It is a truth universally acknowledged that banks in Asian emerging markets are in need of capital. On one level, this statement is a testament to the dynamic growth of Asian economies and the role of capital in fuelling consumer-driven businesses, infrastructure projects, and educational institutions – amongst others. On the other hand, it points to the lack of predictable capital market funding in these emerging economies. The regulatory dimension to this statement, however, cannot be ignored, as capital market funding is predicated on a sound regulatory structure. Regulators in Asia are forging ahead to drive banks into compliance with the ever evolving Basel Accords which seek to harmonize global banking standards with respect to credit, market, and operational risk.

Against this regulatory backdrop, banks are looking to raise additional capital as efficiently - and creatively - as possible. Bancassurance distribution agreements, under which insurers leverage a bank's customer network to distribute insurance products, have become key products in emerging markets. These structures enable banks to earn revenue from sources other than lending and may enable them to ultimately book this revenue as retained earnings so as to boost capital.

Many emerging economies in Asia have insufficient liquidity in the local market to meet the insatiable capital demands of larger banks, requiring the banks to turn to international investors to raise capital. This presents its own challenges given that certain jurisdictions - such as Vietnam - impose foreign ownership limits on equity in banks (30 percent aggregate cap on foreign ownership in Vietnamese banks with single investor ownership caps of 20 percent for strategic investors and 15 percent for other institutional investors). Emerging Asian markets often feature bureaucratic regulatory procedures for foreign investors to become significant shareholders in a bank. Moreover, in the Vietnamese context, stronger banks are being instructed by regulators to absorb weaker banks through merger, further straining their capital base.

This article will review subordinated long-term debt constituting Tier 2 Capital in three Asian markets that are culturally and geographically distinct from one another: 1) Vietnam, 2) Mongolia, and 3) Sri Lanka and explore the practical negotiation and deal hurdles on transactions in those markets.

The Basics: The Basel Accords

The Basel Accords constitute a series of three banking regulations agreed in 1998 (Basel I), 2004 (Basel II) and 2013 (Basel III) set by the Basel Committee on Bank Supervision (BCBS), which provides recommendations on banking regulations in regards to capital risk, market risk and operational risk. A brief overview of the BCBS approach to credit risk is important to understanding the importance of Tier 2 Capital subordinated debt financing and the different approaches taken across jurisdictions.

The Basel II Accords were introduced to stem the perception of poor risk management practices in international banking, and to ensure the liquidity of credit institutions by defining minimum levels of capital.

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Originally published 8 October 2018

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