Economic crisis could delay Lankan banks’ transition to final BASEL III standards: Fitch

• Says APAC banks better poised to make the transition compared to their European counterparts
• BASEL III standards were brought in to strengthen regulatory, supervisory and risk management of banks in response to global financial crisis 
• Any move to restructure SL’s domestic debt could further weigh on banks’ capital bases

The current stresses to the banking sector coming from the prevailing economic crisis could delay further progress on shifting to the final BASEL III standards on minimum capital, but their use of standardised approach to credit risk would limit any impact on their minimum capital requirements if it were to make the transition, Fitch Ratings said. 

BASEL III standards, which were brought in, in response to the global financial crisis (GFC) aiming to strengthen the regulatory, supervisory and risk management of banks, were implemented in a phased approach over a few years and the final BASEL III standards are now coming due. 

In a report which assessed how the banks in the Asia-Pacific (APAC) region are ready for the minimum capital requirements under the final phase of the BASEL III accord, Fitch Ratings identified that most banks in APAC are generally better prepared compared to their European counterparts. 

This is because, according to Fitch, APAC banks have generally adopted more conservative regulatory approaches and they make less use of internal models to estimate risk weights compared to Europe.

BASEL III accord mandates higher capital adequacy requirements for banks in every jurisdiction measured in relation to market, credit and operational risks a bank faces in their regular banking business, as the GFC exposed banks’ thin capital buffers, which were barely sufficient to absorb shocks. 

The additional capital buffers embedded into the minimum capital standards were proved useful during the early days of the pandemic for the Sri Lankan banks to remain shockproof as they drew from the capital conservation buffer they had built as part of BASEL III. 

“The Basel Committee on Banking Supervision’s February 2022 monitoring report (using end-June 2021 balance sheets) estimates a fully phased-in implementation of the final Basel III framework could even lower the Tier 1 minimum required capital for internationally active large APAC banks (disclosed as the rest of the world category but mainly APAC) by an average of 5.5 percent,” Fitch estimated.   

“This compares with an increase in Tier 1 requirements of 18.0 percent and 4.7 percent respectively, for the large European and Americas banks,” it added. 

While many APAC banks have made progress in implementing the final BASEL III rules, Fitch observed that the timelines have been inconsistent or uncertain in many markets. 

For instance Australia, Japan, Hong Kong and Singapore, all of which are BASEL committee members, have scheduled their full implementation in the next two years. Australia and Singapore have scheduled to go live from January 1, 2023 while Hong Kong plans to phase-in the final standards from July 2023 through January 2024. 
Meanwhile, Japan has extended its implementation timeline to March 2024. 

South Korea, another BASEL committee member, implemented the final BASEL III credit risk package during 2020-2021, while the revised market and credit valuation adjustment measurements are slated for 2023. 

Turning to Sri Lanka’s readiness Fitch said, “Sri Lanka has held discussions on advancing regulatory standards, but stresses to the banking sector that the economic crisis is likely to delay further progress.” 

However, any impact would be limited on minimum capital requirements if the country was to make the transition. 
Higher provisions against possible bad loans and foreign currency denominated financial assets have taken some heavy toll on Sri Lanka’s banks’ capitalisation levels already while they remain jittery over the prospects of a likely restructuring of domestic debt, which could further weigh on their capital, likely tipping them below the minimum levels.