April 20, 2017 / 3:30 AM / 8 months ago

Fitch: IFRS 9 Provisions Won't Hit Hong Kong Banks' CET1 Ratios

(The following statement was released by the rating agency) HONG KONG/LONDON/SINGAPORE, April 19 (Fitch) Migration to IFRS 9 - the new international expected credit-loss loan-impairment standard - in 2018 is unlikely to significantly affect Hong Kong banks' regulatory capital, says Fitch Ratings. This is because banks can draw on regulatory reserves for unidentified expected future losses (RR), which the Hong Kong Monetary Authority (HKMA) has said should be large enough to absorb the likely increase in loan loss provisions that will be required under IFRS 9. There will still be an impact on banks through lower profits and Fitch Core Capital (FCC) ratios. IFRS 9, termed HKFRS 9 in Hong Kong, is likely to lead to greater provisioning and earlier recognition of credit losses. It will have an impact on banks' financial statements and, in many countries, regulatory capital. However, Hong Kong banks' common equity Tier 1 (CET1) ratios are unlikely be affected by IFRS 9. A recent survey on a sample of locally incorporated banks conducted by the HKMA showed that their collective provisions and RRs should together exceed new loan-loss provisions required under IFRS 9 - in some cases substantially. It is not clear if the survey covered the impact of IFRS 9 on security holdings, but we do not expect this to be significant for most banks. The RR is a regulatory capital deduction designed to cover expected credit losses, and therefore bridges the gap between IFRS 9 and a purely incurred loss approach. The HKMA sets bank-specific target rates for general loan-loss reserves based on banks' historical losses and other loan portfolio characteristics. This then splits into collective impairment allowances and the RR, which at our rated banks ranges from 0.7%-1.5% of total loans or 0.5%-1.3% of risk-weighted assets (see chart). <iframe allowfullscreen src="//e.infogr.am/regulatory_reserve_provides_cushion_against_i frs_9_impact?src =embed" title="Regulatory Reserve Provides Cushion Against IFRS 9 Impact" width="550" height="643" scrolling="no" frameborder="0"> We include the RR in Fitch Core Capital (FCC) - the main measure that we use to assess banks' capital adequacy - as it is available to absorb future losses. The inclusion of the RR is one reason why our FCC ratios generally exceed CET1 ratios for Hong Kong banks. FCC is likely to decline upon IFRS 9 implementation as banks increase collective allowances and their RR falls. Such a re-designation of loss-absorption buffers would not in itself lead to rating action. The impact of IFRS 9 on Hong Kong banks' profits should be no different from most other banking systems, as we expect that the initial increase in specific and collective loan provisions will hit banks' profits. IFRS 9 will also add to P&L volatility over the credit cycle by design, as expected credit losses will fall during cyclical upswings and rise during downswings. Proposals published by the HKMA last week suggest that it will maintain a bank-specific minimum requirement for general provisions, and - when this is higher than IFRS 9 requirements - banks will continue to hold the excess as an RR. The HKMA has argued that this is necessary to ensure prudence, as well as to allow for potential implementation problems and the greater managerial judgement involved in calculating provisions under IFRS 9. The proposal also states that the element of the requirement that is already captured under the counter-cyclical buffer regime will be released in between 2016 and 2019. Contact: Sabine Bauer Senior Director Financial Institutions +852 2263 9966 Fitch (Hong Kong) Limited 19/F Man Yee Building 68 Des Voeux Road Central Hong Kong Monsur Hussain Senior Director Financial Institutions +44 20 3530 1793 Dan Martin Senior Analyst Fitch Wire +65 6796 7232 Media Relations: Leslie Tan, Singapore, Tel: +65 67 96 7234, Email: leslie.tan@fitchratings.com; Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com. The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings. ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. 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