Arab News, Sat, Feb 24, 2024 | Shaban 14, 1445
Saudi Arabia ahead of US, EU and UK when it comes to Basel IV compliance
Saudi Arabia:
Saudi Arabia’s dedication to financial stability has been underlined by figures
from the Kingdom’s central bank showing its capital adequacy ratio stands at
19.5 percent – far above the 8 percent minimum requirement introduced in the
wake of the 2008 economic crisis.
This position comes as Saudi Arabia is one of the
few countries to be fully compliant with Basel IV regulations, which mandate
that banks maintain specific leverage ratios and designated reserve capital.
This adherence to global standards contrasts with the varied timelines seen
worldwide for Basel IV implementation.
While the EU, the UK, and Switzerland are navigating finalization processes, the
US is yet to commence consultations on these critical reforms, which remain a
top priority for regulatory bodies amidst recent bank failures.
Although Saudi Arabia’s ratio falls slightly below the 20 percent recorded in
the same period in 2023, it still comfortably exceeds the Basel III minimum
requirement of 8 percent, encompassing both Tier 1 and Tier 2 capital.
Basel III is a set of international banking regulations developed by the Bank
for International Settlements to promote stability in the international
financial system. It was introduced following the 2008 global financial crisis
to improve the banks’ ability to handle any shocks from financial stress and
strengthen both their transparency and their disclosure.
Basel III builds on the previous accords, Basel I and Basel II, and is part of a
process to improve regulation in the banking industry. Basel IV, or 3.1, was
introduced in 2017 and is the final reform of Basel III. It focuses on
strengthening the banking sector for increased resilience against future crises.
The target timelines for implementation of the final reforms vary significantly
worldwide.
Originally scheduled to take effect on Jan. 1, 2022, the implementation of Basel
IV was postponed by 12 months due to the COVID-19 pandemic, with transitional
dates being revised and varies among countries.
The Basel IV proposals seek to restore credibility in the calculation of
risk-weighted assets and improve the comparability of banks’ capital ratios.
One of the most significant risks faced by traditional banks is credit risk,
which involves the uncertainty that loans, the primary assets of a bank, may not
be repaid, leading to unexpected losses.
To mitigate this risk, regulators impose a regulatory capital intended to absorb
losses in times of credit default. The absence of sufficient capital can lead to
a bank collapse, posing not only a threat to the individual bank but also to the
broader financial system.
In a February 2023 report, Fitch Ratings
highlighted that Saudi Arabia, along with Australia, Canada, Indonesia, and
South Korea, was among the few jurisdictions that successfully met
the globally agreed official Basel IV implementation date in
January 2023. The report also emphasized Saudi Arabia’s status as one of the
most sophisticated and conservative regulators in the Middle East and Africa.
Under these regulations, banks are required to measure their risk-weighted
assets in a calculation that involves assigning different risk weights to
various categories of assets based on their perceived riskiness. The goal is to
reflect the varying degrees of credit risk associated with different types of
assets in a bank’s portfolio.
Banks are then required to assign regulatory capital to ensure they have a
sufficient buffer to absorb potential losses, particularly during economic
downturns or financial crises. The capital requirements are usually expressed as
a percentage of a bank’s risk-weighted assets.
The key capital types that are allowed under Basel
III are divided into two main tiers: Tier 1 which is the highest quality capital
and includes common equity, retained earnings and other comprehensive income, in
addition to Tier 2, other instruments with specific loss-absorption features.
Within the banks’ capital adequacy calculations under the Basel III framework,
another significant ratio that banks need to comply with is the regulatory Tier
1 capital, which should be maintained at a minimum 6 percent of RWA to safeguard
their financial strength.
In the context of Saudi banks, this regulatory Tier 1 capital reached 16 percent
of their RWA, indicating a robust position that comfortably surpasses the Basel
III requirement for a minimum Tier 1 capital of 6 percent.
Furthermore, this capital encompasses the capital conservation buffer – a
supplementary measure under Basel III intended to absorb losses during economic
stress, fixed at 2.5 percent of total risk-weighted assets.
The primary purpose of the capital conservation buffer is to build an additional
layer of capital that banks can draw upon in times of financial difficulty.
It aims to promote the conservation of capital and prevent banks from depleting
their capital levels to a point where they may be at risk of financial distress.
Importantly, this buffer must be fulfilled using Common Equity Tier 1
exclusively, and it is positioned above the regulatory minimum capital
requirement of 8 percent. This elevates the overall required minimum ratio to
10.5 percent.
If the minimum buffer requirements are breached,
capital distribution constraints will be imposed on the bank.
Tier 1 capital is categorized as going concern, signifying its immediate
capacity to absorb losses as soon as they arise. On the other hand, Tier 2, the
second type of capital considered in calculating the bank’s capital adequacy
ratio, encompasses supplementary capital and operates as a gone concern,
absorbing losses before affecting depositors and general creditors.
Total available regulatory capital is the sum of these two elements - Tier 1 and
Tier 2. Both categories have distinct criteria that capital instruments must
meet before being considered. Banks must adhere to specified minimum levels of
Common Equity Tier 1, Tier 1, and total capital, with each level expressed as a
percentage of risk-weighted assets.
The Basel IV proposals seek to restore credibility in the calculation of
risk-weighted assets and improve the comparability of banks’ capital ratios.
Fitch Ratings said this move is expected to benefit banks with significant
exposures to residential and commercial mortgage loans, as well as high-quality
project finance in Saudi Arabia. The capital ratios of these banks are expected
to improve, thanks to more detailed risk-weightings that are generally lower
than those observed under the previous regime.
However, according to the agency, banks involved in land acquisition,
construction, development, financial guarantees and equities will face increased
capital requirements.
Retail-focused banks are set to benefit from improved capital ratios with lower
risk-weightings, particularly in residential mortgage loans. SAMA’s cap on the
loan-to-value ratio at 90 percent will lead to reduced risk-weights, ranging
from 20 percent to 40 percent, from 50 percent previously.
The overall capital ratio for the Saudi banking sector will remain mostly
unchanged as indicated by a parallel run conducted by SAMA in 2022.