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Photo - ROSLAN RAHMAN/AFP/Getty Images

Are local banks still well-capitalised?

By Chris Kuan

Or corollary to this question, as a friend ask of DBS's new Perpetual notes issued this week "Given that DBS has Tier 1 capital of 14%, why would it want to issue this?"

The short answer to the first question is yes they are still well capitalized but the long answer to the first question which also answers the second question is that they still need more capital.

Why?

The local banks have Common Equity Tier 1 (CET1) capital ratio of 13-14% of Risk Weighted Assets (RWA) and total capital adequacy of 15-16%, high by global standards. However, global banking regulations have moved on which have a significant impact on local banks' relative capital position and their revenue stream.

One of the enviable strength of the local banks is that they are highly profitable despite the MAS requiring them to hold an enormous buffer of capital. This has a lot to do with the reliance on deposits to fund their assets. Deposits are the cheapest source of funding; local banks have lots of it and consequentially little of the more expensive issuance of notes and bonds.

In the new global regulatory standards, the local banks are designated G-SIBs - Globally Systematically Important Bank - roughly in layman's term, they are too big or too important to the global financial system to be allowed to fail. That means they have to abide by a swath of regulations designed to ensure they can resolve a crisis by themselves without government (hence taxpayer) bailouts. The obvious way to achieve this is to enforce a high CET1 ratio. But additionally, banks are required to issue classes of bonds and notes to investors that can be converted into equity should a crisis hit the bank which causes it to run down its CET1.

Therefore it is no longer enough to have strong CET1 like the local banks but all G-SIBs must by 2022 have what is called Total Loss Absorbing Capacity (TLAC) which convert bonds into equities. This is to ensure that bondholders are "bailed in" to absorb losses or conversely speaking bailed out the bank without the bank needing a government / taxpayer bailout. This is to prevent a repeat of the tendency of banks during the Global Financial Crisis to seek government / taxpayer bailout rather than to impose losses on bondholders for fear of being shut out of the bond markets.

Total TLAC including capital buffers needs to hit 21-23% of Risk Weight Assets according to its originator the Financial Stability Board (FSB), well above the local bank's capital adequacy of 15-16%. It is estimated the amount of TLAC needed by G-SIBs around the world totaled US$1.4t. Most of the G-SIBs have begun to build up their TLAC in the past 3-4 years by issuing TLAC compliant bonds or rolling over the old non-TLAC compliant bonds into new TLAC compliant ones.

So where does the local banks stand in this brave new world of safer too big or too important to fail banks?

The local banks are strong in CET1 but lacking in TLAC because they relied heavily on deposits, hence debt in the form of bonds do not figure much in their funding mix. They are also late in the race to build up TLAC. Moody's estimated that the 3 local banks have only S$5 billion of compliant bonds, just 0.6% of assets To achieve the standards imposed by the FSB, the local banks will need to issue a lot more TLAC eligible bonds. This will reduce the reliance on deposits but will also reduce their profitability.

DBS's perpetual note issued this week is just the start - UOB and OCBC will follow suit and there would be more volume to come over the next few years.