NEW YORK--(BUSINESS WIRE)--The recent revision of Panama's bank capital rules is an important step toward Basel III standards, yet falls short of full adoption, says Fitch Ratings. The new rules should strengthen local banks' capacity to absorb losses and maintain higher quality capital, particularly for banks with high-risk appetites within the Panamanian banking system.
Banks with greater reliance on hybrid instruments will likely be more impacted by the changes in the regulation. The new standards are providing banks greater discretion to limit coupon payments on certain hybrids, which strengthens the equity attributes of these instruments. Previously, issuers could only skip dividends on noncumulative perpetual preferred securities if a bank had no earnings to be part of Tier 1. However, under the new rules, skipping coupons may occur even when banks produce earnings. The revised rules push legacy core capital, Basel I Tier 1, qualified instruments into Tier 2 capital.
The new rules incorporate elements of comprehensive income in Tier 1 capital, including unrealized gains/losses on securities available for sale. Incorporating the valuation of investments introduces variability to the regulatory capital position of banks, and, to a greater extent, would impact those entities with more aggressive investment portfolios.
But Panama's revisions do not include Basel III's capital conservation buffer or a countercyclical buffer, which together would materially strengthen capital at local banks. The lack of such provisions makes Panama's current approach an incomplete adoption of Basel III rules, in our view.
A further deviation from Basel III is Panama's permitting the inclusion of loan loss reserves (i.e. Dynamic Reserves) in regulatory capital ratios. While adding Dynamic Reserves will only be permitted after achieving Basel III's common Tier 1, Tier 1 and total capital minimums, these reserves typically inflate ratios by 1.25%-2.5% of the risk-weighted assets corresponding to loans classified as "Normal," the lowest risk category. Panama's inclusion of these reserves in bank ratios began only recently, in September 2014.
Nevertheless, new thresholds for common Tier 1 and total capital are in line with Basel III and should improve banks' loss-absorption capacity. The additional Tier 1 capital component, when combined with the common Tier 1 minimum of 4.5%, must be at least 6.0% of risk-weighted assets. Fitch does not anticipate any of its rated entities being required to strengthen their capital to comply with the new agreement.
Panama is the first country in Central America to incorporate select Basel III rules into their banking regulations. The country follows Brazil and Mexico, which are currently phasing their respective adoptions of Basel III capital requirements. Both Brazil and Mexico are adopting a more complete set of capital rules relative to Panama, including implementing capital conservation and countercyclical buffers. Panama's three-year phase in of the new rules period begins January 2016 and completes January 2019.
The new agreement will have a limited impact on Fitch's analysis of rated entities' capital adequacy. Fitch considers loan loss reserves as loss-absorbing, regardless of accounting classification. Fitch's primary capital measure is Fitch Core Capital, which already excludes all hybrid capital instruments. However, Fitch Eligible Capital includes hybrid capital instruments to the extent that they receive 100%, 50% or 0% "equity credit."
For more details on Fitch's criteria for evaluating hybrid instruments, refer to "Assessing and Rating Bank Subordinated and Hybrid Securities Criteria" (Jan. 31, 2014).
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.