By Anthony Rowley
Asia’s bankers voice fears that the new Accord will have disastrous consequences
For something supposedly as dry and arcane as a new capital adequacy standard for banks, Basel II is generating a lot of controversy in Asia. Some experts warn that the new standard could alter the basic pattern of bank lending in the region, and possibly create a real estate and consumer lending bubble, while others talk of damage to emerging market economic development. Financial officials have meanwhile cautioned Asian banks not to adopt the new standard until they are sure that it is the right thing to do.
Among the most outspoken on the issue is William Seidman, former chairman of the US Resolution and Trust Corporation. “Basel II may turn out to be a very useful way to enhance regulation of the world’s banking system, [but] I am not confident that it will, and I have some company in the view,” said Seidman during this year’s Asian Banker summit in Singapore.
Ratings agency Standard & Poor’s has suggested that only banks in Australia and Singapore so far appear prepared to cope with Basel II, and that even banks in these relatively advanced financial centres will still have to contend with “significant challenges in meeting implementation timetables”.
When east meets west
Ernest Kepper, former senior official at the International Finance Corporation and now a consultant in Tokyo, has doubts about the ability of Asian banks to handle the sophisticated risk management required by Basel II. “Some form of risk management is going to be there, but it is not going to work,” he says. “You cannot take models from the West and simply jack them onto Asia. If Asia does not do this correctly, then the Asian financial system is going to be compromised.”
Seidman advises Asian banks to stick to Basel I until they are sure Basel II will help them to extend better quality loans. Rather ominously, he notes that allowing financial institutions to employ their own models has not worked for mortgage agencies Freddie Mac and Fannie Mae in the US. In almost all cases, Basel II would lead to “less capital supporting the banking system”, Seidman suggests. He acknowledges, however, that Asian banks with robust risk assessment systems are looking forward to the new capital adequacy framework under Basel II. According to banking analyst Daniel Tabbush at CLSA Asia Pacific Markets in Hong Kong, Asian banks are “generally well capitalized under Basel II” with the exception of those in South Korea. It is the impact on banks’ operating margins that concerns Tabbush.
“Expect a rush [by Asian banks] to low-risk weighted mortgage and consumer loans [under Basel II] but also to high-grade corporate loans,” he says. “A crowded market will lower margins, and this will be led by foreign banks operating in Asia. Property developers will benefit more than local banks, a trend playing out globally already.” Because of these concerns, CLSA is underweight in terms of its holding of shares in the Asian banking sector, he adds.
Risk weighted assets are expected to change very little for Asian banks as a whole as a result of adopting Basel II, analysts say. Apart from South Korea, where bank capitalization is still poor despite the banking sector restructuring undertaken there in the wake of the 1997 financial crisis, capital adequacy ratios are generally adequate under Basel II, various analyses suggest. Banks in Indonesia, the Philippines and India will suffer most in terms of strain on their capital.
Winners?
Foreign banks employing sophisticated risk management techniques are expected to be the chief beneficiaries on the Asian banking scene. Such banks already have abundant liquidity, and the regulatory changes adopted under Basel II will enable them to step up their lending in Asia as in other regions of the world, without suffering capital punishment as a result. Tabbush suggests that HSBC and Standard Chartered Bank in particular stand to benefit from adoption of the new standard.
“Banks will crowd the market for low-risk weighted loans, given the lower marginal cost of lending,” he says. “The impact will be lower net interest margins. Required capital for mortgage loans will fall from 50% to 35% and for retail loans from 100% to 75%, making these loans particularly attractive and returns on capital very high at current spreads. Banks will likely shift very quickly to consumer loans as well as small- and medium-size enterprise loans, which can also benefit from a lower risk weighting.”
The rush into low-margin lending that ensues in Asia – led by foreign banks but with domestic Asian banks fighting to keep up and to preserve market shares – will be different to what has happened in the US and other OECD countries where banks have been able to extract high margins in return for undertaking higher risks, says Tabbush. Some officials have meanwhile expressed fears that all of this could possibly lead to a new Asian banking crisis.
One Asian country that should remain relatively shielded from the impact of Basel II is Japan where the foreign banking presence is still small. Without the spur of competition from foreign banks to pile into those areas made more attractive by the new capital adequacy requirements, Japanese banks will not be forced by that reason alone to sacrifice margins, which is fortunate for them because Japan is unique among Asian regimes in that it must comply with Basel II.
... And Losers?
Some are expressing concerns meanwhile that Basel II could hamper the development of emerging market economies in Asia. “For a country like Vietnam, it is clear that the Accord might be very costly to implement and may raise the cost of funding investment,” says Joel Metais, director of the Center of Research on Finance and Economic Desequilibria (CREFED) at the University of Paris-Dauphine.
“The consequences of the implementation of the Basel II Accord are far from being neutral to the economy and the banking system of a country like Vietnam. Because of the adoption of stronger risk management practices, international banks might become more reluctant to lend money to emerging countries,” Professor Metais said during a workshop on Basel II held in Hanoi by the French-Vietnamese Centre for Management Training.
Malaysia’s central bank, Bank Negara, has set 2010 as the deadline for adopting the internal rating-based (IRB) standard required under Basel II. “While local banks are ahead of some of their counterparts in Asean countries such as Indonesia, it is imperative for local banks to start now to meet the 2010 deadline, as regulatory compliance requires accurately estimating the risks associated with bank clients,” says Christopher Marshall, a senior director at Oracle Asia-Pacific.
Charles Dallara, managing director at the Institute of International Finance, summed up the situation to Emerging Markets last year by saying that Basel II presents all emerging market banks with an opportunity as well as a “significant challenge”. For this reason, he said, bankers and regulators in these markets “need to get in gear for Basel II sooner rather than later”. The market will “reward those that get it right and penalize those that miss the opportunity.”