Differing capital rules ‘confusing’

Differing capital requirements being set by Nordic financial supervisory authorities will make comparing banks’ capitalisation across the region increasingly challenging, Standards & Poor’s said yesterday (Wednesday).

The rating agency said that Nordic banks’ capitalisation is already strong in a wider European comparison and that it is set to strengthen further as regulators in the region adopt generally stricter requirements under the EU Capital Requirements Regulation & Directive (CRR/CRD IV). While the accumulation of equity capital will probably moderate over the next 18-24 months, issuance of high quality hybrid capital is likely to increase, improving capital ratios by S&P measures, said the rating agency.

However, S&P analysts believe that the bank capital regulatory terrain is becoming increasingly uneven and that “the differing capital requirements proposed in each Nordic country are unlikely to provide investors with a clear and consistent picture of banks’ capital”.

“We think the different requirements and risk-weight floors … will widen existing disparities caused by banks’ application of internal risk weights to exposures,” they said. “As a result, we believe comparing Nordic banks’ capital using regulatory measures will become even more challenging, in a region where banks routinely compete across borders for large corporate clients and regional investors.”

The rating agency noted that the Swedish FSA, Finansinspektionen, has clarified that it expects to implement systemic risk buffers for the four largest domestic banks under Basel II Pillar 1 and Pillar 2 rules, which would result in an additional 5% core equity requirement for these institutions, “a deviation from their Nordic counterparts”.

In Norway, meanwhile, the FSA (Finanstilsynet) is, unlike its European peers, applying increases in capital requirements to transitional Basel risk-weight floors, noted S&P. Once these floors are removed at the end of 2017, Finanstilsynet intends to raise the level of banks’ risk weighted assets for mortgage exposures under Pillar 1, rather than apply risk-weight floors as prescribed under Pillar 2, as the Swedish FSA is doing.

S&P said that CRD IV is being implemented unevenly in the Nordic region, based on core equity ratio and buffer requirements that the Nordic FSAs have recently proposed or introduced.

“Adding to the confusion, Swedish banks operating in Norway will apply higher Norwegian mortgage risk weights in their Pillar 2 requirements, while Danish banks will apply the Norwegian adjustments in Pillar 1,” said S&P.

It said that Norwegian banks’ regulatory capital ratios will be much lower than their Swedish peers’, but that this will reflect mortgage risk weights that are three to five times higher.

“We do not know whether the market, which tends to focus on capital ratios rather than capital requirements, will fully appreciate the reason for, or have the time to adjust to, this disparity,” said the rating agency.

In Iceland, the FSA expects to apply all the capital buffers available under CRR to systemically important banks, said S&P, while in Denmark and Finland the regulators have so far not indicated that they will implement Pillar 1 systemic risk buffers as in the other three Nordic countries.

“Therefore, the banks in those countries will have somewhat lower core equity requirements than in the rest of the region,” said the rating agency. “Denmark’s regulator will apply additional requirements for systemically important banks, differentiating itself by proposing requirements based on the degree of systemic importance.”

S&P considers that its bank capital measure, the risk-adjusted capital (RAC) ratio, enables a more meaningful comparison of capital levels among Nordic banks as it resolves several inconsistencies among regulatory capital ratios across the region.

RAC ratios for Nordic banks indicate that their capitalisation remains stronger than that of their European peers and is steadily improving, according to S&P.

It said that a large part of this improvement will come from a resurgence of Tier 1 hybrid capital issuance, adding that it expects large Swedish institutions to raise Additional Tier 1 capital in the second half of the year, with Danske Bank having already done so in March this year.