Some large banks would fail common equity minimums: Fitch

The rating agency calculates that five out of 46 of the world’s largest developed market banks would fail the 4.5% common equity capital test proposed in the new rules, with an aggregate common equity capital shortfall of US$20 billion. Including the Basel Committee’s 2.5% conservation buffer, the list of banks with shortfalls rises to 17, and a US$120 billion deficit. Including a full 2.5% countercyclical buffer (which can be met out of common equity or other fully loss absorbing capital), these figures rise to 35 banks and US$420 billion, respectively.

Fitch says it recognizes that banks’ capital and weighted risk numbers will evolve during a transition period, “However, negative impacts on risk weighted assets arising from previously announced changes to the calibration of Basel rules will likely constrain potential mitigating action by banks. This may result in a higher aggregate core capital shortfall across the above universe of banks.”

Additionally, Fitch points out that while the Basel Committee stated that smaller banks mostly already meet its higher capital standards, the reality of their capital raising needs may be different. “The larger banks will set the market benchmark for capital levels and for small banks to remain competitive the market may still expect them to hold higher levels of capital,” it says.

The existence of higher levels of better quality capital will likely be positive for senior bank creditors and for overall bank stability in the long-term, Fitch concludes. Given the long transition periods allowed by regulators, positive rating actions are unlikely in the near-term it says.

However, it also cautions that banks that use surplus capital over regulatory requirements as justification for reducing capital, for example by way of share buy backs or special dividends, could be at risk of rating downgrades.

In addition to restricting or ceasing dividends on common shares, Fitch anticipates regulators will expect banks whose ratios fall within the capital conservation buffer zone of 4.5%-7% to preserve common equity tier 1 capital by not paying coupons on any hybrid capital unless they are legally obliged to do so.

“Furthermore, the 2.5% capital conservation buffer could prove to be more of a technical buffer than one that forms a cornerstone of a bank’s capital planning process as the stigma of falling within the 4.5%-7% buffer zone could be harmful for investor, counterparty and even depositor sentiment towards a bank,” it says. “Banks may therefore view the 7% common equity capital ratio as the de facto minimum requirement and even plan additional operating buffers of some 2%-3% above this. For banks operating at such elevated core capital levels, the higher hybrid coupon deferral risk referred to above would therefore be negated.”

Fitch also notes that the planned countercyclical capital buffer “could prove difficult to impose in reality and there may be little transparency or consistency over the precise triggers and timing. Its imposition over a country’s banking sector could also be counterproductive, serving as an effective ‘red flag’ over a country’s banking system that undermines confidence in a country’s banks long before the ‘corrective’ capital can be raised or generated.”

IE