tier 1, Tier 1 Common Equity (CET1) and Total Capital, respectively.1 These requirements began phasing in on January 1, 2013, with full implementation by January 1, 2019 (for more details on Basel III, please refer to the BCBS’s website).

In response to concerns that illiquidity contributed to and aggravated the global financial crisis, the BCBS also introduced two global minimum liquidity standards. The Liquidity Coverage Ratio (LCR) is aimed at reducing short-term liquidity risks by ensuring that a bank has sufficient high quality liquid assets to survive a significant stress scenario lasting for 30 days. The BCBS recommended the introduction of the LCR in January 2015; the ratio began at a 60% phase-in, increasing by ten percentage points a year to reach the full 100% requirement in 2019. The Net Stable Funding Ratio (NSFR) was also introduced in an effort to ensure that a bank’s long-term sources of funding would remain liquid during periods of financial stress. It requires banks to maintain stable sources of funding, such as traditional deposits, in relation to the composition of their assets and off-balance sheet activities.

A San Francisco Fed review of 75 major banks in 13 Asia Pacific economies indicates that, as of the most recent year-end 2015, the banks are well positioned to meet the Basel III minima for implementation in 2019.2 The strong position of Asian banks with respect to Basel III requirements can be attributed to the build-up of capital and liquidity buffers after the Asian Financial Crisis of 1997-8. Furthermore, Asian banks rely on less leverage and fewer hybrid capital instruments than their western counterparts, resulting in both higher levels and quality of capital.

Another reason that Asian banks already meet and exceed upcoming Basel rules is that many Asian economies have existing capital regulations more stringent than Basel III requirements. In addition, a number of Asian regulators implemented liquidity requirements prior to the Basel recommendations. As a result, Asian banks start off on stronger footing to meet the new capital and liquidity standards. Singapore is an example of these stricter capital standards. In June 2011, the Monetary Authority of Singapore announced that it would require locally incorporated banks to meet a minimum CET1 ratio of 6.5%, Tier 1 capital ratio of 8% and Total capital ratio of 10% from January 1, 2015. These standards are higher than the Basel III minimum requirements of 4.5%, 6.0% and 8.0% for CET1, Tier 1 Capital Ratio and Total Capital Ratio, respectively.3 Furthermore, a number of Asian economies have enforced tighter standards governing capital calculations. Examples include full deduction of deferred tax assets from Tier 1 capital and exclusion of revaluation reserves (i.e., unrealized gains on revaluations of land and building) from Tier 2 capital.4

A number of Asian economies, such as China, Hong Kong, India, Malaysia, Singapore, South Korea, Thailand, and Taiwan, have had prudential liquidity standards in place prior to Basel III. Most of these economies are following the introduction date and phase-in arrangements for the LCR rules. In fact, China began the phase-in period one year ahead of schedule. As Table 1 indicates, the most common prudential liquidity standard is to require banks to adhere to a fixed ratio of a specific class of assets relative to a specific class of liabilities (e.g., current assets to current liabilities). Depending on the type of assets and liabilities the regulator includes in this ratio, an institution may be required to maintain a minimum or a maximum amount of a certain type of asset. A second common prudential liquidity standard is to require financial institutions to estimate their liquidity position and cash flows under various scenarios and adjust their assets and liabilities accordingly. These scenarios typically include changes to assets and liabilities during normal and abnormal business conditions, such as during a crisis. 

Table 1: Prudential Liquidity Requirements in Asia
Jurisdiction Key Liquidity Ratio(s) Requirement
China Liquid Asset Ratio ≥ 25%
Hong Kong Liquefiable Assets/ Qualifying Assets ≥ 25%
India Liquid Assets / Demand and Time Liabilities ≥ 20.75% (40% max.)
Malaysia Minimum Net Asset Requirement 1. Positive net asset position assuming 3% deposit runoff over a week

2. Positive net asset position assuming a 5% deposit runoff over a month
Singapore Liquid Assets / Qualifying Liabilities 1. Bank-Specific: 10% to 15%

2. Bank-General: ≥ 16% 

3. Bank Basic: ≥ 18%
South Korea 1. Current Won Assets / Current Won Liabilities

2. Won Loans / Won Deposits (effective 2014)
1. ≥ 100% 

2. ≤ 100%
Taiwan New Taiwan Dollar Liquid Assets / New Taiwan Dollar Liabilities ≥ 7%
Thailand Liquid Assets / Deposits and Borrowings ≥ 6%
Source: Financial regulatory authorities and laws and regulations of the respective economies NB: Japan has implemented Basel III LCR requirements for its internationally active banks since 2015.

Many observers have argued that Asian regulators’ early focus on prudential capital and liquidity standards was one factor that helped the region avoid the worst of the global financial crisis. Following the crisis, these stricter existing standards also helped Asian banks position themselves to meet the new global uniform Basel III standards. With many banks exceeding these new standards, Asia appears to be at the forefront of creating a safer global banking system.

1. Previous Basel II minima were 2.0% for CET1 Ratio, 4.0% for Tier 1 Capital Ratio, and 8.0% for Total Capital Ratio.

2. Namely, Australia, China, Hong Kong, India, Indonesia, Japan, South Korea, Malaysia, Pakistan, Philippines, Singapore, Taiwan, Thailand.

3. 2019 Basel III minima excluding capital conservation buffer of 2.5% for CET1 Ratio and Total Capital Ratio.

4. Basel II Implementation in Full Swing: Global Overview and Credit Implications. Moody’s Investors Service, August 4, 2014.

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Walter Yao

is a Director in the Division of Financial Institution Supervision and Credit (FISC) at the Federal Reserve Bank of San Francisco.