SPECIAL FOCUS
On top of this capital framework
there is now a formal ‘leverage
ratio’, designed to limit the
reliance on complex risk-based
capital calculations.
Tier 1 capital. In order to ensure consistency across jurisdictions,
the definitions of what constitutes appropriate capital instruments
are being formalised. More complex capital instruments such as
redeemable hybrid capital instruments are to be phased out.
Capital must be permanent, and the right to be repaid should be
subordinated to the depositor in the event that the bank is to be
liquidated, thereby making the capital truly ‘loss absorbing’.
A new capital requirement is the introduction of the ‘conservation
buffer’. This has been developed to temper the behaviour of
banks where traditionally large dividend payouts and generous
compensation practices were deemed necessary to signal strength
to the markets, despite an economic downturn. The conservation
buffer, when breached, will effectively temper the right to make
discretionary payments such as dividends and bonuses, and once
it is breached the bank will be expected to rebuild its capital in
anticipation of higher defaults and resulting losses.
Banks are also known to respond to economic cycles,
aggressively lending in times of general prosperity and adopting
a more conservative approach in economic downturns. To address
this behaviour, a new ‘countercyclical capital buffer’ has been
introduced. This new buffer will be enforced by the regulator when
credit growth in the economy is considered excessive. Banks will be
forced to hold additional capital during this period, which should
reduce their appetite to lend, thus helping to reduce the risk of losses
associated with defaults during the correction of the markets that
inevitably follows a boom period.
Unlike other industries, the banking sector uses capital as a base
from which all lending activity is calculated. Each loan is made up
of capital (savings from investors) and a much larger component
of deposits from customers. As the economy grows, so does the
demand for loans and the corresponding incremental need for
capital, and therefore banks are continuously looking for more
capital to support their expanding lending activities. On top of this
capital framework there is now a formal ‘leverage ratio’, designed
to limit the reliance on complex risk-based capital calculations. The
leverage ratio will set a simple Tier 1 capital requirement (broader
than common equity) of 3% on overall bank lending activity, moving
from a risk-based calculation of 8.5%.
The global dominance of certain banks means that their failure
would be felt in many countries, and the presumption that a bank
is ‘too big to fail’ is now being specifically addressed in additional
legislation. This class of bank, referred to as a ‘systemically important
financial institution,’ will require an additional layer of capital over
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Continued »
Edition 1
SA BANKER
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