Basel Committee reduces sovereign role in bank capital calculations

Capital requirements for banks may edge higher under the new Basel rules, which reduces sovereign role in the capital calculation, according to Fitch Ratings in a new report.

The report indicated that exposure to banks through debt holdings and counterparty transactions will attract regulatory capital charges that no longer give benefit for potential sovereign support, pushing up capital requirements, which would make debt issued by banks in certain jurisdictions becoming less attractive to other banks under new Basel rules.

That is the new rule would tamp down the recently increased appetite for Eurobond debt issue by Nigerian banks as increase charges would make such debt issue less attractive

“From January 2022, regulatory capital requirements calculated by banks using their own models will be subject to floors based on the Basel standardised approach. For debt and counterparty exposures to financial institutions, this means banks will have to hold capital based on credit ratings, excluding any uplift for sovereign support,” the report stated, adding that uplift is worth several notches in some jurisdictions, notably China and parts of the Middle East.

“We factor sovereign support into many banks’ ratings in parts of the Middle East and Asia, where we believe the national authorities are very likely to provide support to banks in need.

“The impact is most significant for Kuwait, the UAE, China and Qatar, where the sovereign ratings are significantly higher than most banks’ Viability Ratings. (A bank’s Viability Rating reflects its intrinsic creditworthiness excluding any potential sovereign support.),” it noted.

The foremost rating agency said risk weights on some bank exposures will more than double when the benefit of sovereign uplift is excluded from the calculations,” adding that the impact varies significantly, particularly for debt tenors of three months or longer, and is heavily influenced not only by the amount of uplift removed but also by the resulting rating level, with several “cliff edge” effects.

“For example, removing one notch from an ‘A-’ rating would entail a shift into a new Basel risk-weighting bucket, increasing the risk weight from 30% to 50%. In contrast, removing five notches from a ‘BB+’ rating would have no capital impact, as the “before” and “after” positions at these lower rating levels both attract a 100% risk weight,” Fitch said.

The higher capital charges are currently unlikely to have major implications in practice due to the fact that in jurisdictions where significant sovereign uplift in bank ratings is prevalent, banks tend not to issue much debt as they are mainly deposit funded. Their reliance on bank counterparties is largely limited to foreign banks providing support for their offshore expansion and limited trading portfolios.

Equally, non-bank lenders could partly fill any gap resulting from higher charges as they are not subject to Basel rules.

The explained scenario fits perfectly with Nigeria banks where tier-2 capital was largely insignificant until the recent Eurobond chase by banks.

According to Fitch, the ensuing higher capital charges from the regulation, may however, constrain future expansion of banks’ use of debt financing or push up the pricing of counterparty credit risk.