Банкеръ Weekly



Shareholders in most domestic banks should again forget about getting dividends in 2007. This is happening for the first time in recent years. Financial institutions such as DSK Bank, United Bulgarian Bank (UBB), and Societe Generale EXPRESSBANK, which had been traditionally distributing dividends, refrained from doing that in 2006. And the reason was not their bad indicators for 2005. On the contrary, all the three banks reported record high profits, but none of them gave a single penny in dividend, and the entire positive financial result was set aside as reserves in their equity capital. That was done due to the sharpened competition between banks for winning market shares, and launching more and more loans was the most powerful means for achieving that. Hunger for financing was particularly great among citizens. For that reason banks' efforts were directed to consumer and mortgage credits. But according to BNB's regulations, which copy international requirements about capital adequacy almost word for word, the volume of extended loans may not go up without raising the equity capital at the same time. And the equity capital comprises of several components: shareholder capital, reserve funds, and undistributed profit. Bankers know that ratio is regulated by an indicator which is the most important one when a bank's stability is concerned. This is
the capital adequacy coefficient
In most countries worldwide, especially in developed industrial countries, this coefficient is 8 per cent. It is calculated on the basis of two components. The first one is the equity capital, and the second one is the general risk component, which is the sum of the quantitative expression of risks, connected with all receivables of a certain bank - from its deposits in other financial institutions (their risk is evaluated at 20-50% of the aggregate amount of the investment), to the credits (whose risk is evaluated at 50-100% risk of the size of extended loan). The equity capital is divided by the general risk component in order to calculate the capital adequacy coefficient, which is at least 12% for Bulgaria as per effective regulations in this country. The higher coefficient was introduced back in mid-1997 with the motive that the stricter requirements in that respect would raise the discipline in the banking sector and protect it from new serious crises. Nine years later that argument is valid no more. Within the passed period banks managed to prove they were undertaking the necessary measures in order to guarantee their stability. Nevertheless, with the introduction of the new capital adequacy requirements, known as
Basel II
the high coefficient will be maintained. However, the arguments are different this time. Experts from BNB's Bank Supervision department believe that if they reduce the capital adequacy coefficient from 12% to 8%, that would make pointless all currently efficient measures for restricting credit growth.
Restrictions will be eliminated as of January 1, 2007 but we hope to counteract the headlong increase of loans by the 12% capital adequacy coefficient and by maintaining the current risk weight for consumer credits at 100%, which are higher than projected in Basel II, Peter Andronov, Director General of BNB's Bank Supervisions department, told a reporter from the BANKER weekly in an unofficial conversation not long ago.
The introduction of the new requirements will force banks not only make sizable additional expenses, but also set aside additional capital for covering some new risks, such as
the operational risk
which should take into consideration the potential possibilities of losses in case bank info systems are blocked, as well as in case of mistakes or abuse on the part of employees; thefts, robberies and any such accidents. In line with the style of Basel II drafted procedures, that risk is calculated according to many indicators and quite complex equations. According to some bank heads, its covering will swallow a considerable part of the financial institutions' equity capital. Bank managers do not want to be quoted regarding that issue as they fear their clients might get a wrong impression about the respective credit institutions' stability. One of them, however, a CEO of one of the four biggest banks in this country, pointed out flat his institution would have to set aside its entire 2006 profit as reserves and raise its equity capital in order to meet all requirements of Basel II and maintain the possibility for credit growth. According to him, the bank's capital adequacy ratio is a little above 13 per cent now. After covering the operational risk its adequacy ratio will drop below 12% and its equity capital should be raised in order to satisfy the requirements of Ordinance No 8.
The executive director of another big domestic credit institution said that meeting the above-mentioned requirements is a problem to all banks which count on their development on the credit market. A considerable part of the positive financial result for 2005 will be spent to cover the risks under Basel II. The balance will be swallowed by
the upgrading of Bulgarian banks' info systems
to the new requirements for appraisal of individual clients' solvency. In fact, that is the most essential part of the banks' preparations for the introduction of the Basel II standards. The new Ordinance No 8, which BNB's Board of Governors approved on principle a month ago, stipulates two models of evaluating risk. One of them is the so-called standardized model where all calculations have been strictly set by the BNB and will be applied by each bank. The second one is the so-called internal model where each credit institution offers to the BNB its own proposal for evaluation of individual assets' risks, including in it all undertaken measures and operations for reduction of risk, e.g. more and higher guarantees, hedging schemes, etc.The application of the internal model principally enables banks to evaluate many of the extended loans (mostly to corporate clients) by a lower degree of risk and that results in raising their general potential for launching credits.
However, the introduction of the internal model for risk evaluation creates danger that the data which banks send to the BNB might turn out partially or completely incompatible, because each financial institution will be calculating them according to its own specific way. As a result of that the BNB might be unable to get a clear picture of the risk profile, or in other words - a picture of the financial situation of the entire sector. And the central bank's Board of Governors makes its all important decisions, e.g. the growth of credits, the mandatory minimum reserves, the degree of provisioning, etc. on the basis of that picture.
There is still one more problem. In order to apply the above-mentioned internal model banks should have a 5-year database for each of their clients. Moreover, it should be drafted in accordance with the requirements of the Basel standards. Not a single credit institution in this country has such info archives at present. Therefore, the BNB has imperatively recommended to Bulgarian banks to adopt the standardized model for risk evaluation. This means that all credit institutions will be obliged to change their info systems in order to introduce the requirements of that model and make considerable expenses which will be different for each bank as they depend on the number of clients and the volume of effected operations. Moreover, credit institutions' managers are not inclined to make public exact figures, connected with the various improvements of their info systems. However, the money which banks spend for the fulfilment of all requirements imposed by Basel II are evident in their expenditures for maintenance. In end-August 2006 they amounted to BGN202.6MN, up BGN20MN from a year earlier when banks also spent sizable amounts for the introduction of the IBAN international code for current accounts. Thus, as long as there are significant transformations connected with the observation of international standards, banks' profits will continue to sink in the purchase of new financial software and dividends will remain a dream.

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