Regulation: Chile to adopt Basel III

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By:
Rob Dwyer
Published on:

Implementation of global standard will lead to higher tier-1 capital levels; banks well capitalized but predictions of sovereign downgrades cloud outlook.


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The impact of Chile’s move to adopt Basel III as the central part of a drive to modernize its banking law should be “manageable”, according to one analyst of the country’s banks.

In mid-June, the Chilean government confirmed it would send a bill that would “gradually” implement Basel III rules. The bill, which will update the current banking law dating from 1986, will also replace the country’s existing banking supervisor with a new, more powerful Financial Markets Commission (CMF).

Adopting these standards in Chile is essential to ensure our continued financial integration with the rest of the world,” says a statement from the central bank alongside the announcement of the policy.

There is no formal timetable for the move.

The main change would see minimum capital requirements increase to at least 15.0% due to an increase in the tier-1 requirement to 6.0% from 4.5%. The total minimum regulatory capital level is proposed to stay unchanged, at 8.0%.

As well as additional tier-1 requirement of 1.5%, the new regulations include a conservation buffer of 2.5% and an anti-cyclical buffer of up to 2.5%. Also, systemically important institutions could see additional capital requirements levied by the new commission on a case-by-case basis.

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Tito Labarta,
Deutsche Bank

Deutsche Bank banking analyst Tito Labarta has analysed the impact of the regulatory change on some of the Chilean banks and says he doesn’t expect any significant short-term impact on the banks under his coverage.

These are Banco de Chile and Santander Chile – which will likely be classed as systemically important. Both have relatively strong capital ratios and high returns on equity.

“However, an excessive systemically important capital buffer – ie greater than 1% – could be a potential risk … in which case their ability to distribute dividends could be impacted, particularly given their historically high payout ratios of at least 60%, and above 2.0% the banks could need additional capital,” Labarta says.

He points out, however, that the law proposes a gradual implementation of the new regulations, which would be likely to take these issues into account. Banco de Chile has a tier-1 ratio of 10.8% and a capital ratio of 13.9%, while Santander Chile is at 10.8% and 13.7%, respectively.

As such, both banks appear to be well capitalized and above the minimum requirements.

The proposed law would incorporate the current financial oversight regulatory body (SBIF) into a more powerful organization, the CMF, with the government indicating that the current roles and responsibilities of the SBIF would be strengthened by the integration.

Meanwhile, recent system data released by the SBIF show a benign backdrop for the banks to begin preparing for any increase in tier-1 regulatory capital.

The banking system saw net income rise by 20% in May (up 3% year-on-year), while return on equity increased to 15.4% from 12.8% in April (but fell from 15.7% in May 2016).

The results reveal an increase in asset quality – with a drop in provisions and a 5 basis point improvement in system non-performing loans to 1.94% – combined with a small increase in fees that offset flat net interest income and lower trading gains.

Total loans for the system were flat sequentially, as weakness in corporate loans (–1% from April 2017 and up 2% year-on-year) offset a mild growth in consumer lending (a 1% month-on-month increase and up 9% year-on-year).

Negative rating

However, this favourable macro-environment could become challenging nearer to the implementation of Basel III. Two rating agencies have recently revised Chile’s sovereign credit rating outlook to negative from stable as the country’s fiscal deficit and debt-to-GDP ratio have increased.

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Brent Harrison, IIF

According to Brent Harrison, an Institute of International Finance (IIF) research analyst who was lead author of report Credit Downgrade Looms, this balance sheet downturn has been compounded by one of the lowest growth rates among the country’s peers. The government projects GDP growth of 1.5% in 2017.

Last year was the first year since 2004 that the country’s gross debt was higher than its savings, causing Chile to lose its net creditor status. The country’s fiscal position has worsened since the global shock in 2008, with Chile’s ratio of debt to GDP on an upward trend.

The central government’s debt is now more than 500% larger than it was in 2007 and the fiscal deficit expanded to 3.2% of GDP in March 2017 – from 2.8% at the end of 2016 – due to increases in spending on education and health that continue to exceed revenue gains from tax reforms enacted in 2014.

Those reforms appear to be a key factor in the deteriorating fiscal position. At implementation, the government had aimed to increase tax revenues by 3% of GDP to finance spending increases and reduce fiscal deficits.

Neither of these objectives has been achieved and this increases the country’s exposure to a potential copper price shock that could lead the government to increase sovereign support of state owned companies such as Codelco, which would add further strain to the public finances.

The IIF report’s conclusion is blunt: “We believe the combination of perennially low growth rates and rapid balance-sheet corrosion will lead to a downgrade in Chile’s credit rating, within investment grade, this year or next.”