After the financial crisis in the US of 2007 – 2008
financial regulators have set rules towards full disclosure by 2019. US banks
have already started to report their capital condition in terms of Basel III,
and have complied. Thus, they are reporting pro forma capital ratios since
2012. Pro forma in finance is a method of calculating financial results in
order to emphasize current or projected figures.
Since the financial crisis regulators are implementing
tighter rules to ensure the sustainability of banks. The crisis exposed
weaknesses in the balance sheets of many banks. Their lending practices were
risky while capital not adequate enough to cover their exposure.
The Basel committee on banking supervision is
responsible for the proposals on financial sector reform. According to the Bank
of International Settlements, Basel III is a comprehensive set of reform
measures, designed to strengthen the regulation, supervision and risk
management of the banking sector.
Specifically, it intends to increase common equity and
Tier I capital requirements, provide additional capital buffers, set a minimum
leverage ratio and add mandatory liquidity coverage ratio. Tier 1 is a measure
of the bank’s core equity capital compared with its total risk weighted assets.
It is a measure of the bank’s financial strength. The Tier 1 is based on the
sum of equity and disclosed reserves.
Capital buffers vary according to a percentage of risk
weighted assets. Banks without adequate capital run into trouble, and they can
either raise capital (as we will see for a Greek bank) or cut back on lending.
A bank’s risk weighted assets includes all assets that
the bank holds that are systematically weighted for credit risk. For example,
cash has 0% risk weight; loans secured by letter of credit are riskier than a
mortgage loan secured with collateral.
The European Banking Authority disclosed results of
transparency of 64 European banks from 21 countries. The aim was to share
information about banks’ operations according to a uniform benchmark. The data
involved a bank’s composition of capital and risk weighted assets, market risk (exposing
investments in foreign countries), and credit risk. The data was for Q1 2014,
and for the second quarter 2014, it will be released in the coming months.
As far as for the four Greek banks that participated,
those were Alpha, National, Eurobank and Piraeus. The findings for 2013 showed
that capital requirements appeared inflated. Core Tier 1 for Alpha was 14.4% in
Q2 2013 vs 13.9 for Q1 2013, National was 8.6% in Q2 2013 vs. 13.8% for Q1
2013, Piraeus 15% vs. 13.8%, and Eurobank, 12.4% vs. 8.1%.
These differences as for the Greek banks lie in the
deferred tax assets related to the PSI losses. The regulator, Bank of Greece,
allows Greek banks to recognize regulatory capital only 20% of Tier 1 of the
total PSI, as opposed to full recognition. Loan to value ratios for Greek
residential mortgages is at 70% for the four Greek banks, with Alpha at 61.8%,
National at 67.4%, Eurobank at 81.5% and Piraeus at 69%. Loan to value is a
lending risk assessment ratio that financial institutions examine before
approving a mortgage loan. Higher LTV ratios are higher in risk, so if the
mortgage is approved, it will cost the borrower more.
The case with Eurobank is that it announced a share
capital increase which will be completed soon. The Chief executive of the bank
recently said in the daily newspaper, Kathimerini, that that bank will obtain a
high core Tier 1 capital adequacy ratio in the banking system, and the lowest
loans to deposit ratio.
Meantime, according to Reuters, the Troika has agreed
that a lower capital ratio can be used in the second stress tests (end of Q2
2014) for Greek banks bringing it in line with the European benchmark. Last
year, the Greek administration had announced the recapitalization of the Greek
banks. The purpose of the 28 billion euros was to ascertain if Greek banks can
sustain and absorb future shocks with the problem of bad loans.
The Troika agreed to set the Tier 1 capital ratio at
8% as opposed to 9% in 2012. This will mean lower capital needs for the nation’s
four banks.
Bill T. Alexandratos
+306984474984
