S&P warns banks against reducing capital too soon in anticipation of Basel II

Standard and Poor's will review, and possibly downgrade, issuers that will be found to have reduced their capital levels in anticipation of the effect of the new Basel Accord, also known as Basel II, according to Paris-based Scott Bugie, the rating firm's managing director for financial services ratings.

Bugie said during a teleconference call in mid-October that there was a danger that financial firms under Basel II would be tempted to reduce their capital levels in anticipation of a widely expected Basel II effect – regulatory capital reduction. He said even after the implementation of Basel II, a bank that will adjust its regulatory capital downwards without a change in its economic capital would face a ratings review. But S&P will not review the ratings of banks that will fail to implement the Accord.

Bugie said that S&P ratings would benefit greatly from the enhanced disclosure requirements under Pillar 3 of the new framework, which should increase transparency and release information for other industry participants.

“We think we will benefit greatly from these disclosure requirements to the point that we will not have to evaluate banks’ compliance with the Accord. We will use the information that will be released for the purposes of Basel II to determine how a bank is managing its risk profile, especially in credit risk management,” said Bugie.

In a report released in mid-October called ‘Basel II: Evolution not Revolution for Banks’, S&P said the increased transparency to be brought about by Basel II in banks will improve comparability in financial analysis. The rating agency warned banks against expecting too much too soon from Basel II because the Accord depends on the policy decisions at the national level.

The report said the greatest capital relief under Basel II will go to retail lending, thereby boosting consumer spending.

“Under Basel II, lending areas with predictable risks, notably mortgage lending and revolving lines of credit, will require less regulatory capital for credit risk compared with corporate lending, given the same assumptions of probability of default (PD) and loss-given default (LGD). Consequently, the banks that specialise in retail lines are the most likely beneficiaries of the new framework.”

S&P did not anticipate a sudden, substantial reduction in capital, either today in anticipation of Basel II or in three or four years when national supervisors complete implementation. Whether banks will in fact reduce capital in the future will depend on counterparties, investors, peer pressure and on the credit ratings banks wish to maintain.

BaselAlert.com