Safest capital for banks

Saturday March 28, 2009

REGULATORS and investors globally are beginning to look at banks’ shareholders funds as the safest form of capital that the financial institutions may use.

As losses have begun to wipe out shareholders funds, some Western banks now see they make up less than 1% of Tier-1 capital.

Tier-1 capital is widely considered the core measure of a bank’s financial strength, but not when shareholders fund is only 1% of the total, Jupiter Securities Sdn Bhd research head Pong Teng Siew tells StarBizWeek.

According to Pong, the reason for this is partly the use of structured products as Tier-1 capital, also known as innovative Tier-1 capital by some large multinational banks.

“You cannot be operating on structured products as capital. Losses can be absorbed by shareholders funds but not by these structured (products).”

Looking at Malaysian banks, the same problem does not exist with shareholders funds, as defined in the balance sheet, exceeding the total value of Tier-1 capital.

Pong agrees that Malaysian banks, being more conservative, are not facing the same problem and still stand up well in the light of this new benchmark measure.

He points out that Bank Negara in its annual report on Wednesday has expressed similar sentiments.

In fact the central bank mentions that Malaysia has begun using innovative Tier-1 capital instruments as well, although likely to a smaller extent.

“Despite the more active capital management activities by banking institutions in recent years and introduction of more innovative Tier-1 capital instruments, approximately 90% of Tier-1 capital comprised ordinary shares, share premium, statutory reserves, general reserves and retained earnings (net of unaudited losses) less goodwill,” Bank Negara says in its annual report.
As a result of the high use of share capital, the equity to assets ratio of the banking system is at 10% of total risk-weighted assets or 6.8% of total assets. Even for investment banks, the equity to assets ratio remains manageable at 6.9% to 47.7%.

“This still compares favourably with the benchmark used by the US regulators that deem any Tier-1 capital to total assets ratio of more than 3% to 4% as strong.

“Arising from the current crisis, there has been greater emphasis on traditional capital (ordinary shares and reserves) to gauge the capital strength of banking institutions,” Bank Negara says, adding that it will monitor closely international developments in this area.

http://thestar.com.my/news/story.asp?file=/2009/3/28/business/3567560&sec=business