In its final meeting for year 2010, the Monetary Board approved an amendment to the existing risk-based capital adequacy framework of the BSP to incorporate certain provisions of Basel 3 aimed at improving the quality of bank capital. In particular, the BSP has adopted the Basel 3 criteria for inclusion of non-common equity components in banks’ capital base as a basis for determining capital instruments that can be counted as regulatory capital by Philippine banks from 1 January 2011 onwards.
Basel 3 revises the existing international capital standards, commonly referred to as Basel 2. It represents the core of international banking reforms that are deemed to address the weaknesses that were made evident during the global financial crisis. A major component of Basel 3 involves changes to the definition of bank capital. Under Basel 2, banks’ qualifying capital consisted of Tier 1 and Tier 2 capital. Tier 1 capital is further divided into Core capital and Hybrid Tier 1 capital, while Tier 2 capital is divided into Upper and Lower categories. Tier 2 capital could contribute up to 100 percent of the amount of Tier 1 capital to form a bank’s capital base. On the other hand, Basel 3 still retains the division between Tier 1 and Tier 2 capital, but Tier 1 capital is now sub-divided into Common Equity and Additional Going-Concern capital components while the subcategories of Tier 2 capital have been removed. Moreover, majority of the capital base must be in the form of Common Equity elements. Basel 3 likewise sets out minimum criteria for instruments to qualify in each of the sub-categories of capital. Notably, instruments included in Additional Going-Concern capital and Tier 2 capital must not be governed by conditions that give the issuing bank an incentive to redeem the instrument, which are deemed to lessen the instrument’s ability to absorb losses. These include increases in coupon or dividend rates in the event that the instrument is not called at a pre-determined date.
In line with existing regulations, Philippine banks are still following the Basel 2 definition of capital. Over time, they have issued capital instruments such as Unsecured Subordinated Debt (UnSD) that have qualified as either Hybrid Tier 1, Upper Tier 2 or Lower Tier 2 capital. Under the newly-approved guidelines, however, banks issuances must prospectively comply with Basel 3 criteria for Additional Going-Concern capital in order for these to qualify as Hybrid Tier 1 capital, and the criteria for Tier 2 capital for these to qualify as Lower Tier 2 capital. Moreover, the BSP will no longer allow new issuances of capital instruments to be included in Upper Tier 2 capital.
Eligible capital instruments under Hybrid Tier 1 capital, Upper Tier 2 and Lower Tier 2 capital based on existing regulations that have been issued as of December 31, 2010 shall continue to be recognized under their respective categories until such time that further guidance on this aspect is issued by the BSP. At this point in time, too, the BSP is not yet making any changes to the capital structure of banks. Thus, the minimum capital ratios as well as the limits on the amounts that can be included as Hybrid Tier 1 and Upper and Lower Tier 2 capital are being retained. Banks’ prospective issuances shall likewise be subject to these caps.
The adoption of the new criteria for capital instruments is part of BSP’s commitment to continuously institute reforms that will promote a stronger banking system. The BSP is also studying the other components of Basel 3 in order to determine how the principles are best applied to local circumstances. “The BSP has always expressed its broad support for the objectives of the international reforms. While they are primarily geared toward big banks, we appreciate that there are certain lessons that apply universally. We would like to see our banks push the envelope when it comes to improving risk management and governance. We believe Basel 3 has a role to play in this area, “ Governor Tetangco said.