BSP caps banks 'large exposures'
The Bangko Sentral ng Pilipinas (BSP) has redefined big banks’ “large exposures” with a limit set at 25 percent of Tier 1 capital, which is a bank’s core capital.
The large exposures framework imposes prudential limits to ensure banks have strong capital ratios and could cover losses in the event of a sudden collapse of a counterparty or a group of connected counterparties.
In a proposed circular which will be adopted in two years, the BSP said “large exposures” of BSP-supervised financial institutions (BSFIs) will be equal or above 10 percent of its covered banks’ Tier 1 capital, double from its previous five percent.
Large exposures refer to a BSFI’s exposures to counterparty or a group of connected counterparties that is equal or greater than 10 percent of their Tier 1 capital under applicable and existing capital adequacy framework.
The previous definition of “large exposures” was equal or greater than five percent of a financial institution’s qualifying capital.
The draft circular included a transitory period before its adoption by January 2024. But, for monitoring purposes, all universal and commercial banks and its subsidiary banks will observe the large exposures framework and the large exposures limit. They are also required to submit reports starting with the reporting period ending Dec. 31, 2022. The maiden report will be submitted to the BSP on March 31, 2023.
The BSP has adopted the Basel Committee on Banking Supervision standards of setting a BSFI’s large exposures limit at 25 percent of Tier 1 capital. The limit is the sum of all the exposure values to a single counterparty or to a group of connected counterparties.
The draft circular will adopt stricter monitoring and reporting of the covered banks’ large exposures. It must report the top 20 of its largest exposures to the BSP, among other required reports, on a semi-annual basis or every June 30 and December 31.
If a covered bank breaches the large exposures limit, it will be required to include its risk assessments in its Internal Capital Adequacy Assessment Process or ICAAP.
The draft circular’s feedback deadline is April 29, for banks’ comments and suggestions on the amendments for the large exposures guidelines.
The BSP said that in amending its guidelines on large exposures, it is “cognizant that risks arising from the exposures of (BSFIs) to a single counterparty or group of connected counterparties could pose concerns to the stability of each BSFI and to the financial system.”
The BSP added that BSFIs are expected to “properly and accurately identify, measure, monitor and control large exposures across books and operations in order to protect BSFIs’ solvency from maximum losses resulting in sudden counterparty failure.”
Based on the draft circular, big banks’ large exposures including the exposures of their subsidiary banks and quasi-banking units, will be computed and compared with Tier 1 capital on both solo and consolidated bases. Tier 1 capital or core capital which are equity and retained earnings, is applied to monitor a bank’s capital adequacy. Qualifying capital is both Tier 2 -- which are reserves such as loan loss reserves and other capital instruments -- and Tier 1.
The BSP in the proposed guidelines on large exposures has expanded the coverage of connected counterparties which are a group of counterparties that are connected through direct or indirect control of one of the counterparties over the other or economic interdependencies, and treated as a single counterparty.
In assessing economic interdependence, for example, the BSP has set additional criteria. The BSP refers to economic interdependence as “a situation where counterparties are reliant on each other” and therefore if one counterparty has financial problems it will affect all counterparties’ creditworthiness, in particular the covered banks.
Covered banks, previously only defined as financial institutions in the previous circular, will determine connectedness based on economic interdependence that will impact on the financial capacity or ability to pay the obligations of the other counterparties.
The BSP proposes several criteria for this such as: that 50 percent or more of a counterparty’s annual gross receipt or gross expenditures will come from transactions with the other counterparty; or that one counterparty has fully or partly guaranteed exposures and that exposure is so significant that the guarantor is likely to default if a claim occurs.
Other criteria include: a significant part of a counterparty’s business is transacted with the other counterparty which cannot be easily replaced by business from other customers within a reasonable time period; the expected source of funds to repay the loans of both counterparties is the same and neither counterparty has another independent source of income from which the loans may be serviced and fully repaid; and it is unlikely that the financial difficulties of one counterparty would cause difficulties for the other counterparty or counterparties in terms of full and timely repayment of liabilities.
In further assessing economic interdependence, the BSP said that this will also be determined if the insolvency or default of one counterparty is likely to be associated with the insolvency or default of other counterparties and since they rely on the same source for the majority of ther funding, a situation could arise when an alternative provider could not be found.
Similar with the previous circular, the BSP said that in cases where the criteria do not automatically imply an economic dependence that results in two or more counterparties being connected, the covered banks or quasi-banks will have to provide evidence that a counterparty which is economically connected to another, can still pay its liabilities “within a reasonable period time even if the latter’s financial condition weakens.”
Big banks’ capital adequacy ratio (CAR) remain sufficient and stable at 17.4 percent on consolidated basis as of end-September 2021, although lower compared to 17.6 percent in the second quarter ending in June.
CAR which is a bank’s measure of capital health in relation to its risks and liabilities, is well-above the 10 percent minimum threshold set by the BSP and eight percent minimum by the Bank for International Settlements.