What investors and depositors should know about new banking regulations.
Almost quietly and without much reporting from the mainstream media, Singapore will soon be ensuring that local banks including local subsidiaries of foreign banks are even safer in the brave new world of safer banks. This will be effected by proposed legislative amendments to the MAS Act to give statutory powers to the Monetary Authority of Singapore to resolve distressed or failed banks.
The Global Financial Crisis saw vast amount of tax payers monies used to rescue banks. The global regulatory regime has since moved inexorably towards reducing the probability of tax funded bail outs of banks. This has generally focused on increased capital requirements to bolster their ability to absorb losses and liquidity requirements to enable banks to continue to operate under stressful conditions.
A key feature of the push towards safer banks is bank resolution regimes which largely involved “bailing in” of the banks’ creditors, e.g. bondholders and depositors. Prior to the bank resolution regimes, not only banks but regulators were reluctant to bail in creditors primarily because creditors did not expect to absorb losses like shareholders but mainly because such a move have catastrophic consequences for the economy, particularly when depositors were involved. The result is the very high likelihood of a tax funded bailout which help create the moral hazards of excessive risk taking by the banks.
Under the Basel 3 bank regulatory requirements, banks already hold much more capital. Core Equity Tier 1 (CET1) ratio well in excess of 10% is common place compared to the past where Singaporean banks were some of the very few to be that highly capitalized. However this is not enough. Working in conjunction, the Financial Stability Board also set a dateline of 2022 for Global Systemically Important Banks (G-SIBs) to reach a Total Loss Absorbing Capacity (TLAC) of 20-22%. The difference between CET1 and TLAC is to be made up of bailing in creditors to absorb losses.
“Bail-in” Singapore style
In the proposed legislative amendments to the MAS Act, the scope of bailing in exclude liabilities such as secured liabilities, short-term liabilities owed to financial institutions and payment systems, amounts owed to vendors for goods and services, senior debt and all deposits. This is largely in line to those implemented elsewhere,
Because of these exclusions, local banks will need to issue new classes of bonds of a subordinated nature (i.e. lower ranked to aforementioned liabilities) with specific provisions that these bonds can be written down to zero value or converted to equity by regulatory action in times of crisis.
Impact on depositors
Depositors and customers who depends on banks to make and receive payments will have the benefit of even safer local banks.
Impact on Bondholders
Due to the exclusion of senior debt, most bond holders will not be affected. However, going forward, bond investors must be especially cognizant of the class of bonds they invest – those that are not subject to bail in and those that are subject to bail in, the newer subordinated bonds which are broadly named AT1 (Additional Tier 1) or Non Viability Perpetual Capital Notes. Obviously, the former are much safer than the latter. Local banks have already issued the first tranche of these and the difference in rating between the two classes of bonds is informative.
|Moody’s ratiings||Long Term Senior Unsecured Debt||AT1 or Non Viability Capital Securities|
The new classes of bail in bonds are rated 5 notches below the highest ranked senior debt for DBS and OCBC and 4 notches for UOB. This denotes that the bail in bonds are much riskier than those that are excluded and therefore command a higher yield. Investors in bail-in bonds should also note that in stressed conditions, where clauses are provided, regulators may require banks to suspend interest payment on without triggering the conversion to equity.
Impact on Shareholders
High capital ratios invariably means banks are less profitable. But until now, this was not the case with local banks. This is likely because in exchange for maintaining high capital ratio, MAS restrict banking competition to allow banks to earn better returns. The MAS is also less stringent on the requirement for long term funding because of the focus on capital ratios. This adds to the banks’ profitability because long term funding increases the average cost of funds which reduces the net margins earned.
However, to make up the short fall between their CET1 ratio and TLAC, local banks will need to issue significant number of bail-in bonds between now and 2022. The increased cost of funding will reduce their margins. Therefore, without other profitability drivers kicking in, the proposed legislative amendments to the MAS Act is likely to mean that the local banks will be less profitable.
Ultimately, local banks will conform to the global effect of the new bank regulatory regimes across the world – safer, less leveraged, lower moral hazards but less profitable.
Chris Kuan is an astute commentator of Singapore and international affairs.