CRISIL s criteria for rating Basel III compliant non-equity capital instruments of Banks. June 2013

Transcription

1 CRISIL s criteria for rating Basel III compliant non-equity capital instruments of Banks June 2013

2 Key Messages Basel III guidelines are designed to improve the quality and quantity of capital of the banking system Total equity capital more than doubled to 8.0% from 3.6% under Basel II Tier I capital instruments to have equity like features, unlike under Basel II Non-equity Tier I instruments have higher equity-like features than in Basel II Ratings will be lower than those issued under the Basel II regime Unlike Tier I instruments, Tier II instruments do not pose materially high risk to the investors Ratings likely to be the same as or close to the bank s corporate credit rating (CCR) CRISIL s treatment of the non-equity capital instruments in banks capital analysis is in line with the regulatory treatment 2

3 Basel III to enhance quality and quantity of capital 3

4 Basel III designed to enhance quality and quantity of capital As a % of risk weighted assets Basel III Basel II Equity capital ratio (A) 5.5% 3.6% Capital conservation buffer (B) 2.5% Total equity capital ratio (C = A+B) 8.0% 3.6% Non-equity Tier I capital ratio (D) 1.5% 2.4% Total Tier I capital ratio (E = C+D) 9.5% 6.0% Tier II capital ratio (F) 2.0% 3.0% Total capital ratio (E+F) 11.5% 9.0% Total equity capital requirement more than doubled to 8.0% from 3.6% under Basel II 2 3 Tier I capital instruments to have equity like features, unlike under Basel II Tier II capital instruments eligibility reduced to 2% No distinction of Upper and Lower Tier II instruments under Basel III 4

5 Basel III defines stringent capital thresholds for banks 10.0% Total equity capital ratio 8.0% 6.0% 4.0% 2.0% 0.0% 8% - Threshold for likely coupon non-payment (non-equity Tier I) 6.125% - Pre-specified trigger for principal loss (non-equity Tier I) Point of non-viability (PONV) trigger for principal loss (Tier II)# Point of non-viability# Liquidation of bank# # The highlighted capital thresholds have not been specifically defined in Basel III guidelines issued by RBI. These are indicative capital thresholds based on CRISIL s expectations Breach can cause potential loss on non-equity capital instruments 5

6 Rating approach of non-equity Tier I Instruments 6

7 Three key equity-like features to increase risks for investors 3.6% Equity Principal loss absorption Existence of full coupon discretion 8.0% Equity High capital threshold for likely coupon non-payment Tier I instruments under Basel II did not have two of these features Under Basel II, banks not allowed to pay coupon if total capital ratio falls below 9% 7

8 Risk attributes of non-equity Tier I instruments Feature 1 Existence of full coupon discretion Feature 2 High capital threshold for likely coupon non-payment Feature 3 Principal loss absorption Availability of full coupon discretion to banks represents potential risks for investors However, banks unlikely to exercise discretion in normal course of business Discretion expected to be exercised only if capital falls below regulatory threshold Feature - 1 Risk spectrum Increasing order of risk 8

9 Risk attributes of non-equity Tier I instruments Feature 1 Existence of full coupon discretion Feature 2 High capital threshold for likely coupon non-payment Feature 3 Principal loss absorption If total equity capital falls below the threshold of 8%, the likelihood of coupon nonpayment increases Regulatory constraints on distribution of earnings kick in once equity capital falls below 8% CRISIL believes that this threshold is high Narrow gap of 1% between the threshold and existing systemic total equity capital (9%) Several instances in past 5 years when total equity capital was lower than threshold 66 out of 105 instances for PSBs 4 out of 55 instances for private sector banks However, these instances are not fully indicative of the likely risk, given regulatory capital need was much lower Feature - 2 Risk spectrum Increasing order of risk 9

10 Risk attributes of non-equity Tier I instruments Feature 1 Existence of full coupon discretion Feature 2 High capital threshold for likely coupon non-payment Feature 3 Principal loss absorption Introduced for the first time for Indian banks This feature will cause principal write down (temporary/permanent) or conversion to equity on breach of pre-specified trigger (6.125%) Can lead to significant loss to the investors Feature - 3 Risk spectrum Increasing order of risk 10

11 Ratings to be lower than those under Basel II given higher risks Starting point for ratings to be the corporate credit rating (CCR) of the bank (same as rating on Lower Tier II instruments under Basel II) Rating will be notched down from the CCR to factor in these risk attributes Ratings will be lower than those under Basel II CRISIL ratings for Basel II Tier I instruments are currently same as or one notch to CCR of banks Tier I (Under BaseI II) Tier I (Under BaseI III) Rating CCR 11

12 CRISIL s assessment will also focus on other key aspects Current reported capital adequacy of the bank and the share of equity in the total reported capital of the bank Philosophy of the bank to maintain a buffer in equity capital over and above the regulatory threshold of 8 per cent CRISIL s expectations of movement in the bank s capital adequacy levels over the medium term Bank s ability to raise equity capital which is driven by factors such as Current shareholding pattern Past track record in raising capital Current market price (if listed) For public sector banks, the government s stated and articulated policy of maintaining minimum 51 per cent government shareholding is also taken into consideration CRISIL s outlook on profitability of the bank 12

13 Rating of Tier II Instruments 13

14 Rating for Tier II instruments to be closer to that under Basel II Total equity capital ratio 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% Strong regulatory measures expected to avoid non-viability Point of non-viability (PONV) trigger for principal loss (Tier II)# Point of non-viability# Bank liquidation# # The highlighted capital thresholds have not been specifically defined in Basel III guidelines issued by RBI. These are indicative capital thresholds based on CRISIL s expectations Principal loss at PONV trigger for Tier II instruments, a new feature CRISIL believes PONV trigger is a remote possibility in Indian context Strong regulatory supervision and systemic importance to ensure timely intervention No past record of any scheduled commercial bank in India going into liquidation Rating for Tier II instruments will be the same as or close to CCR CCR captures the inherent risk of this feature 14

15 Treatment of Basel III hybrids in capital analysis of banks ratings 15

16 Non-equity Tier I instruments to be treated as core capital CRISIL s treatment of the non-equity capital instruments under Basel III in banks capital analysis is in line with the regulatory treatment Non-equity Tier I instruments will be treated as part of core capital due to higher equity like features- Perpetual in nature High loss absorption capacity Discretionary payout with existence of full coupon discretion Low proportion (maximum of 1.5 per cent) in the Tier I capital base of 9.5 per cent Basel III compliant Tier II instruments will be considered as secondary form of capital Loss-absorption capacity of Tier II instruments are not on par with that of non-equity Tier I instruments 16

17 About us CRISIL Limited CRISIL is a global analytical company providing ratings, research, and risk and policy advisory services. We are India's leading ratings agency. We are also the foremost provider of high-end research to the world's largest banks and leading corporations. CRISIL Ratings CRISIL Ratings is India's leading rating agency. We pioneered the concept of credit rating in India in With a tradition of independence, analytical rigour and innovation, we have a leadership position. We have rated over 60,000 entities, by far the largest number in India. We are a full-service rating agency. We rate the entire range of debt instruments: bank loans, certificates of deposit, commercial paper, non-convertible debentures, bank hybrid capital instruments, asset-backed securities, mortgage-backed securities, perpetual bonds, and partial guarantees. CRISIL sets the standards in every aspect of the credit rating business. We have instituted several innovations in India including rating municipal bonds, partially guaranteed instruments and microfinance institutions. We pioneered a globally unique and affordable rating service for Small and Medium Enterprises (SMEs).This has significantly expanded the market for ratings and is improving SMEs' access to affordable finance. We have an active outreach programme with issuers, investors and regulators to maintain a high level of transparency regarding our rating criteria and to disseminate our analytical insights and knowledge.

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