FINANCIAL HOLDING COMPANIES (FHCs) can breathe a sigh of relief now that the date for compliance with the capital adequacy framework has been set at Jan 1, 2019, later than the deadline of 2017/2018 that the industry had expected.

According to a discussion paper issued by Bank Negara Malaysia last month, FHCs will have to comply with Basel III requirements on a consolidated level effective Jan 1, 2019. This means they will not be required to comply with the same phased-in implementation as banks.

Banks have been adopting the Basel III requirements gradually since Jan 1, 2013, and have until Jan 1, 2019, for full implementation.

Listed FHCs include Affin Holdings Bhd, Alliance Financial Group Holdings Bhd, AMMB Holdings Bhd, CIMB Group Holdings Bhd, Hong Leong Financial Group Bhd and RHB Capital Bhd.

A possible reason FHCs are given a later deadline is that they may need more time to develop a model to compute the types of risks for the group as well as figure out their capital-raising strategies going forward. This, states Bank Negara in its discussion paper, will ensure a consistent measurement approach to be applied to similar exposures across the group.

“If a subsidiary of a Malaysian banking business is on the advanced approach [for the computation of risk-weighted assets], Bank Negara will leave it to the bank to decide whether it wants to use the advanced approach based on its model or the standardised approach based on ratings. But it is different for FHCs,” says a finance executive familiar with the matter.

“The latest discussion paper states that FHCs must use the advanced approach if their Malaysian banking units are already doing so. This means they have to develop these models, and the models are subject to Bank Negara’s approval.

“This means FHCs will have to plan their capital raising to ensure they meet the requirements. For now, instruments issued by holding companies are not recognised much, except for ordinary shares.”

The executive recalls that during the Basel II exercise in 2006, banks were given four years to prepare before adopting the advanced approach, and two years if they were to adopt the standardised approach to calculate risks.

“The Bank (Bank Negara) acknowledges the additional demands placed on the operational capacity required to compute and aggregate risk exposures across the groups, particularly under an advanced approach. In this respect, the FHC is expected to take early steps to develop and implement regulatory capital reporting systems across the group, including the overseas subsidiaries,” states the regulator in its discussion paper.

According to the paper, an advanced approach for a risk type refers to internal rating-based approach for credit risk, internal model approach for market risk and standardised approach or alternative standardised approach for operational risk.

It adds that for credit risk, the adoption of the advanced approach can be done based on an asset class or a subclass, and for market risk, the adoption of the advanced approach can be done based on a broad risk category.

A managing director of an FHC says some of them are already in compliance with this capital requirement as they had expected the deadline to be earlier than 2019.

“In the past, we (holding companies of banks) didn’t need to observe the capital ratios at the group level. With the new concept paper, we have to observe them,” he says.

“Stricter capital requirement is also a reason driving mergers and acquisitions in the local banking scene. When capital needs become higher and competition goes up, ROEs (returns on equity) come under pressure … scale makes a difference.”

According to the central bank’s paper, FHCs will need a common equity tier 1 (CET-1) ratio of 4.5%, core ratio of 6%, total capital ratio of 8% and a counter cyclical buffer — a capital conservation buffer of 2.5% of total risk-weighted assets. The ratios are in line with the Basel III requirements that banks have to adhere to.

A banking analyst notes that some of the FHCs have been forthcoming with their ratios. “We are not able to calculate the ratios ourselves … We depend on the holding companies to share them with us for now. As at June 30, 2014, the

CET-1 ratio for RHBCap was 9.2% while CIMB was 9.5% and AFG, 10.05%.”  

Prior to the 2019 implementation, Bank Negara is proposing a three-year regulatory submission of the capital position of the FHCs on a consolidated basis, starting from 2016.

“This will allow the Bank (Bank Negara) sufficient time to assess the level of readiness of the financial groups as well as identify any potential transitioning issues,” the discussion paper states.

A banking consultant says one of the biggest challenges for FHCs is when they have subsidiaries in a less stringent capital requirement territory and they would still need to consolidate and abide by the Malaysian rules.

“For example, if the local requirement of the foreign subsidiary is only RM60 million worth of capital in that territory, compared with the RM100 million needed by the FHC in Malaysia, this would mean that the FHC needs to pump in RM40 million. The incremental RM40 million is huge … ROEs will be affected,” he adds.

Bank Negara is in the midst of gathering feedback on the discussion paper.

This article first appeared in The Edge Malaysia Weekly, on November 17 - 23, 2014.

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