Korean banks making the most of Basel III window

Cheaper regulatory capital has been raised.

According to Fitch, Korean banks are making the most of the delayed implementation of Basel III by raising cheaper regulatory capital.

Fitch Ratings considers elements of the current fund-raising initiatives as pre-funding, as banks recognize the likelihood of increased costs of issuing Basel III-compliant capital securities amid continuing investor uncertainty about risk-pricing and the Point of Non-Viability (PONV). PONV is the point where a bank is deemed to have failed.

Here's more from Fitch Ratings:

Basel III implementation for Korean banks has been postponed to December. As a result, issuance activity in the current quarter, comprising old-style Basel II securities, has remained busy, driven by both refinancing needs as well as pre-funding for next year. Issuance has been supported by a couple of reasons.

First, banks have substantial capacity for issuing securities - along with refinancing maturing securities - which has been under-utilised in the past relative to regulatory caps.

Second, the investor base for such non-core capital is predominantly domestic, familiar with these investments, and with established pricing and liquidity norms.

In contrast, elsewhere in Asia where the Basel III regulatory framework is now in place there is currently considerable investor uncertainty about the Basel III-compliant securities. Established market norms are still evolving with respect to each regulator's stance around loss-absorption triggers, the means of loss-absorption, and the level of regulatory capital buffers.

Investor concerns were highlighted in our recent survey of Asia-Pacific senior investors, where 65% of the respondents cited uncertainty about loss-absorption triggers of Basel III capital instruments as an issue. Moreover, risk-pricing and secondary market liquidity were other areas of significant concern.

These issues, together with the window available to Korean banks, means that it makes sense to stock up on such old-style (Basel II) instruments, especially as newer (Basel III) instruments are likely to prove more costly and (initially) more difficult to issue.

In particular, the yields on subordinated debt remain low, and a pick-up in Basel II sub-debt issuance by Korean banks reflect an attempt to lock in the benefits of cheaper regulatory capital.

Korea's contingent capital requirements and loss-absorption trigger points have been proposed; and the PONV for Tier 2 instruments, per Basel III rules, is in the process of being finalised. Current proposals suggest the likelihood of explicit triggers being defined in the regulations. If this happens, it would be a departure from the rest of the APAC region and would help address one of the main concerns for investors.

PONV may be triggered earlier at the discretion of the regulator, but capital triggers may help stabilise risk-pricing early on after the introduction of Basel III, and potentially pave the way for smoother issuance of new-style capital instruments.

The upshot of all this is that Korean banks are stocking up on legacy Tier 2 instruments amid the window of opportunity offered by a delay in the timeframe for the implementation of Basel III. This does not have any near-term credit implications for the banks themselves. But it does highlight the uncertainty confronting both issuers and investors amid the ongoing tightening of capital adequacy standards.