UK: A Rethink Of Capital Requirements For Asian Banks?

Last Updated: 10 December 2008
Article by Lea-Anne Lee

The current financial crisis has placed pressure on banks in the US, Europe and the Asia Pacific region to review the structure of their businesses as well as their compliance with global standards. Bail out packages have been passed by governments in all three regions (albeit to varying degrees) in order to boost financial sustainability. The level of implementation of international financial standards is also coming under review, as governments and market commentators consider whether more stringent regulatory requirements are necessary.

Given the nature of the financial crisis and the risks it has highlighted, one of the key compliance issues to be addressed by regulators and banks is the level of capital reserves that banks should be obliged to keep. This briefing brings into focus this particular element of the suite of regulatory conditions that banks may be required to satisfy in order to weather the present storm. As the briefing acknowledges, banks in the Asia Pacific region may benefit from a privileged position compared to their peers in other parts of the world.

Bail out measures

In the global financial turmoil that began in the second half of 2007, the world has seen the failure of big names in the banking industry, including Bear Sterns and Lehman Brothers. Faced with what commentators have called the worst economic crisis since World War II, governments have acted to save their countries' financial systems, often by acting to save distressed banks. The US government has pledged about US$172bn out of a total US$250bn to a wide variety of banks and financial institutions, such as Goldman Sachs, Citigroup and JPMorgan Chase, including by way of subscription for preference shares1. The UK government has also announced a capital injection of £37bn into the nation's major banks: £20bn into RBS and £17bn into HBOS and Lloyds TSB upon their successful merger. As a result, the banks will be partially nationalised; the government will have a 60 per cent stake in RBS and a 40 per cent stake in HBOS and Lloyds TSB. In continental Europe, the French government is injecting €10.5bn into the top six banks in the country and ING will receive €10bn from the Dutch state. The governments of other European countries such as Germany, Italy and Spain have also injected money into banks operating in those countries.

Bail out measures have also been announced in a number of countries in the Asia Pacific region, including Japan, Australia, South Korea, China and HK. In China, it is reported that economic stimulus measures worth RMB4,000bn (US$586bn), a sum which represents about 15 per cent of gross domestic product, will be taken over the next two years. As noted in BusinessWeek, the measures will be 25 per cent financed by central government and 75 per cent financed by provincial authorities, corporate investors and bank loans, and they will include massive spending on infrastructure, tax rebates for exporters and increased aid for the rural economy. Despite the broad scope of the measures, they do not appear to encompass the injection of new capital into banks. In Hong Kong, on the other hand, the Hong Kong Monetary Authority (HKMA) has taken steps to ease banks' short term funding pressures and provide assurances to the market about the availability of liquidity. As reported by Hong Kong's Information Services Department, until the end of March 2009 the HKMA will lend money for up to three months to individual licensed banks against collateral of acceptable credit quality and at a lower interest rate compared with the interbank rate. Chief executive Donald Tsang has also announced in his 2008/09 policy address that the HKMA will review and strengthen the supervisory framework for liquidity risk management of authorised institutions and will revise the methodology for calculating capital adequacy ratios in accordance with the latest international guidelines.

Challenges for the banks

The reason for the above bail out measures is of course that national banking systems are facing a number of challenges, of which three are explained in the Economist dated 11 October 2008. The first is one of solvency, as banks are struggling to replenish capital after suffering major losses. The second relates to long-term funding, as banks have not been able to borrow in the longer-term paper markets and have found it difficult to finance the share of their assets not covered by deposits. And third, there is a short-term liquidity problem. Banks have been cut off from their main source of liquidity as short-term money markets have been effectively closed. To address these inter-related issues, which the Economist has labelled a 'three-headed monster', various governments have committed taxpayers' money in order to recapitalise financial institutions. This will certainly improve banks' capital position, which is chiefly indicated by their capital adequacy ratio (CAR) and 'Tier 1' capital ratio, as discussed below.

Capital adequacy ratio and Tier 1 capital ratio requirements

Before 1988, there was no standard definition of capital. As central banks used different definitions of the term, it was difficult to compare the financial position of banks in different countries. In order to provide a level playing field, the concept of capital for regulatory purposes was standardised in the first Basel Capital Accord (Basel I). Basel I was formulated by the Basel Committee on Banking Supervision (the Basel Committee) at the Bank for International Settlements (BIS), an international organisation formed in 1930 to foster international monetary and financial co-operation and to serve as a bank for central banks around the world. Based on deliberations by these central bankers, Basel I provided a set of minimal capital requirements for banks whereby banks' assets are classified according to credit risk. Basel I has been widely adopted by over 100 countries, however it is now seen as outmoded compared to the more comprehensive second accord (Basel II), which was adopted by the Basel Committee in June 2004.

The two Basel accords make use of a bank's CAR, the ratio of a bank's capital base to its exposure to various risks, and a bank's different 'tiers' of capital as classified by reference to the capacity of each tier to absorb losses2. Tier 1 (core) capital mainly consists of ordinary shares, irredeemable non-cumulative preference shares and disclosed reserves. Tier 2 capital mainly consists of subordinated debt and hybrid capital instruments. As Tier 1 capital is the 'highest' form of capital, the Tier 1 capital ratio has been called the 'purists' measure' of the cushion protecting against unexpected losses. Under the Basel accords, banks' benchmark Tier 1 capital ratio is 8 per cent. However, the Wall Street Journal has reported that according to UK analysts banks need to raise their Tier 1 capital ratio to 9-10 per cent in order to create an adequate buffer against future losses. The Economist has noted that a number of European banks, including RBS and Crédit Agricole, have recently raised their Tier 1 capital targets in preparation for a harsher economic climate and more stringent requirements by regulators.

In recognition that capital adequacy and Tier 1 capital requirements cannot be considered in isolation, Basel II incorporates the following three more holistic 'pillars'.

  • Pillar I comprises a set of rules for calculating the CAR and Tier 1 capital ratio, taking into account operational, credit and market risks. A minimum CAR of 8 per cent is prescribed under Basel I and II, as mentioned above, however there is no minimum requirement for the Tier 1 capital ratio.

  • Pillar II prescribes sound internal processes for the assessment of capital adequacy and risks that are not covered under Pillar I. When assessing capital adequacy, financial institutions are required to consider their position in the business cycle. They can hence prepare for a downturn by building up higher levels of capital in good times. There is also a supervisory review process.

  • Pillar III provides for enhanced market transparency and discipline, supplementing the supervisory effort that forms part of Pillar II. Pillar III relates primarily to the disclosure of risk profiles, capital adequacy and risk management.

Basel II improves on its predecessor by taking account of a wider range of risks and differentiating between the risks presented by different borrowers. Moreover, Basel II offers scope for flexible application, as it allows banks to implement it in a manner suited to the degree of complexity in their operations. There are three levels of compliance with Basel II: a standardised approach and two internal ratings-based (IRB) approaches, foundation and advanced. Furthermore, Basel II comprises more risk-sensitive capital requirements and provides incentives for better risk management and a more effective supervisory framework. For all of these reasons, Basel II has been well-received. According to a 2006 survey by the Financial Stability Institute, about 100 countries planned to apply Basel II within a few years of its introduction. In the European Union, member states implemented the standardised approach in 2007 before moving on to the more advanced IRB approaches in January 2008. The US is planning to implement the advanced approaches in mid-2009. In the Asia Pacific region, Basel II has been adopted to varying extents. In addition to the countries listed in the table below, other Asian countries that introduced Basel II during 2007 and 2008 include the Philippines, India, South Korea, Malaysia, Thailand and China.

Implementation of Basel II in some Asia Pacific countries3


Credit risk (standardised approach)

Credit risk (advanced approach)


January 2008

January 2008


January 2007

January 2007


March 2007

March 2008

South Korea

January 2008

January 2008


January 2008

January 2008


January 2007


In Hong Kong, the policy framework developed by the HKMA largely comprises the advanced approach to Basel II. Hong Kong's early adoption of such a framework will hopefully help it to cope as well as possible with the financial crisis. Indeed, the HKMA framework already provides the further and more urgent international recommendations that are now being made in other jurisdictions in order to improve the resilience of banking systems and to strengthen capital and liquidity requirements and risk management practices. In China, the China Banking Regulatory Commission (CBRC) issued guidance on the implementation of Basel II on 28 February 2007, followed by further guidelines on 18 September 2008 concerning monitoring requirements and technical specifications (eg in relation to capital measurements, risk disclosure requirements, internal rating systems, specialised credit ratings, management of credit risks and operational risk requirements). Large Chinese commercial banks with overseas branches or many offshore businesses are required to comply with Basel II from as early as the end of 2010, although with possible postponement until 2013. Other commercial banks, including branches of foreign banks in China, may implement the current Chinese capital supervision provisions and obtain approval for compliance with Basel II from the end of 2011.

According to the Measures for Management of Capital Adequacy Ratios of Commercial Banks, which have been in place since 1 March 2004 (and amended on 3 July 2007), the CAR of commercial banks in China should be at least 8 per cent and the Tier 1 capital ratio should be at least 4 per cent. It is reported in the 21st Century Economic Report and the National Business Daily that: (i) in September this year, the CBRC raised the minimum CAR of small and medium sized listed commercial banks to 10 per cent and the minimum Tier 1 capital ratio to 5 per cent; and (ii) next year, it is expected that a CAR of at least 12 per cent and Tier 1 capital ratio of at least 6 per cent will be required for such banks. These increased capital ratio requirements may have been made in response to the financial crisis. However, according to the First Financial Daily and the China Securities Journal, an official at the CBRC has stated that the new requirements constitute guidance rather than compulsory requirements. It nevertheless appears that the CBRC can require individual banks to conform to specific standards, as the 21st Century Economic Report states that an employee at Everbright Bank China has confirmed that the CBRC required the bank to maintain a CAR of above 9 per cent from the end of 2008.

As the above discussion shows, important steps towards full implementation of Basel II are occurring in the Asia Pacific region. Overall, it appears that the application in the Asia Pacific region of the standards set out in Basel II is keeping pace with that in the US and Europe – although enforcement may possibly be lacking. However, a different picture emerges in respect of recapitalisation efforts.

The Asia Pacific region: a different picture

Compared with the US and Europe, the extent of recapitalisation efforts in the Asia Pacific region is not yet fully clear. Concerns have been expressed regarding the balance sheet strengths of Asian banks and the stance of local regulators in respect of Tier 1 capital ratios, with some market commentators asking whether Asian governments should require Tier 1 capital ratios to be kept at a certain level as part of their bail out and economic stimulus packages. As reported in the Financial Times, however, the average Tier 1 capital ratio and CAR of banks in the Asia Pacific region stood at 10.16 per cent and 13.19 per cent respectively in 2007. These ratios are considerably higher than those of the banks' American and European counterparts. In fact, it is reported that the ratios currently remain at a reasonable level in most countries in the Asia Pacific region despite some slight declines due to more stringent calculations under the Basel II framework. As a result, Alistair Scarff, head of Asia Pacific financial institutions research at Merrill Lynch, has reportedly stated that 'The financial health of Asian banks is very different to that of a decade ago. From my vantage point, no bank in Asia faces having to recapitalise to shore up their balance sheet at this stage.' The answer to the above question concerning Tier 1 capital ratios therefore seems to be that currently there is no pressing need to impose a minimum requirement on Asian banks. In other words, the existing Basel I and Basel II commitments, where implemented and imposed on banks in Asia, may be sufficient for the time being.

One explanation for the different situation in Asia compared with the US and Europe is that Asian banks may not face all the same problems as their American and European peers. For instance, while the extent of global exposure to sub-prime lending remains unclear, it appears that Asian banks may be less exposed than US and European banks. Whatever the cause of recent losses, however, the Financial Times has reported that of the US$500bn written off by banks in January to August 2008, write-offs by Asian financial institutions accounted for only about 5 per cent whereas the 23 banks in the world with the most asset write-downs and credit losses are all North American and European. In fact, not only have Asian banks managed to avoid large write-downs during the current climate, they have also accumulated profits. In the second half of 2007, amid the US sub-prime crisis, the aggregate net profit of the 300 largest banks in the Asia Pacific region increased by 37.5 per cent. The Financial Times has indicated that these impressive results may be attributed to improvements in various aspects of the banks' business after the 1997-98 Asian financial crisis, as well as improved creditworthiness due to banks' requirements for better asset quality, enhanced risk management, concerted regulatory efforts and strong growth in core businesses supported by solid economic growth.


George Soros recently espoused his theory before the US House of Representatives' Committee on Oversight and Government Reform, that markets do not tend towards equilibrium but are instead inherently stricken with a defect he calls 'reflexivity'. This defect is due to distorted views of market participants and biased market conditions, which tend to reinforce trends and create bubbles such as the recent housing bubble. Soros argues that regulation is necessary to prevent the natural creation of such bubbles. He notes that bubbles cannot be controlled purely by monetary means, therefore additional tools must be used such as variable margin requirements and minimal capital requirements to control the amount of leverage that market participants may employ. Soros's perspective provides persuasive support for the idea that further financial regulation is a necessary component of a never-ending search for an optimum market equilibrium.

If one accepts Soros's argument that it is time for the pendulum to swing back from relative financial deregulation toward greater regulatory oversight, then one is likely to agree that banks should be a key target of such increased oversight. This briefing paper has discussed banks' capital reserves, which constitute a key indicator of financial condition and thus cannot escape the regulatory gaze. In the present circumstances, it seems wise to promote full implementation of the existing international standards regarding banks' capital position. Further capital requirements in addition to Basel I and Basel II may also be necessary, and will no doubt be introduced in due course. As Michel Tilmant, the chief executive and chairman of ING, is reported by the New York Times to have said, 'market conditions have changed dramatically in recent weeks and have led to an internationally recognised belief that going forward, in this market environment, capital requirements for financial institutions should be higher.'

While regulatory action in respect of banks appears more critical to some countries' financial systems than to others, it seems likely that concerted global efforts that are swiftly applied would be beneficial to all. So far banks in the Asia Pacific region may not have been hurt as badly as those in other regions by credit losses in the current downturn, possibly because of the quality of their assets. Nevertheless, looking ahead, it would seem prudent for banks in this region to strive to maintain the strongest possible capital position. Regulators may assist by requiring effective implementation of Pillar II of the Basel II regime, which adds a layer of supervisory judgment to the more rule-based Pillar I. Effective supervisory judgment is likely to play a particularly key role as an alarm bell to signal potential problems. As Mr David Carse states in his review of the HKMA's policy framework on banking stability, 'The broad thrust of the international supervisory initiatives is, in a sense, a return to basics – focussing on strengthening capital and liquidity requirements and risk management practices.'


1 Source of these and other data in this paragraph: the Financial Times.

2 There is also Tier 3 capital under Basel II. 'At the discretion of their national authority, banks may also use a third tier of capital (Tier 3), consisting of short-term subordinated debt ... for the sole purpose of meeting a proportion of the capital requirements for market risks.' Annex 1a, Basel II – comprehensive version.

3 Source: Banking on More Capital, Finance and Development (a quarterly magazine of the IMF), and the website of Financial Supervisory Commission (Taiwan), available at

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

In association with
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.