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Banking Systemís Capital Adequacy Ratio (CAR) Remains Strong under the Basel 2 Framework

04.11.2008

The Philippine banking system’s average CARs as of end-September 2007 remained strong at 14.71 percent on solo basis and 15.70 percent on consolidated basis, which are both higher than the 10 percent required minimum ratio.  The said CARs were calculated based on the revised CAR framework (patterned after Basel 2) for universal and commercial banks (U/KBs) and their subsidiary banks and quasi-banks, and the old CAR framework (patterned after Basel 1) for stand-alone thrift banks (TBs) and rural and cooperative banks (RB/Coop banks). 

The new requirements of Basel 2 caused the decline in the CARs of the banking system of 283 basis points and 311 basis points as compared with last quarter’s CARs of 17.54 percent and 18.81 percent on solo and consolidated bases, respectively.  On solo basis, 197 basis points of the 283 basis points net drop in CAR can generally be attributed to the introduction of capital charge for operational risk.  An additional 97 basis point-reduction was due to the increase in capital charges for credit risk of foreign currency (FCY) denominated exposures to National Government (NG) and Real and Other Properties Acquired (ROPAs), which accounted for 57 basis points and 40 basis points  decrease, respectively.  The impact of said changes was slightly mitigated by the decrease in the capital charge for market risk.

Consistent with Basel 2 framework, FCY denominated exposures to NG attract a 100 percent risk weight (from zero percent risk weight) which is applied on a staggered basis, i.e., 1/3 of the risk weight starting 1 July 2007, 2/3 of the risk weight starting 1 January 2008 and full risk weight starting 1 January 2009.  ROPAs, on the other hand, are assigned risk weight of 150 percent (from 100 percent risk weight).

Universal and Commercial Banking Industry.  The U/KB industry posted an overall CAR of 14.68 percent on solo basis and 15.85 on consolidated basis as of 30 September 2007.  These were 321 basis points and 350 basis points lower than the industry’s end-June 2007 CARs of 17.89 percent and 19.35 percent on solo and consolidated bases, respectively. 

The decline in CARs in the U/KB industry was likewise caused by the changes brought about by the adoption of Basel 2 framework.  Similar to the banking system’s CARs, the reduction in U/KB industry CAR was largely driven by the new capital charge for operational risk, along with the higher risk weights assigned to FCY denominated exposures to NG and ROPAs.  On a solo basis, the 321 basis points reduction in CAR were accounted for as follows:  introduction of capital charge for operational risk (224 basis points), increase in capital charge for credit risk mainly on account of FCY denominated exposures to NG and ROPA (112 basis points), and reduction in capital charge for market risk (negative 15 basis points). 

Thrift Banking Industry.  As of 30 September 2007, the TB industry CAR decreased to 14.60 percent on both solo and consolidated bases or a decline of 96 basis points from the 15.56 percent CAR as of 30 June 2007.  The impact of adoption of Basel 2 framework on the ten (10) subsidiary TBs of U/KBs primarily caused the decrease in the TB industry CAR.  The average CARs of the said peer group dropped from 19.59 percent as of 30 June 2007 to 16.55 percent as of 30 September 2007 both on solo and consolidated bases.

Rural Banking Industry.  The CAR of the RB/Coop banking industry as of end-September 2007 was lower by 4 basis points at 15.58 percent from the 15.62 percent as of end-June 2007. The RB/Coop banking industry exhibited a relatively stable CAR as they remained under the old Basel 1-type CAR framework which covers only credit risk.

The revised CAR framework which is based on the standardized approaches of Basel 2 is considered a more risk-sensitive measure of a bank’s solvency position.  It was issued under Circular No. 538 dated 04 August 2006 and took effect last 01 July 2007 covering U/KBs and their subsidiary banks and quasi-banks.

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