On 10 January 2012, the Bangko Sentral ng Pilipinas ("BSP" or Philippine Central Bank) issued Memorandum No. M-2012-002 which implements the minimum risk-based capital requirements embodied in the document "Basel III: A global regulatory framework for more resilient banks and banking systems" ("Basel III").  Issued December 2010 and revised June 2011 by the Basel Committee on Banking Supervision ("BCBS"), Basel III seeks to institute reforms through international standards on risk-based capital to enhance global capital and liquidity rules and help bring about a more resilient banking sector.  To a large part, these reform measures are a product of the lessons learned from the 2007-08 global financial crisis and the ensuing initiative to make banks stronger to withstand future financial distress by way of gradually raising the level of high-quality capital in the banking system.

The new capital standards cover both universal and commercial banks as well as their subsidiary banks and quasi-banks.  Subject to some defined exceptions, the BSP prescribes the changes implemented under the auspices of Basel III, as follows:

  • The system of categorisation of capital base classified into specific tiers (i.e., Tier 1 or going-concern capital consisting of common stock, preferred stock, and retained earnings while Tier 2 or gone-concern capital comprising revaluation reserves, undisclosed reserves, general provisions, and subordinated debt) as was used in Basel III shall be adopted (e.g., no more subcategories for Tier 2);
  • The eligibility criteria for newly included categories of capital shall also be adopted (e.g., Hybrid Tier 1 equity—capital with both equity and debt characteristics—must be issued and paid up);
  • Existing limits on certain eligible categories of capital are eliminated (e.g., eligible Hybrid Tier 1 capital is originally limited to 15 percent of total Tier 1);
  • Regulatory deductions and adjustments, for example, goodwill and other intangibles, deferred tax assets, and treasury stock, shall be taken out of Common Equity Tier 1 Capital ("CET1") in full, in contrast to the traditional practice of deducting from Tier 1 and from Tier 2 on a 50-50 basis;
  • The minimum ratios are pegged for total Tier at 7.5 percent, capital adequacy ratio ("CAR", or the quotient of the qualifying capital divided by the risk-weighted assets) still at 10 percent, and CET1 at 6 percent .  Before Basel III implementation, the regulatory regime prescribes the minimum ratio of 5.0 percent  (6.0 percent as trigger for prompt corrective action) for Tier 1, 10.0 percent  for CAR, and none for CET1.  A capital conservation buffer of 2.5 percent should also be added to the foregoing ratios to arrive at the prescribed minimum ratios.  The ratios prescribed by Basel III, together with the regulatory adjustments, shall be fully adopted by 1 January 2014.  Instruments rendered ineligible because of such reforms may qualify as regulatory capital on or before the 2013 yearend, notably in contrast to Basel III's staggered implementation; and
  • Covered banks and quasi-banks shall be subject to new disclosure requirements on regulatory capital.

In addition, the rules on risk-based capital adequacy framework and the use of third party credit assessment agencies are also enhanced.  These changes are effective beginning January 2014.  This means all the new capital requirements shall come into force at a single date rather than on a staggered or piece-meal basis.  Hence, a single reckoning point may prove simpler and easier for banks to accommodate in their capital and liquidity planning.  Furthermore, implementing guidelines shall be issued on the 1st quarter of 2012, which shall be final by the third quarter after considering comments of covered banks.  Other aspects of Basel III like counterparty credit risk and monitoring leverage ratios shall be implemented later in 2012.

It is noteworthy that the minimum capital adequacy ratios adopted by the BSP in the meantime before full adoption of the Basel III standards are above the minimum prescribed internationally.  In this connection, the BSP enjoys a distinctive track record of regulating and supervising banks operating in Philippine jurisdiction to make them comply with global capital requirements.  This further move towards Basel III standards will continue to give the Philippine legal regulatory framework a positive impression with respect to risk mitigation in the international banking industry.

Considering the changes prescribed by Basel III, it is prudent and sound for covered banks to consider and factor in as early as practicable the new regulatory regime under Basel III for purposes of their capital planning.  They can also start phasing out ineligible capital instruments.  Moreover, participation in the quantitative impact study ("QIS") to be conducted by the BSP during the exposure period will help banks usher a smooth transition to the new regulatory regime.  The QIS is a comprehensive exercise that will help the BCBS assess the impact of capital adequacy and liquidity standards so set.  The "parallel run" period, during which the QIS shall be made, will enable the BSP to address issues and make adjustments as necessary to implement the Basel guidelines.

As a final note, initially adopting the Basel III standards (in particular, the more stringent minimum capital requirements) may be perceived as a disincentive for banks to engage in business deals and projects with considerable credit, market and liquidity, or operational risks in their effort to meet the required minimum ratios.  This is understandable given the motivation for banks to lend and earn rather than keep their funds locked in required capital—in other words, higher minimum requirements mean a more expensive compliance.  Nonetheless, prompt consideration and action by stakeholders to comply with Basel III standards may rather aid them in adjusting to the new regulatory system once full implementation of those standards is carried out by the start of 2014.  The crucial question, however, as to whether or not Basel III will save the banking sector from another financial crisis remains to be seen.