jaydee wongwatthanaroj basel iii: a need for thai banks ...608296/fulltext01.pdf · jaydee...
TRANSCRIPT
Jaydee Wongwatthanaroj
BASEL iii: A need for Thai Banks and
the increase of Capital level
Business Administration
Master’s Thesis
30 ECTS
Term : Spring 2012
Supervisor: Dan Nordin (Ph.D.)
Acknowledgement
I would like to firstly thank to my supervisor, Dan Nordin (Ph.D.), for the provided suggestions and
guidances, as well as other professors in Karlstad University, whose advice and comments stimulate the
multiple ideas on this paper. I wish to say special thanks to financial stuffs working on Bank of Thailand
for providing the useful recommendation and information. Last but not least, I would like to thank to all
of my friends and family who always kindly give me the encouragement, cheerful support and
consultation on my paper. This thesis would have not been finished without you guys. Lastly, the
gratitude goes to Karlstad University for giving me the great opportunity to study the various
knowledgeable courses. Thanks for the wonderful experiences in Sweden.
Jaydee Wongwatthanaroj
Abstract
The international banking regulation is known as “Basel” firstly released in 1988 to sound the banks. It
has been improved for two versions, and now is called “Basel iii regulation”. This regulation ensures the
soundness of the banks by focusing on the increase of capital level. Yet, it comes with several draw
backs, especially with the decrease of banking profitability. The regulation is, of course, worth
implementing on the banks attending in the high risk financial transaction, but How about the banks
taking in the lower risk? Like the banks in emerging countries.
Therefore, the purpose of this paper is to find out if the banks in emerging countries really need this
regulation or not. This paper takes different banks in Thailand, which are Bangkok Bank, Siam
Commercial Bank, KrungThai Bank, Bank of Ayudhya and Kasikorn Bank as the case study. Furthermore,
I extend the study to see the effect for the increase of capital level in term of lending spread on Thai
banks in order to maintain Return on Equity (ROE). The research has been analyzed by introducing the
Thai current banking situation from 2009 -2011 as the finding. These are compared and discussed with
the pillars of Basel iii regulation, which has been divided into new minimum capital level, leverage ratio
and liquidity standard, and also calculated to see the lending spread effect via the equations provided by
Bank for International Settlements (BIS).
Finally, the result shows that Thai banks hold low-risk financial instruments and also have a high level of
capital. Thus, there is no need for Thai banks to adopt all main regulations from Basel iii. Only leverage
ratio that Thai banks should consider. For the lending spread, it is found that 0.83% lending spread of
total asset value needs to be increased in order to maintain the profitability, from increasing 1% in
capital level.
Keyword: Basel iii regulation, capital level, liquidity standard, Net Stable Funding Ratio, Available
amount of Stable Funding, risk-weighted assets, leverage ratio, Collateral Debt Obligations, Common
Equity, Total Capital Ratio, Target Standard Ratio, Thailand
Table of contents
Chapter 1: Introductions ....................................................................................................................1
1.1 Research Background .................................................................................................................... 1
1.2 Purposes and Aims ........................................................................................................................ 3
1.3. Thesis organization ............................................................................................................................ 4
Chapter 2: Research methodology ......................................................................................................5
2.1 Research Design .................................................................................................................................. 5
2.1.1 Research Strategy ........................................................................................................................ 5
2.1.2 Research Approach ...................................................................................................................... 6
2.1.3 Case study method ....................................................................................................................... 6
2.2 Data Collection .................................................................................................................................... 7
2.2.1 Primary Data ................................................................................................................................ 7
2.2.1 Secondary Data ............................................................................................................................ 8
2.3 Data Limitation ................................................................................................................................... 9
2.4 Reliability and Validity ........................................................................................................................ 9
Chapter 3: Literature Reviews .......................................................................................................... 11
3.1 Balance Sheet of Banks ..................................................................................................................... 11
3.1.1 Assets ......................................................................................................................................... 12
3.1.2 Liabilities and Equity. ................................................................................................................. 12
3.1.3 Off-Balance Sheet (OBS) ............................................................................................................. 13
3.2 Banking Management ....................................................................................................................... 14
3.2.1 Liquidity Management ............................................................................................................... 14
3.2.2 Asset Management .................................................................................................................... 15
3.2.3 Liability Management ................................................................................................................ 15
3.2.4 Capital Management ................................................................................................................. 16
3.3 Financial Risks ................................................................................................................................... 16
3.3.1 Credit Risk................................................................................................................................... 16
3.3.2 Market Risk ................................................................................................................................ 17
3.3.3 Operational Risk ......................................................................................................................... 18
3.3.4 Systemic Risk .............................................................................................................................. 18
3.4 Basel Regulation................................................................................................................................ 19
3.4.1 Basel i ......................................................................................................................................... 19
3.4.2 Basel ii ........................................................................................................................................ 22
3.4.3 Global Financial Crisis and Basel Regulation ............................................................................. 24
Chapter 4: Theoretical Framework ................................................................................................... 27
4.1 Basel iii .............................................................................................................................................. 27
4.1.1 New level of Capital Adequacy ................................................................................................... 27
4.1.2 Leverage Ratio ........................................................................................................................... 30
4.1.3 Liquidity Standards ..................................................................................................................... 30
4.2 The Impact of higher capital level ..................................................................................................... 31
Chapter 5: Empirical Parts and Findings ............................................................................................ 34
5.1 Capital level situation of Thai banks ................................................................................................. 34
5.2 Leverage ratio of Thai banks ............................................................................................................. 38
5.3 Liquidity ability of Thai banks ........................................................................................................... 39
5.4 The impact of strengthening the capital level in terms of lending spread for Thai banks ................ 40
5.4.1 Lending spread ........................................................................................................................... 40
5.4.2 Structure of financial statements of Thai banks ........................................................................ 41
5.4.3 Estimates of higher capital level. ............................................................................................... 42
Chapter 6: Analysis & Discussion ...................................................................................................... 44
6.1 Basel iii and Financial situation of Thai banks .................................................................................. 44
6.2 The dependence of lending spread measure .................................................................................... 49
Chapter 7: Conclusion & Further research ......................................................................................... 50
7.1 The needs for Thai banks to adopt Basel iii ....................................................................................... 50
7.2 The impact to Thai banks from strengthening capital level in terms of lending spreads ................. 51
7.3 Further research ................................................................................................................................ 51
References ....................................................................................................................................... 53
APPENDIX A: Implementation Timelines. .......................................................................................... 61
APPENDIX B: The calculation of increasing capital level to the lending spread .................................... 61
List of Abbreviations
ASF Available amount of Stable Funding
BAY Bank of Ayudhya
BBL Bangkok Bank
BCBS Basel Committee on Banking Supervision
BIA Basic Indicator Approach
BIS Bank for International Settlements
BOT Bank of Thailand
CCF Credit Conversion Factor
CDOs Collateral Debt Obligations
CET1 Common Equity Tier1
EAD Exposure At Default
ECAIs External Credit Assessment Institutions
EU European Union
KBANK Kasikorn Bank
KTB KrungThai Bank
LCR Liquidity Conversion Ratio
LGD Loss Given Default
NPL Non-Performing Loan
NSFR Net Stable Funding Ratio
OBS Off balance sheet
PD Probability of Default
QIS Quantitative Impact Study
ROE Return on Equity
RWA Risk-Weighted Assets
SA Standard Approach
SCB Siam Commercial Bank
SIFIs Systemically Important Financial Institutions
SPV Special Purpose Vehicles
TCR Total Capital Ratio
TSR Target Standard Ratio
VAR Value At Risk
1
Chapter 1: Introductions
This chapter consists of three different parts, aiming to provide how the research questions have
been contributed and the purpose of this study. The first part is Research Background that
contains of general idea and the historical overview of Basel regulation as well as the link to how
the questions have been developed. Second are the purpose and research questions of this study.
Lastly it ends with how this study is organized on Thesis organization.
1.1 Research Background
Banks and financial institutions are one of the important roles in the economics system. They give an
access of financial transactions for people and corporations that have purposes into the particular
productive activities. Consequently, this leads to the expansion of economics (Rabiul 2010). For this
reason, to reduce the risk of their failure that could happen from the inability to meet demanded
obligations, and to maintain the stakeholders’ trust, there is need for regulations to supervise them.
Bank regulation comes from the concern of creditors, mostly from depositors, related to the risk on the
lending side to meet their obligation (Watanabe 2011).
There are several regulations aiming to sound the risk banks taking, for instance, Solvency ii, Capital
Requirement Directives, etc. However, this paper focuses on the regulation called “Basel Regulation”. It
has been developed by The Basel Committee on Banking Supervision (BCBS). Basel i, the first version of
the framework was released in 1988, and pays attention on the capital adequacy level of the banks.
Capital is the quality assets banks need to save to buffer the unexpected risk (Drumond 2009).
Basel i views domestic currency and government debt as the most reliable assets or risk-free on the
bank, and considers other assets such as, different types of loans to have risk proportionally. These
assets will be calculated via the mathematical model to gain the optimal level of capital requirement for
each bank (Jablecki 2009). After implementing, Basel i had been hugely criticized because of the rough
assessment of risk on each asset, and it cannot cover all viable risk (Jablecki 2009). Years later, the
revised framework, called Basel ii, has been issued to tackle with the previous criticism and 1990s
2
financial crisis. This version improved the way to do risk assessment to be deeper and clearer, and
expanded the covers for all relevant risk as well as the inclusion of incorporate regulations (Docherty
2008). Unfortunately, Basel ii has become a huge issue after the systematical failure of banks and
financial institutions from global financial crisis in 2008. Many researches show that the framework of
Basel ii is not enough and has various flaws to assess the risk due to several reasons, for example, the
troubling with calculating capital requirement, the liquidity asset is not enough, etc (Rosato 2011).
So, in December 2010, BCBS has released Basel iii aiming to fix the flaws of the previous Basel and higher
the resilience of financial system. The latest framework increases the level of capital requirement as well
as higher the proportion of reliable assets. Furthermore, it adds two more standards to ensure the
liquidity of the asset, which is leverage and liquidity ratio (Walker 2011). The implement of Basel iii will
be gradually applied on banks and financial institutions, starting from 2013, until it will be fully
implemented in 2019 (Bank for International Settlements [BIS] 2011A). More detail of implementation
timeline shows in APENDIX A. Due to the challenges of each Bank from different countries and regions,
some have decided to apply Basel iii in their own way, meaning that they adjust some small details with
their own regulations simultaneously whereas, in some countries, for example EU (European Union),
Basel iii is seamlessly applied because of the long-term consistency with Basel ii (Chabanel 2011). Yet,
the coin always has two sides. Basel iii comes with several criticisms for example; weaker banks might
find itself in the tough situation from raising more capital, it takes huge cost to implement, etc (KPMG
2010). The distinctive criticism is the significant pressure on profit and ROE. In December 2010, the
result of Quantitative Study Impact (QIS)i shows that after implementing Basel iii, Group 1 Banks need
the additional capital estimated to be more than €577 billion, and Group 2ii needs about €25 billion to
meet the requirement. This estimation is not even included the cost of skilled employees, new strategies
and so on (BIS 2010A).
Of course, this framework is worth implementing in the countries with the highly complicated financial
transaction like in US, Japan, or UK, which normally comes with high return rates. What about in the
countries that holds less complicated financial instrument or emerging markets? Smith (2012) and Borak
(2011) say Basel iii is not suitable with the emerging markets because the need for additional capital
i QIS is a study conducted by BCBS in order to assess the impact from new requirement related to the capital base.
ii Group 1 Bank is the 103 studied banks that have the Tier 1 capital, further explained in section B of 3.4.1, over €3
billion, and Group 2 Bank is the 109 banks whose Tier 1 capital is lower than €3 billion.
3
requirement could impede the viable economic growth. Santos (2011) argues that the financial
condition of emerging markets already started to face the more and more volatile risk in the market due
to the upcoming investors. But, Euroweek (2011) debates even though emerging markets have higher
risk, it is insignificant comparing to the needs for the growth of GDP to meet with the population
demand and could damage the financial market. Roger and Vitek (2012) clarifies that Banks can raise
capitals from different ways, but they have a tendency to widen the lending spread to gain more capital
rather than decrease the amount of lending or issue new equities. These processes eventually lower the
economic activities.
Therefore, in this paper, I have chosen banking sector in the emerging markets to study if they really
need to implement Basel iii or not. Moreover, I extend my studies to estimate the impact of increasing
the capital level in terms of lending spread on the focal banks. Thai banks have been chosen as the focal
case. Thailand is considered as one of the important emerging markets in Asia which is currently in the
process of studying the potential to adopt Basel iii framework (Mellor & Suwannakij 2012). The Thai
banks’ study of implementing Basel iii aims to gain trust from both investors and customers. It is also
stimulated by the preparation to be part of Association of South East Asia Nations (ASEANiii
) in 2015 as
Thailand is anticipated as the main distribution center on this region (Sirisophonsin 2009).
1.2 Purposes and Aims
This paper aims to attend the preliminary investigation on the banking sector in Thailand to study if
there is a need to adopt the pillar requirements from Basel iii framework. These requirements mainly
consist of new capital level, leverage ratio and liquidity standards, which will be further explained on this
paper. Moreover, the aim is extended to study the impact on the Thai banks’ profitability from the
increase of capital level.
iii
The South East Asian association aiming to accelerate the economic growth, social progress and cultural
development by the collaboration of equality, sovereignty, independence and territorial integrity among 10 members, consisting of Brunei, Cambodia, Indonesia, Lao, Malaysia, Myanmar, Philippines, Singapore, Thailand, Veitnam
4
Research Questions
1. Is there a need for Thai banks to adopt Basel iii regulations? In what extent?
2. The impact to Thai banks from strengthening capital level in terms of lending
spreads to maintain the profitability (ROE)?
1.3. Thesis organization
The thesis consists of six chapters. The first chapter is the introduction where research motivations and
problem background together with purpose and research questions are provided. Chapter two states
research methodology while theoretical and empirical frameworks are developed in chapter three and
four as the basis of the discussion in chapter five. Lastly, summarized ideas and managerial implications
including further research suggestions will be found in conclusion at chapter six.
5
Chapter 2: Research methodology
This chapter provides how the research is conducted in order to answer the research questions.
This consists of Research design showing the method the researcher uses to conduct the
research, Data collection illustrating how the data is gathered as well as the limitation and
reliability of this paper.
Research refers to the art of reliable scientific investigation to define the answer for the particular
question or improve the theory by relying on the related information in any fields (Cooper & Emily 1995;
Kothari 2004). The purpose covers the search for the insight that is hidden under the information or
characteristic and relationship between the variables (Kothari 2004). There are many types of the
research, depending on its purpose and the way to conduct the information. This thesis is the business
research, which is the systemic process, involving in the planning, acquiring, analyzing and disseminating
the data, in order to guide the managerial decision of the organization (Sachdeva 2009).
2.1 Research Design
2.1.1 Research Strategy
“Qualitative method studies things in their natural settings, attempting to make sense of, or interpret,
phenomena in terms of the meaning people bring to them (Jha 2008)”. The purpose is to understand the
logical link of why and how the focused circumstances happen (Sachdeva 2009). The link could be the
relationship with different aspects or factors that are related to the focused problems (Cresswell 2009).
The qualitative technique is related in two processes which are the data collection and data analysis. The
first process includes the group of interviews, excerpt or passages from the reliable documents and the
observation of human behavior (Cresswell 2009; Sachdeva 2009). The latter is involved in the application
of the analysis model to the data that is written or recorded from the data collection (Sachdeva 2009).
6
Mostly it is used in case study involved, and emphasizing on document more than quantifiable data
(Alan B. & Emma B 2007).
This thesis tries to understand the relationship and the aspects that influence the implementation of
Basel iii regulation and to find out the consequence of increasing the capital level, which leads to the
answer of the research question. Moreover, the data is collected by the reliable documents. These are
consistent to the qualitative method. Therefore, qualitative method is adopted in this thesis.
2.1.2 Research Approach
Deductive approaches are the way to analyze data, beginning with the insight from theories and
generalization, then, seek for the related data by collecting the information from the particular instances
(Cresswell 2009).
This thesis adopts the deductive approach. This is because it starts with the understanding of the
overview Basel iii regulation and the financial model of the impact of increasing the capital level, which
are the focused theoretical part of this research. Then the research question is emerged based on the
mentioned theories. After that the data collection is conducted by using a case study of the financial
situation of Thai commercial banks, and then is connected with the theory to analyze the finding.
2.1.3 Case study method
Case study is the research method that focuses on the empirical exploration of the real-life
phenomenon via the analysis of limited conditions (Bruns and William 1989). Woodside (2010) adds that
the case study method is involved in three purposes. First is to explore the new facts or areas when less
theory is provided. This can be said that the ability to answer all the relevant “what” and “how”
questions. Secondly it aims to describe the relationship or mechanism of the particular event. Last is to
logically explain why the event happens as well as the anticipation of the longer term of the individual
(Zainal 2007).
7
Basel iii on this study has supported the idea of case study method because it is currently on the process
of development, which can be considered as the new area of study, and the study also intend to explore
the relationship of Basel iii framework that logically affects to the Banks in Thailand. This relationship is
divided into two aspects. First is from the different standards that requires Thai banks to implement,
and Secondly, the link between the capital level to the lending spread of Thai banks is studied. This
paper applies Thai banks as case study, focusing on the financial situation of Thai commercial banks. It is
the Basel iii-related financial performance and transaction of the particular banks. Five highest assets’
Thai banks have been selected to study because it is the significant factors that can clearly show the
effect of Basel iii implementation. The need to implement pillars of Basel iii as well as the impact to the
lending spread of these banks after the increase of capital level is aimed to the study. The chosen banks
are Bangkok Bank, Krung Thai Bank, Siam Commercial Bank, Kasikorn Bank and Bank of Ayudhya.
2.2 Data Collection
2.2.1 Primary Data
Cresswell (2009) explains Primary data is the data that is directly collected from the original sources. The
data is mainly intended to use as the particular information to answer the research question. The way
to gather primary data can be conducted by the multiple methods, for example, the in-dept interviews,
questionnaires, the targeted documents or papers (Bryman & Bell 2007). In this paper, the document
analysis is used as the way to collect the data and answer the particular research question.
A. Document Analysis
The documents used in this paper are mostly from the website of five representative banks. The focus is
the relevant documents that are derived from individual annual reports and Basel II disclosure-Pillar 3
reports of the focal banks from 2009 -2011 are used to investigate on this study. The other information
is from Bank of Thailand website.
8
2.2.1 Secondary Data
Secondary data is the existing information, indirectly gathered from the sources, which can be said it is
not collected or investigated by the researcher, but from other sources (Sachdeva 2009). Cresswell
(2009) has divided the sources into two categories that are internal and external sources. . Internal
sources are the data gathered from the research-focused organization or case, for instance, the
organizations, companies, etc. For external sources, it is data issuing from outsources. This could be
journals, news, books and so on.
The secondary data gathered on this thesis mostly come from online sources. The data of the theoretical
part is mostly from Bank for International Settlements, which are the Basel III regulations and the
measurement of capital changes. The other information is mostly from scientific journals that are found
on Karlstad University database, for instance, Business Source Premiere, Emerald and etc. Some are
derived from the web search engines like Google and Blink. The key words used on the search are
mostly “Basel iii”, “Basel regulations”, “Capital level”, “Banking management”, “Financial crisis”,
“Financial risk”, “Bank of Thailand”, “risk weight assets”, “leverage level”, “Banking liquidity”, “Banking
equity”, “Thai commercial banks” and so forth.
Kothari (2004) says the research process starts with the careful defining of the problems, reviewing the
concepts of the theories and previous findings to have the insight of the particular phenomenon. After
that the design research, as well as the data collection, is conducted. Lastly, the data is analyzed based
on the theories, and subsequently interpreted into the final report. The data analyzed on this thesis is
the case study analysis, which needs to be consistent and applicable on the theories.
In this paper, the Basel iii regulation and the related equations of Capital level increased are studied to
be the theoretical part. Moreover, the background of Banking management, different financial risks and
the previous Basel regulations have been reviewed as the literature reviews. The main sources of these
parts are from Bank for International Settlements, but other sources like, journals and text books are
also be studied in order to have a better insight and earn more reliability on the theories and literature
reviews. After that, for the data collection, Thai financial banking situation, primary data, is selected as
the case study, and is analyzed by two methods. To answer the first research question, the findings of
case study related to the current capital levels, leverage ratios and liquidity ability of Thai banks are
9
compared with the Basel iii regulation, which divided to capital level, leverage ratio and liquidity
standards. This comparison is discussed to see the need for Thai banks to adopt the pillars from Basel iii.
For second method, the focus of the findings turns to financial statements from different banks, and is
brought into the equations provided in the theory about the impact from capital level measure to
answer the latter question.
2.3 Data Limitation
The data limitation is concluded into three aspects. First is there are some detailed regulations from
Basel III framework is still in the development process. Secondly, most of the information comes from
individual banks, so there are some data that is confidential and need the management level’s approval
to access. Furthermore, for these reasons, the interview is not able to conduct. The author had on the
process to reach the management level on each representative bank as well as Bank of Thailand for the
interview, but due to the authorization and inconsistent time problems, there was no response from
them. Third is from the different ways of banks to provide the detailed information. Thus, with the same
type of data, some are found in one bank, and are unable be found in others. Furthermore, because of
the data, in the empirical parts, mainly derived from the bank’s financial statements, the biased data
might be slightly appeared.
2.4 Reliability and Validity
Reliability and Validity are defined in the term of trustworthiness, precise and quality in qualitative
research (Golafshani 2003). Eliminating the bias and increasing the trustfulness of the researcher are the
way to make the research more reliable and valid (Golafshani 2003). This can be achieved by applying
the triangulation, which is a credible guidance, emphasizing on collecting the data from multiple sources
in the research (Bryman & Bell 2007). The researcher can also clearly state how the data is gathered as
well as the method to analyze it (Bryman & Bell 2007).
As mentioned above, the data used in this thesis is mainly from the multiple internationally approved
papers of Bank for International Settlements as well as financial statements of certified banks and
10
information from Bank of Thailand. These are approved by the Government of Thailand and reliable
international auditing companies, for instance, Pricewaterhousecoopers, Deloitte, KPMG and
Ernst & Young.
11
Chapter 3: Literature Reviews
This chapter provides all the comprehensive backgrounds that are needed to illustrate in order to
have a clear understanding of the theoretical framework. This chapter overviews the significant
parts of Banks’ Balance sheet, which are Liabilities, Equities, Assets and Off balance sheet (OBS).
Another is the relation and meaning of Liquidity, Assets, Liabilities and Capital, explained in Bank
management topic. The chapter also provides the summary of financial risk related to Basel iii that
includes Credit risk, Market risk, Operational risk and Systemic risk. Finally, it summarizes the main
concepts of Basel i and Basel ii as well as, Global financial crisis in 2007 that is one of the significant
reasons to the development of Basel iii framework.
3.1 Balance Sheet of Banks
Before going with the balance sheet of Banks, it is more comprehensive to begin with the pillar
of regular balance sheet.
Balance sheet shows a snapshot of the organizations’ financial situation at the particular time.
According to Figure 1, it is divided into two sides. The left side represents what they use their fund with,
while the right one is how they raise the fund. Assets are the list of properties, cash, other equipment
and investments. Liabilities are the organization’s obligation that is mostly debt. From (1), the difference
is equity which is new worth (Berk & Demarzo 2009).
The balance sheet identity: Assets = Liabilities + Equity (1)
Figure 1: Balance Sheet (Berk & Demarzo 2009)
12
For the banks, the structure and ideas of balance sheet are the same, but there are some detail
differences in the bank identity. Loans are the bank’s significant assets, and the primary liabilities are the
customer deposit. Banks make profit by being funded from liabilities and equities then using these funds
to issue the loans or get the securities. So, the spread from cost of fund, and lending rate are their profit
(Douglas et al. 1986). The more detail of banks’ Assets, Liabilities and Equity will be more explained in
3.1.1 and 3.1.2.
3.1.1 Assets
As mentioned above, assets are what the fund is used with. The asset held by banks can be broadly
divided into two types, earning asset and non-earning assets. The proportions of non-earning assets are
always higher than the desired level (Leonall & Albert 1969). Koch and Macdonald (2009) have provided
the principal bank asset account. The account includes Cash as well as the reserve to prevent loss and
deposit to the central banks, Loans that is the primary earning assets, lease to the customers, other
fixed and intangible assets, and different types of investments. Most of the bank investment is securities
that widely consist of debt securities, equity securities and derivative contracts. Rose (2001) have
clarified that debt securities are eligible debts banks own to other counterparties, such as bonds,
Treasury bills and speculated banknotes. Equity securities are the share banks hold in another banks,
company or partnership, which are in the form of capital stocks. Derivatives are the contract that states
the concurrent conditions and payments, directly relying on the particular values. The values could be
rice, gold prices, foreign exchanges or interest rate. The derivatives can be separated into 5 types, based
on the detail in each contract, that are Futures, Forwards, Swaps, Options and Warrants.
3.1.2 Liabilities and Equity.
Koch and Macdonald (2009) have defines Banks’ liabilities and Equity accounts are the source of fund
banks are able to raise. The largest part in liabilities for banks is deposits that is the claim on banks from
the other counterparties, and has been divided into two board categories. The first category is the
demand deposit with the non-interest bearing account, and can be withdrawn at any time. Another is
13
saving deposit. It is an account that people are allowed to withdraw only in the determined period with
interest bearing. Debt is also considered to be part of liabilities. This could be the loan and securities
banks make from other parties. There are short and long-term debts. These are the debt banks make
within and longer than one year with the other parties. For the equity, it represents the difference
between banks’ assets and liabilities. It consists of stocks contributed from the owners, and the retained
earnings. The Equity usually refers to core capital, which is the last source for banks to bear the loss, and
can be viewed by different quality, judging from the risk each of it takes (Rose 2001). This will be
explained further.
3.1.3 Off-Balance Sheet (OBS)
OBS is the way banks conducting businesses that do not appear on the balance sheet as assets and
liabilities (BIS 1986). Koch and Macdonald (2009) have explained that the meaning covers two aspects.
First are the assets or liabilities, traded in the market, that are unable to meet the standards from formal
exchanges, which is mostly from small companies. Secondly, it means the clams that will not appear on
the balance sheet as long as it is not succeeded. This could be the gainful activities that banks attend, for
instance, the act as a broker that provides an arrangement for funds with the collected fee. Another
could be the promised obligation that generates the payment in the future. The latter case usually refers
to the different types of promised securities.
Giandomenico (2011) says the securities that meet these mentioned aspects are widely known as Over-
The-Counter (OTC) securities. One of the famous OTC securities is Collateralized Debt Obligations (CDOs)
that will be explained further in section A and B of 3.4.3. OBS market is different from country to
country. Besides, OBS assets are preliminarily judged to have high risk as the transaction is informal and
not properly regulated. Some are complicated, and hard to assess the intrinsic risk, such as CDOs and
Credit Default Swap (CDS). However, the investment in risky OBS normally comes with high return rate.
Thus, its rate grows every year (Casu 2005).
14
3.2 Banking Management
The basic role of Banks is to take a deposit, and turn it into loans. To gain the profit, the interest they
charge on loans must not be less than the interest paying to the depositor. This spread must also cover
the operational cost and the loans that are defaulted, for instance, the failure of borrowers to pay the
interest (Hull 2009). In the present day, most of large banks provide both commercial and investment
banking. Commercial Banking is about managing the deposit and lending transaction, while investment
banking provides services related to assisting with raising capital for companies, and giving advice about
financial decision (Yang 2012). This mechanism shows that there are many risks involving in banks ‘
activities, for example, the risk of borrowers not to pay as agreed or the large-amount withdrawal at the
same time. Therefore, the attention is significantly needed on the management of assets and liabilities
to tackle with these risks.
3.2.1 Liquidity Management
Liquidity refers to a capability of banks to turn their assets into demanded obligation without lowering
the value. These mentioned assets are called liquid assets. The risk they face in this ability is defined as
the liquidity risk (BIS 2008). Thus, liquidity management is one of the important things in the banks. It
ensures the ability for banks to gain the intended cash flow (BIS 2008). The failure of liquidity in one
bank can lead to the systematic problem on financial markets. When Banks face the liquidity problem,
they have two options. First is selling the assets to the market in order to be more liquid. The latter is
raising fund from outside, which could be other banks or central banks (Pokutta & Schmaltz 2011).
Most of the liquid assets have very low returns such as, cash and government bond, so it is rational for
banks to hold the illiquid assets in order to gain the highest profitability (Bordeleau & Graham 2010).
Moreover, BIS (2006A) says banks often assume that their certain assets are liquid, and expect that the
central banks always support for the liquidity problems as well as the guarantee of the deposit from the
deposit insurance. For these reason, banks do not manage their liquidity as properly as they should.
15
3.2.2 Asset Management
Under the profit maximizing principle, Leonall and Albert (1969) explains that the objective of
commercial banks is to gain the highest profit as possible. So, they always structure their asset to get
the greatest return by increasing the proportion of earning assets along with trying to lower the risk.
This is the aim of asset management. Koch and Macdonald (2009) suggest 5 basic steps to sound these
assets, beginning with determining the comprehensive goal and criteria of considerable assets. Next, the
forecast of related key environment, such as interest rate, inflation, must be taken into account before
holding the assets. Then, banks need to have ability to assess the risk involved and liquidity of the
specific assets. The last step is the need for diversification the risk, meaning that they should limit to
invest in one concentrated area. Final step is to formulate strategies to manage the existing assets, such
as the determination of the portfolio size to stay in the intended profitability and regulations.
3.2.3 Liability Management
As mentioned above, Liabilities are one of the sources of fund, and each source has different cost,
maturity and repayment. Therefore, liability management is the way aiming to manage these sources to
gain the highest profit to shareholders with the reasonable risk (Gupta & Jain 2004). They continue
saying that it is to ensure the supply of funds in order to be liquid, and maintain the earning asset in the
long term.
They say that banks should hold the optimal mix of debt and deposit, depending on the taxes and
bankruptcy cost (Gupta & Jain 2004). Leonard (2002) adds banks which are mainly sourced by the
deposit has lower tendency to face liquidity problems than one with the borrowed fund, debt.
Furthermore, he suggests 2 ways for banks to manage the liabilities through lowering the liquidity risk.
First is liability diversification by holding the different types of sources to diversify the risk. Second, the
maturity should be focused. This is often ignored by liquidity managers, and the point is that holding
short-term liabilities can lower the liquidity risk.
16
3.2.4 Capital Management
Capital is the amount banks can bear against the losses to ensure its survival, meaning that it is the
absorption of losses from different risk. These risks will be clarified in the next section, 3.3. Thus, capital
management has become the legal requirement for present banks in the world (Francis & Osborne
2012). This leads to the questions, which is “how much capital banks should hold”. Hempel and
Simonson (1999) have mentioned that there are three main factors influencing this amount. First is the
function for each bank. Banks that conduct the financial transaction with the higher risk, of course, need
more level of capital than low-risk banks. Secondly, the need for lowering the financial leverage to
increase the return rate to the owners. This means, to attract and keep the shareholders, banks need to
have an optimum financial leverage from level of equity, which should be small enough to generate the
appropriate return rate to owners along with buffering the risk. Last is the regulation related to capital
adequacy.
3.3 Financial Risks
“Risk is a measure of the probability and severity of adverse effects” (Haimes 2009). In financial way, risk
is involved in the uncertainty and leads to the change in profitability and losses. Unlike most companies,
for banks and financial institutions, they must be heavily regulated to prevent these risks (Rayhavan
2003). Hull (2009) says the more risks are taken, the higher return can be gained. Chen et al. (2006)
supports that for this reason, they have a tendency to take excessive risk. Therefore, the understanding
of each type of risk they expose and the implication from it need to be studied for Banks in order to
keep these risks at optimum level (Rayhavan 2003).
3.3.1 Credit Risk
Credit risk is the probability that the customers or borrowers are unable to pay the agreed obligation
(Rayhavan 2003). This is the most significant risk as loans are the crucial part for banks. These losses are
absorbed in the form of default, which is the failure of borrowers to pay the interest or principle. (Hull
17
2009) Thus, the aim of credit risk management is to lower the potential of this risk, and is closely
consistent to the way of asset management mentioned in 3.2.2. Furthermore, to clarify the credit risk
management, Rahaven (2003) defines that there are six instruments that can take out the credit risk.
First is the determined ceiling that the banks can bear. This could be the limited level of loan types, for
instance 10% of total fund for individual borrowers. Second, the preliminary measurement of risk can be
done by using the review or scores from the approved credit agency as the references. Third is the risk
rating model that is adopted by the banks. This model should clearly include various types of risk that
affect the borrowers. Another is setting the loan pricing that is consistent with the expected loss,
meaning that the customer with high risk should be priced high. Fifth is the diversification of risk by
distributing the borrowers to different industries. The last tool is the close review of overall credit risk
process should be appointed. This usually refers to the credit audit.
3.3.2 Market Risk
Hull (2009), Misra and Vishnani (2012) defines market risk as the potential of decreasing in value of
bank’s off/on balance sheet due to market movements. The value is affected by the fluctuation of
current exchange rate, interest rate market and commodity prices. Rahaven (2003) adds Stress testing,
the predicted economic condition of the factors that have undesirable consequences, is one of the tools
banks adopting to assess the market risk. He continues saying market risk has been roughly influenced
from four different risks. Liquidity risk is, as mentioned in 3.2.1, the ability of turning the asset to meet
the obligation at the optimal price.
Interest rate risk gives the negative consequences from the volatility of interest rate to the particular
assets, for instance, lowering the income cash flow or value of assets (Entrop et al. 2009; cited in
Bhattacharya & Thakor, 1993, p. 18). Another is Foreign exchange risk. It is the potential loss from the
swing of currency rate affecting to both the expected principal of currency and return on investment
(Gibbons 2010). The last is country risk that is the risk related to international transaction. It is the
possibility of loss banks facing from unable payment of service and debt due to a particular country’s
condition. It could be political problems or differences in government regulations (Rahaven 2003).
18
3.3.3 Operational Risk
Operational risk is known as the risk concerning about the failure of internal processes, people and
external incident (BIS 2011B). Rahaven (2003) adds that this risk is mainly contributed by two factors,
which is the rapid growth of both financial technology and instruments, and the systematic linkage,
between them, that usually comes with the complicated regulations. The risk is concerned with the
failure of the internal control and corporate governance, causing the error of performance as well as
fraud and finally dropping of the profit. Thus, this can be rationally concluded that operational risk is one
of the root causes and interfere with credit and market risk (BIS 2011B). Rahaven (2003) suggests that
the way to mitigate this risk. He refers operational risk is hard to be measured and controlled. Banks
need to focus on the procedural standard of internal audit and control, along with the shared
understanding of considerable operation to the particular staffs.
3.3.4 Systemic Risk
The concept of systemic risk is defined as the risk involved in the spread failure of a number of banks to
other financial intermediates (BIS 2010B). BIS (2002) explains the existence of this risk is supported by
two important factors. First is the significant role of financial sector and the payment system to the
growth of entire economic system. Thus, there is no room for the banks’ failure. Secondly, the financial
system is fragile to the events. The events can basically refer that the trust of depositors relies on the
banks to use the fund with liquid assets. Hence, it means if one depositor is unable to receive the
demanded obligation or, easily say, the trust is lost, this leads to the instant withdrawal of funds. The
worse scenario is that the expectation on the other banks in the financial market having the similar
problems. Subsequently, the spread of financial failure happens from one bank to the entire financial
system. This is usually called “Contagion”.
They also say the particular bank should regularly disclose the related and reliable information of the
risk exposure to the other banks, and stakeholders in order to show the capability to manage the risk.
Subsequently, the trust from both banks and investors can be gained.
19
3.4 Basel Regulation
Due to the financial risks, mentioned in 3.3, surrounding the banks, there is a need for banks to prevent
these risks. Therefore, the risk regulation is developed. The main reason for the risk regulation is to
mitigate the systemic risk and make sure that banks keep adequate capital on the optimum level with
their risk (Apostolic et. al 2009). However, the problems arise as the understanding of capital and the
way to regulate tended to be different in each country and continent. Another reason turns the increase
of risk from the growth of complicated financial instrument (Hull 2009).
For these reasons, the Bank for International Settlements (BIS), one of the oldest international financial
institutions, had established the Basel Committee on Banking Supervision (BCBS) in 1974 aiming to set
the standard of understanding and the banking regulation in every country (BIS 2009). After a long
development of the standard, in 1988, the first document was issued, which usually refers as “The 1988
BIS Accord” or “Basel i”. The objective of this accord is to set the minimum level of capital level
proportionally with risk they are taking. The framework has been regularly improved due to the change
of financial conditions. This goes to the issue of revised framework, Basel ii and iii released in 2004 and
2010 respectively (BIS 2009).
3.4.1 Basel i
The focus of Basel i is on the strengthening the capital level of banking system to tackle with only the
credit risk and the compatibility to apply on the banks in different countries, BCBS memberiv
. However,
for the other risks, these are examined by the supervisors when assessing the overall capital adequacy
(BIS 1998). The framework is divided into three elements, which is following.
iv
A group of Basel Committees coming from Argentina, Australia, Belgium, Brazil, Canada, China, France,
Germany, Hong Kong SAR, India, Indonesia, Italy, Japan, Korea, Luxembourg, Mexico, the Netherlands, Russia, Saudi Arabia, Singapore, South Africa, Spain, Sweden, Switzerland, Turkey, the United Kingdom and the United States
20
A. Minimum Capital Level
BIS (1999) and BIS (1998) say minimum capital level is the least capital that Banks are required to hold.
BCBS has given the detail in the form of equation which is present below
Target Standard Ratio (TSR):
≥ 8% (2)
The equation (2) refers that the minimum level of capital must be more than 8% comparing to the risk
weighted assets. This minimum level is called Target Standard Ratio (TSR). The fraction between capital
and risk weighted assets, sometimes, is known as Total Capital Ratio (TCR) (BIS 1998). This means that
the bank can stand for the loss up to 8% of their risk weighted assets for the credit risk. The more detail
of each element in the equation will be explained on B and C.
B. The Construction of Capital
Tier 1 and Tier 2 capital can be referred as total capital base, and is not limited for equity and retained
earnings (Hull 2009). He also says Tier 1 Capital represents equity capital, which is usually known as core
capital. Equity capital consisted of the fully paid common stock as well as perpetual preferred stock and
after-tax earnings. BIS (1998) adds at least 50% of the total capital base is in the form of equity capital.
For Tier 2 Capital, sometimes called supplementary capital, the elements are hard to interpret due to
the different legal and accounting standard in each member, and consist of kinds of reserve to cover the
loss, such as undisclosed or revaluation reserve. The other type of element is the different kinds of
hybrid securities, which is the financial instrument that combines the characteristic of both debt and
equity. It also includes subordinated debt, with a maturity more than five years, banks holding.
C. Risk-Weighted Assets (RWA)
21
Risk-weighted assets are the assets that market’s value has been adjusted to reflect the risk they take.
This is done by the multiple of assets’ value and the risk weight determined by BSBC. The more risk the
asset takes, the higher the risk weight is (Bessis 2010). BCBS has included the total assets from both on
and off-balance sheet, and each asset is weighted by different categories of risk (Bessis 2010). There are
five level of risk weight, which is 0, 10, 20, 50 and 100%. Each weight represents the level of exposure to
the risk or, easily explanation, the risk of the counterparty failure from credit risk. 0% means riskless. It
is composed of cash reserves, the loan that the counterparties are central banks and government. For
the highest risk, 100%, it is the other claims such as corporate debt and bond from low reliable
countries, private sectors, plant and equipment (BIS 1998). Hull (2009) clarifies the risk-weighted assets
are, therefore, calculated by the multiple between assets’ market value and the risk weight. For the
OBS, the assets need to be converted by factors from the BCBS to include the equal credit risk before
calculating by the same method.
D. The drawbacks of Basel i
After releasing in 1988, there are lots of criticisms towards the ability to sound the banking system.
Most of the criticisms go to the same way, which is the focus on the narrow assessment of risk
(Bhowmik & Tewari 2010). It tackles only with the credit risk even though BCBS have argued that they
already deal with market and operational risk by having the supervisors to assess the overall capital
adequacy (BIS 1998). Another most criticized issue is about the simple and board of weighing credit risk.
This can be explained that, in practice, each type of assets affects from various risk in different ways.
There is no differentiation between corporations with different risks in Basel i. Thus, Bhowmik and
Tewari (2010) criticizes assets in the same category should not be treated with the same risk-weight.
Jones (2000) supports that this leads bank to have a tendency to higher yield by holding more risky
assets, and selling the least risky with in the same risk categories. For this way, banks can reduce the
hold of capital without the decrease of risk. This treatment usually refers to “artificial arbitrage”
(Apostolic et. al 2009).
22
3.4.2 Basel ii
In order to deal with the mentioned criticisms and the banking crisis in 1990s, Basel ii, the revised
version of Basel Accord, was released in 2004. It provides sets of new regulations to increase the risk
sensitivity by the inclusion of market and operational risk. The framework covers capital charges,
expansion of the scope with the deeper calculation of the risk-weighted assets. Besides, the new ways of
measurement and supervision are included. The new accord comprises of three pillars. These are
following (Bessis 2010).
A. Pillar i: Minimum capital requirements
Although the calculation of the minimum capital requirement has been improved in order to cope with
the mentioned criticisms, the main idea of it still exists. The remaining idea includes the 8% of TSR, and
the definition of Tier1 and Tier2 Capital as mentioned in B on 3.4.1. However, there are some
differences, which is the inclusion of market and operational risk they are exposed to in the equation.
Another is the addition of Tier1 Capital to Risk- weighted assets ratio. The ratio should be exceeded
4.25%. These can be shown by the following equation (BIS 2006B).
Target Standard Ratio (TSR):
≥ 8% (3)
Tier1 Capital to Risk-weighted assets ratio:
≥4.25 % (4)
Moreover, another difference is banks are able to discretionally choose the way to calculate the risk-
weighted assets from each risk. The calculation of the risks is briefly described by the following.
For the credit risk, banks have two alternatives, the standard approach (SA) and Internal Rating- Based
Approach (IRB). The first approach is similar with the method used in Basel i. Yet instead of using the
23
categories from BCBS, the risk weight relies on the external credit assessment institutions (ECAIs), such
as, Standard & Poor’s. Each rating level represents the categories of risk which are not the same for
claims on sovereigns, banks, non-banks, and it ranks from0-150% (Balin 2008). Alternatively, BIS (2006B)
says the second approach is the allowance for banks to develop their own method internally with the
help from regulators. It is believed that the internal development model can reflect more risk sensitive
and precision. Risk weighting of IRB relies on the measurement from four components, Probability of
default (PD), Exposure at default (EAD), Loss given default (LGD) and Credit conversion factor (CCF) BIS
(2006B). Furthermore, IRB banks adopting can be conducted by two methods. One is the foundation IRB,
which banks are discretionary able to develop the model only for PD. The other components go to the
estimation from the regulators. Differently, in the advanced way, all four components are estimated by
banks BIS (2006B).
Another risk added is Operational risk. Hull (2009) and Apostolic et. al (2009) says there are three
choices to conduct. First is Basic indicator approach (BIA), stating that capital requirement from this risk
is set at 15% of the gross income. Second is Standardized Approach, which is similar with BIA, but it
determines the percentage of requirement according to the particular asset’s gross income. The last
method is Advanced Measurement Approach. It allows banks to calculate their own reserve from
operational risk, yet the final result needs to be approved by the Basel regulators.
The last is market risk. Balin (2008) explains Basel ii has weighted the risk from the difference between
fixed income assets and market-based assets such as, stocks, currencies, etc. For first type, the
measurement of market risk is called value at risk (VAR), and alternatively, Advanced Measurement
Approach can be adopted if banks are able to develop their own VAR internal model. As usual, the
approval is needed. Banks that is not able to adopt two mentioned method, they can choose to use the
right-weighting categories based on the maturity, and ECAIs. The latter type goes by three methods.
Simplified Approach uses the similar way with non-VAR fixed income assets. Scenario Analysis allocates
risk from assets by the possible scenario market might face in the future. Last is known as Internal
Model Approach which allows banks to develop their own model on case by case.
24
B. Pillar ii: Supervisor Review Process
Bessis (2010) states the aims of pillar ii are to emphasis the needs to have regulator interaction, and
extend the right for banks to have their own process of assessing the capacity adequacy consistent with
the risk taking and strategy. BCBS says giving the authority for regulator and banks to review the capital
level is the way to protect banks from risks that is not included in the first pillar. These risks could be
reputational risk, liquidity risk, strategy risk, and importantly, the concentration risk, which is the risk of
giving out the concentration loans to counterparties (BIS 2006B).
C. Pillar III: Market Discipline
The third pillar deals with the increasing the disclosure of the banks’ process from the above pillars to
measure the risk, and capital adequacy (BIS 2006B). However, Hull (2009) argues that banks have a
tendency to disclose such information, giving the supervisor a difficult time. The information such as,
the level of Tier 1 and Tier 2, the capital reserved for each risk, CAR ratio, and so on. All this should be
provided publicly under Basel ii’s standards. Balin (2008) says the intention on this pillar is to increase
the discipline for banks and help the shareholders and investors to make a financial decision.
3.4.3 Global Financial Crisis and Basel Regulation
In this sector, the weaknesses of Basel Framework are emphasized, which is directly related to the
global financial crisis of US in 2007, especially that Basel ii that is implemented during this crisis. This is
the start of the spread-out domino effect to all over the world.
25
A. Sub-prime lending
The financial crisis has originally begun in the US mortgage market in 2007. At that time, due to the crisis
in 1990s, US interest rate was very low, which was one of the policies from the US government to heal
the economy (Sanchez 2011). Moreover, they encouraged the people to have houses by allowing the
borrowers who had the under standard credit, low equity or income to get loans. This type of loan
usually refers to sub-prime loans or lending.
This generated the rapid inflation of the house pricing in the US previous years before 2007. The loan
was backed by the house they bought. Thus, there were thoughts circulating the customers that the
housing price always increased, and they could easily sell it for the profit. Likewise, if the borrowers fall
to pay the obligation, the banks can foreclose the house and sell it on the market with a nice price
(Zimmerman 2007). Unfortunately, the prices stopped inflating because the interest rate on sub-prime
loans, which was low for some period, was anticipated to increase to reflect the real market situation.
Subsequently, this leads to the default from the unable payment of interest rate and loans, and they
could not, anymore, make profits from selling house (Bessis 2007).
B. Securitization
Before the financial crisis in 2007, securitization was believed that it was the potential way to sound the
financial system by the distribution of risk (Songshin 2009). According to the figure 2, the model begins
with banks or originators issue the loan that is backed by the different assets to the borrowers. The
assets could be cars, firm bond or house loan. Then, these portfolios of loans are removed from the
Figure 2: Securitization model (Jobst 2008)
26
bank’s balance sheet and turned into the so-called Collateral Debt Obligations (CDOs). The transferring
process is conducted by a company aiming to fund assets, the special purpose vehicles (SPV). The banks
make profit by selling this asset-backed loan to the SPV. After that, SPV distinguishes the risk of each
transferred loans or securities into different categories, with the advice from ECAIs, by high risk, high
returns ideas, and then sell them to the investors all over world. SPV makes profit by selling these CDOs
to the investors with the price higher than the principal. Therefore, the flows of interest rate from the
borrowers go directly to the investors (Hull 2009). The clash flow of this process is following.
Importantly, both Basel i and ii are not able to include the risk from off-balance sheet distributed to the
third party. No capital is charged for banks to securitize the loans. Securitizations by mortgages were
huge attractive because this was a win-win situation for every player. Banks can distribution risk while
receiving the profit from selling the mortgage loans to SPV, and ECAIs, in practice, could not give reliable
information for such complex risks in time. Therefore, no one knows exactly who bears the risk
(Zimmerman 2007). As a result, the players did not know how much risk they were holding until it
turned obvious, and the default was started. (Apostolic et. al (2009) Furthermore, during this period,
there were insurance against the credit default, known as Credit Default Swap (CDS), one of the OTC
derivatives, with no proper risk management, among financial institutions. These processes triggered a
credit crunch, and also lead to the spread-out liquidity problems to most banks (Zimmerman 2007).
27
Chapter 4: Theoretical Framework
This chapter aims to give the theories that are mainly used to analyze the study. All theories
provided here will be used together with Empirical data to answer the research questions. The
theories consist of the detail of Basel iii framework, which has three sections, New level of Capital,
Leverage Ratio and Liquidity standards. This Basel iii, 4.1, will be used to answer the first research
question. Moreover, it provides the relation of different equations, 4.2, that are used to assess the
impact of higher capital level to discuss the second research question.
4.1 Basel iii
The latest Basel Accord is known as Basel iii, and has been officially released at the end of 2010 by BCBS.
BCBS clearly realized the needs to improve the regulation and supervisions from Basel ii after the global
financial crisis. So, Basel iii aims to increase the quality and quantity of the capital adequacy as well as
the inclusion of macro prudential measures (King & Tarbert 2011; cited in Hannoun, 2010, p. 3). The
brief framework and its potential consequences are divided into three sections, which is following.
4.1.1 New level of Capital Adequacy
BIS (2011A) states the idea of Tier1 and Tier2 are the similar with Basel i and II, but BCBS has changed
the detail in both quality and quantity. For Tier 1, the capital is mainly consisted of the common equity
and retained earnings. According from figure3, the difference is BCBS has divided Tier 1 into two levels,
Common Equity Tier1 (CET1) and Additional Tier1. The first level is formed by the highest quality of
assets, which is the common stocks or other qualified assets from Base iii and retained earnings. CET1
should be at least 4.5% of total risk-weighted assets. The latter is the types of preferred stocks and other
paid-in capital that are not qualified with the standard. Basel iii does not determine the minimum for
28
Additional Tier 1. Both of CET1 and Additional Tier 1 must have at least 6% of total risk-weighted assets.
They continue saying, for Tier2 Capital, it is aimed to prevent banks from become illiquid. It consists of
the hybrid capital debt and various types of subordinate debts. The minimum total capital ratio or TSR
for minimum capital is still at least 8% (King & Tarbert 2011; cited in Hannoun, 2010, p. 3).
Figure 3: Structure of Minimum Total Capital Ratio (BIS 2011A).
Moreover, BCBS has emphasized the needs for banks to hold more capital than minimum by introducing
two capital buffers which is conservative buffers and countercyclical buffers (BIS 2011A). King and
Tarbert (2011) states banks are required to keep the first buffer on the top of minimum capital
requirement at 2.5%, only CET1, of total risk-weighted assets. Therefore, this makes CET1 should be at
least 4.5% +2.5% = 7% of total risk-weighted assets, which makes the minimum total Capital ratio plus
conservative buffer is 10.5% of total risk-weighted assets. For the countercyclical buffers, it comes after
the addition of the mentioned buffer. This buffer, ranged from 0-2.5% is required only when the
economic faces the excessive credit growth. This is the prevention of the unexpected losses after the
downturn is perceived.
Another issue affecting the capital level is the risk coverage. After the global financial crisis shows that
some of the off-balance sheet assets were not well covered, especially from OTC derivatives, and it
cannot coup with the complicated financial obligation, such as securitization or CDO. Thus, BCSB has
included more material risks banks face to the model, and focuses on the credit counterparty risk. Bank
29
of Thailand [Bank of Thailand] (2011) and BIS (2011A) have concluded improvement into five main
things. First is the improvement of risk model, that the calculation is deeper, based on the worst case
scenario, and stressed more on VAR model. Second is the revision of the way to base on ECAIs to make
it reflect more precise risk. This includes the encouragement for banks to develop their own risk rating
model with the info from ECAIs, especially with securitization. Third and fourth is the higher charge of
risk weight for OTC derivatives, and the more regulations about controlling the risk from securitization
respectively. Both of this improvement aims to tighten more capital to buffer the counterparty credit
risk. Last is the increase of risk weight for the financial transaction with the internationally active
institutions which have high credit risk.
Furthermore, BSBC states that the extra charge is needed for the systemically Important Financial
Institutions (SIFIs). This is based on many characteristics of banks for instance, size, market importance,
complexity and so on, which is current in the developing process (BIS 2011A).
From these mentioned details, there is no doubt that the large improvement in capital adequacy and
risk coverage model increases the soundness of the banks. This is referred by Blundell-Wignall and
Atkinson (2010), and Sheldon (2010). They also pre supposes that the latest way to risk modeling and
weighting provided by Basel iii are the best approach, especially dealing with the OTC derivatives, and
supports the need for the provision from additional buffers. They claim that this is to ensure that the
capital condition remains silent even in the bad time. However, the studies from Slovik and Cournède
(2011) and, Killan (2010) have clearly shown that the increase of capital ratio has a negative impact to
the overall GDP, especially in US and EU countries. Hulster (2009) indicates that most of countries in EU
will face the decline in average 0.35% for each 1% lower in lending spread, and 0.2% in Asian and other
emerging markets. For the OECD countries, the study concludes that for each 1% increase in capital ratio
lowers the GDP by 0.04% (Slovik & Cournède 2011). BCBS has conducted the quantitative impact study
(QIS) for Basel iii. The result shows that after fully implementing Basel iii for risk-based capital
requirements, the sampled banks face the decline averagely 4% in CET1 ratio from 11% - 7%. This causes
the need to raise more CET1 capital to meet 7% as regulations, which is approximately 600 billion euro.
30
4.1.2 Leverage Ratio
BSBC defines leverage ratio is the Total Tier1 Capital divided by On and Off balance sheet assets. This
must be not less than 3% (BIS 2011A). Dalmaz (2010) says the ratio is designed to be simple and without
risk capture measure, which have a possibility not to capture all risk related, leading to excessive
leverage. This is to prevent the too much dependence on sophisticated risk model. King and Tarbert
(2011) clarifies before the crisis, there are many banks building up the excessive leverage despite that
the number of TCR was still in a good level Blundell-Wignall and Atkinson (2010) adds that this leads to
the credit crunch from the underestimated intrinsic risk. Moreover, when banks build up excessive
leverage, and then face the not captured risk, for example market risk that crushes down the assets’
value, banks will be forced to sell the assets. This also results in systemic liquidity problems.
4.1.3 Liquidity Standards
King and Tarbert (2011) say the liquidity problem is initially one of the significant factors influencing the
financial crisis. There were banks finding themselves in the hard situation with the asset conversion to
cash, which happened from the tightened short-term funding for banks and the severe decrease in
asset’s value. This leads to the lower in the capital level.
BIS (2011A) says therefore, in Basel iii framework, BSBC has determined two standard ratios that is
Liquidity Conversion Ratio (LCR) and Net Stable Funding Ratio (NSFR). The first ratio aims to make sure
that banks have enough high liquidity assets to offset the net cash outflow during the stressed scenario.
BCBS defines it as stock of high-quality liquid assets under Basel iii standard divided by total net cash
flow within 30 days under the stressed test. They also divided the highly liquid assets into two levels.
First is the highest liquid asset, such as cash or government bond, which should be at least 60% of total
highly liquid assets, and 0% of haircut. The latter level is the lower liquid asset with have good rating
from ECAIs or 20% risk weight from Credit risk, and at least 15% haircut.
31
Another ratio is NSFR, which aims to ensure the longer-term liquidity and is defined as the available
amount of stable funding divided by required amount of stable funding (BIS 2011A). The first funding is
source of fund consisting of liabilities and equity part with longer than one year maturity. They are
converted by Available amount of stable funding factors (ASF factors) based on the safe from outflow
level. For instance, the deposit with insurance from individual gets the higher ASF factors than the
wholesale funding. The under fraction is the use of fund for both On and Off balance sheet assets.
Differently, these assets are weighted by RSF Factors that range the lowest liquid assets as the highest
factors. Both ratios should not exceed 100% (BIS 2011A).
4.2 The Impact of higher capital level
The increase of capital requirement from Basel iii, of course, impacts the profitability for banks (BIS
2010A). Roger and Vitek (2012) states that when banks face the lower of Return on Equity (ROE), they
are likely to widen the gap of lending spread, which is the difference between the interest rate on loans
and the cost of liabilities, than issue new equities or cutting lending. ROE is the proportion of net income
returning to the shareholders (Berk & Demarzo 2009).
The method derived from King (2010) on BIS Working Paper No. 324, is used in this paper. He assumed
that banks pass every higher cost of loans to the end-customers by increasing the lending spread on
loans. Moreover, to make the methodology possible, the calculation assumes there is no change in ROE,
cost of debt and operating cost as well as the source of income and bank’s structure.
The study aims to assess the impact to ROE with a given higher capital level, and the lending spreads
required to maintain the same ROE. In this section, the related equations and some explanations from
King (2010) are introduced.
Assets = Cash + Interbank Claims + Trading assets + Loans + Investments + Other assets (5)
Liabilities = Deposits + Interbank funding + Trading liabilities + Debt + Other liabilities (6)
Equation (5) and (6) are derived from the composition of Balance sheet. Another set of equations is
from the income statement. It shows the financial performance of the organization, which is evaluated
by the summary of the sources of revenues, expenses and net profit, within the given period (Berk &
Demarzo 2009). The detail is varied based on the particular organization.
32
For the bank income statement, the revenue has been separated into two categories, which is the net
and none interest income. First is interest income minus interest expense. Interest income (IntIncome) is
the income from loans (IncomeLoans), trading assets, and investments (other IntIncome). Interest
expense (IntExp) is from the interest on deposits, interbank funding, trading liabilities and wholesale
funding. Non-interest income (NonIntIncome) is generated by the trading assets and trading liabilities
(Trading Income) with fee and commissions.
Thus, the net income is from the revenue deducted by operating expense (OpExp) and taxes.
Net Income = [(IncomeLoans + other IntIncome - IntExp) + NonIntIncome - OpExp ](1 - tax) (7)
Then we move to investigate the source of funding. It consists of Short-term liabilities, wholesale
funding and equity. Short-term liabilities consist of trading liabilities(TradLiabs) and interbank funding
(IBFund). Wholesale funding is the debt with maturing within and longer than one year, which is short
and long-term debt respectively. Interest rate(r) on long-term debt is normally higher than short term.
Wholesale funding = Short-term Debt (rshort debt) + Short-term Debt (1- rshort debt) (8)
The last part in (7) can be referred to Long-term Debt because it is the remain from Short-term debt
IntExp= rdeposit(Deposits) + rshort debt(IBFund + TradLiabs + Short-term Debt) + rlong debt (Long-term Debt)
(9)
Where rdeposit is the interest rate on deposit, and rshort debt is the interest rate on short-term debt, which is
also applied on IBFund and TradLiabs, and rlong debt is the interest rate long-term debt. These interest
rates are calibrated from the long-term average from banks’ interest expense on his samples. The
equations follow.
rdeposit = x (10)
rshort debt = x + 0.01 (11)
rlong debt = x + 0.02 (12)
The related equations ((8),(9),(10),(11)) can be combined to;
X =
(13)
33
The last source of funding is equity, which can be found by;
rEquity = ROE =
(14)
ROE is the measurement of profit to the shareholders per unit, which is provided every given period.
This study focuses on the Capital level. Therefore, TCR is introduced.
TCR =
(15)
King (2010) assumes that the increase of shareholder’s equity is proportional with RWA to meet the TSR.
Et+1= E + ΔTCR(RWAt+1) (16)
The increase of the equity is offset by the debt, and it is assumed that the long-term debt is placed
because it is the most expensive liability.
ΔLong-term Debt = -ΔEquity (17)
Debt is offset with more expensive equity, leading to a decrease in the interest expense since the
amount of debt is one of the factors in equation (8), and it is lower. Therefore, the net income will
increase, and this causes the lower in ROE. The final assumption is banks offset the ROE by increasing
the lending spread (α) on loans.
IncomeLoanst+1= IncomeLoans + (α)(Loanst+1) (18)
Thus, the equation defining the rise in lending spread needed to maintain the same ROE is following.
Note that the increase in Capital level is directly relative with the lending spread as long as there is no
change in cost of debt and equity, and Long-term debt is offset by the increase in Equity.
α =
(19)
34
Chapter 5: Empirical Parts and Findings
This chapter focuses on the relevant data gathered from the financial statements of the focal banks
and Bank of Thailand (BOT)’s documents. The aim is to give the overview of Thai banks’ financial
situation. The information here will be mainly used with the theories in Chapter 4 in order to
answer the research questions. The structure is presented based on the relevant theory. Thus, it
begins with the situation of Thai banks’ capital level, leverage, liquidity ability and ends with the
finding of lending spread needed to offset the ROE from higher capital level.
The study takes Thai commercial banks as case study, and has chosen five banks holding the highest
total assets from 2009 -2011 as the group to represent the overview of financial situation of banks in
Thailand. The five banks are Bangkok Bank (BBL), Krung Thai Bank (KTB), Siam Commercial Bank (SCB),
Kasikorn Bank (KBANK) and Bank of Ayudhya (BAY). The data presented in this part is the related
financial transaction and detail that are consistent with the Basel iii and the impact of higher capital
level theory. Most of it is derived from the five banks’ annual reports and Basel ii – Pillar iii disclosures.
Yet, there is some information that is not provided from individual banks. Thus, the others are from the
statistic data, from BOT, of 14 average commercial banks used instead of the representative banks, and
regulation conducted by BOT.
5.1 Capital level situation of Thai banks
Table 1 shows the current average capital structure of representative banks in Thailand. Most of capital
relies on Tire1 Capital, which is over 50% of total capital and consist of the qualified items from Basel
regulations. The total capital and Tier1 Capital to RWA are 15.19% and 11% respectively. Bank of
Thailand (BOT) has stipulated the additional rules to buffer more risk taking. The rules are the increase
of TSR to be at least 8.5% of RWA from Basel’s 8%, and must include at least 4.25% of Tier1 Capital to
RWA on it (BOT 2012B).
35
Items (Average Bank 2009 - 2011) Amount(Unit: Million baht)
Tier 1 Capital 119,537
Paid up share capital 39,057
Premium on share capital 19,875
Legal and profit reserve 18,181
Retain earning afer appropriations 41,806
The Others 4,924
Deduction items (1,256)
Tier 2 Capital 45,601
Total Capital (Tier1 + Tier 2) 165,134
Total risk-weighted assets 1,091,549
Minimum capital requirement ( TSR = 8.5% of total RWA) 92,779
Tier1 Regulatory Capital (4.25% of total RWA) 46,390
Total Capital to Total risk-weighted assets 15.19%
Tier1 Capital to Total risk-weighted assets 11.00%
Net loans and
accrued interest
receivables
Net investment in
debt securities
Deposits (including
accrued interest
receivables)
The others Total
Avals, guarantees of
loans and letter of
credits
OTC derivativesUndrawn committed
linesTotal
Up to 1 year 494,120 62,919 25,165 - 582,204 35,099 706,420 6,146 747,664
Over 1 year 497,935 88,959 4,655 - 591,548 5,263 453,338 39,187 497,788
Valuation
Adjustment (2,340) - - - (2,340) - - - -
Total 989,715 151,877 29,819 - 1,171,412 40,362 1,159,757 45,333 1,245,452
Significant on-balance sheet assets and off-balance sheet items before credit risk mitigation classified by remaining maturity (2009)
Remaining
Maturity
On-balance sheet assets (Million baht) Off-balance sheet assets (Million baht)
Considering the capital structure from Basel ii in Table 1 and comparing with capital adequacy from
Basel iii, Banks currently have the amount of CET1 around 99,044 million baht. This number is gained
from the accumulation of Paid up share capital, Legal and profit reserve, and Retain earning after
appropriations, based on CET1 definition on 4.4.2. It means CET1 is, now, 9.01% of RWA for Thai banks.
Another issue affecting the level of capital level is the risk banks taking. According to the detail about
risk model improvement in 4.1.1, Basel iii focuses on the deeper risk management to tackle with the
complicated financial transaction that they have faced from global financial crisis. Particularly, the
purpose is to prevent the credit risk of counterparties. Therefore, the data below shows banks’
transactional assets, exposing to the credit risk, of both on and off balance sheet from 2009-2011.
Table 1: The average capital structure of Thai banks from 2009-2011 (BAY 2011A; BAY 2010A; BAY 2009A; BBL 2011A; BBL 2010A; BBL 2009A; KBANK 2011A; KBANK 2010A; KBANK 2009A; KTB
2011A; KTB 2010A; KTB 2009A; SCB 2011A; SCB 2010A; SCB 2009A)
Table 2: Banks' on and off balance sheet assets exposing to credit risk in 2009 (BAY 2009B; BBL 2009B; KBANK 2009B; KTB 2009B; SCB 2009B)
36
Net loans and
accrued interest
receivables
Net investment in
debt securities
Deposits (including
accrued interest
receivables)
The others Total
Avals, guarantees of
loans and letter of
credits
OTC derivativesUndrawn committed
linesTotal
Up to 1 year 564,611 61,965 27,475 - 654,051 40,873 876,875 11,645 929,393
Over 1 year 577,244 80,133 4,640 - 662,018 6,028 572,835 46,661 625,524
Valuation
Adjustment (2,978) - - - (2,978) - - - -
Total 1,138,878 142,099 32,115 - 1,313,091 46,901 1,449,710 58,306 1,554,917
Significant on-balance sheet assets and off-balance sheet items before credit risk mitigation classified by remaining maturity (2010)
Remaining
Maturity
On-balance sheet assets (Million baht) Off-balance sheet assets (Million baht)
Net loans and
accrued interest
receivables
Net investment in
debt securities
Deposits (including
accrued interest
receivables)
The others Total
Avals, guarantees of
loans and letter of
credits
OTC derivativesUndrawn committed
linesTotal
Up to 1 year 595,056 82,193 29,256 3,840 710,344 51,234 925,206 12,620 989,060
Over 1 year 677,656 98,189 2,961 3,586 782,392 6,769 412,650 39,254 458,672
Valuation
Adjustment (3,521) - - (62) (3,583) - - - -
Total 1,269,191 180,382 32,216 7,364 1,489,153 58,003 1,337,856 51,874 1,447,733
Significant on-balance sheet assets and off-balance sheet items before credit risk mitigation classified by remaining maturity (2011)
Remaining
Maturity
On-balance sheet assets (Million baht) Off-balance sheet assets (Million baht)
Table 3: Banks' on and off balance sheet assets exposing to credit risk in 2010 (BAY 2010B; BBL 2010B; KBANK 2010B; KTB 2010B; SCB 2010B)
As shown in Table 2, 3, and 4, it shows the overall assets from banks that contain the significant credit
risk from each year, 2009 – 2011. On the on-balance sheet side, more than 80% of assets rely on the
loans that are the main interest income for the banks, and most assets are hold with long-term maturity,
about 60%, comparing to the short term. The other side is the assets from off-balance sheet. The
distinct part item is banks significantly hold OTC derivatives over average 90% of total off-balance sheet
assets
Other than OTC derivatives, another main financial instrument causing global financial crisis in 2007, as
mentioned in section A and B of 3.4.3 is the securitization, especially the credit risk from CDOs. Thus,
this is also the risk that Basel iii aims to buffer. In Thai banks, there are only two, out of the chosen five
Table 4: Banks' on and off balance sheet assets exposing to credit risk in 2011 (BAY 2011B; BBL 2011B; KBANK 2011B; KTB 2011B; SCB 2011B)
37
Items Fair value (Million baht)
Investmet, net 180,125.10
CDOs 135.91
Average CDOs, Krung Thai Bank from 2009 - 2011
Items Fair value (Million baht)
Investmet, net 75,105.00
Trading securities(private sector) 177.33
Average Trading securities, Bank of Ayudhya from 2009 - 2011
banks, that have been found holding CDO as their investment in the annual reports. The two banks are
Krung Thai Banks and Bank of Ayudhya.
Table 5 shows the average amount of CDO that Krung Thai Bank has invested for the past three years.
The number of CDOs is considerably only 0.08% of the total investment. For the latter bank, Table 6, the
amount of CDOs is not appeared. The annual report only states that the CDOs invested have categorized
as one of the trading securities of private sector. So, to avoid the incorrect data, I bring the overall
number of these securities, and compare with the total investment. This indicates that even though
their investment of CDOs is accumulated with the other irrelevant securities, the proportion is just
0.24% of net investment.
Moreover, as said in 4.1.1, Basel iii requires banks conducting the financial transaction with the
internationally active institutions exposing to the high credit risk to increase the risk weight for the
particular assets. According to Table 2, 3 and 4, loans represent over 80% of the assets on the on-
balance sheet. This can be reasonably viewed that most of the credit risk come from the issued loans.
Table 5: Average CDO that Krung Thai Bank investing from 2009 – 2011 (KTB 2011A; KTB 2010A; KTB 2009A)
Table 6: Average Trading securities that Bank of Ayudhya invests from 2009 - 2011 (BAY 2011A; BAY 2010A; BAY 2009A)
38
Loan to individual customers 1,050,322
Bank of Thailand and Financial Institutions Development Fund 101,165
Commercial banks 3,438
Other financial institutions 23,951
Total 128,555
USD 16,260
JPY 1,376
EUR 1,286
Others 5,699
Total 24,620
Total interbank domestic and foreign items 153,175
Average Bank Loan on 2009 - 2011 (Milion baht)
Interbank Domestic items
Interbank Foreign items
Items Amount (Million baht)
Tier1 Capital 58,144
On-balance sheet 806,766
Off-balance sheet 888,903
Average 14 commercial banks 2009 - 2011
Therefore, the data, Table 7, showed below is the comparison between the loans banks issue to the
individual customers, for instance, corporations, people, etc., and loans issued to the interbank and
other financial institutions. Most of the loans are to individual customers, which cover around 70% of
total issued loans. The rest is to interbank and financial institutions, that is around 12% for domestics
and 18% for the foreign.
5.2 Leverage ratio of Thai banks
BSBC mentioned in 4.1.2 that leverage ratio is the Tier1 Capital divided by On and Off balance sheet
assets, which should be at least 3%. The statistic data, from BOT (2012A), of the related data is shown
below.
Table 7: The Loans of Thai banks from 2009 – 2011 (BAY 2011A; BAY 2010A; BAY 2009A; BBL 2011A; BBL 2010A; BBL 2009A; KBANK 2011A; KBANK 2010A; KBANK 2009A; KTB 2011A; KTB 2010A; KTB 2009A; SCB 2011A; SCB 2010A; SCB 2009A)
Table 8: the leverage ratio related information from 2009 – 2011 (BOT 2012A)
39
Items Amount (Million baht)
Liquid assets 169,599
Loans 487,377
Deposits 515,593
Total assets 806,766
Status of liquidity %
Loans/Deposits 95%
Liquid assets/ Total assets 21%
Liquid assets/ Deposits 33%
Average 14 commercial banks 2009 - 2011
From the number in Table 8, the preliminary number for Basel iii’s leverage ratio is gained by 58,144
million baht divided by the accumulation of On and Off balance sheet assets that is 1,695,669 million
baht. Therefore, the leverage ratio for Thai banks is, currently, 3.42%.
5.3 Liquidity ability of Thai banks
Due to the authorization problem to access the ongoing liquidity standard’s estimation in Thai banks,
and some detail in the LCR and NSFR equation is confidential, they are not able to calculate in this part.
So, the data shown here is the preparatory assessment of the liquidity ability of Thai banks, which is as
well used by BOT to estimate the liquidity for Basel iii implementation.
Table 9 shows the average amount of the items and status indicating liquidity level. On top, as referred
in 3.2.1, liquid assets mean the asset transacted to the obligation without decreasing its value. In this
Table, it is the liquid assets, with the defined qualification from BOT, which consist of cash, the deposit
with BOT and unobligated assets. The others are loans and deposits with counterparty that the number
Table 9: The amount of items and status indicating liquidity from 2009 - 2011(BOT 2012A)
40
0
1
2
3
4
5
6
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010
pe
rce
nta
ge
Thai lending spreads, year 1990 - 2010
is slightly different. The difference is shown as Loans/Deposits that is 95% or 5% in difference, and the
Liquid assets to total assets and to deposits are 21% and 33% respectively. Moreover, to make sure the
liquidity, BOT adds the regulation that requires commercial banks to have not less than 6% of average
total deposit (BOT 2010).
5.4 The impact of strengthening the capital level in terms of lending spread for Thai banks
In this section, the study provides the estimation, based on the balance sheet and income statement of
five chosen banks, and focuses on the lending spread rate. Hence, it starts with the fact of Thai lending
spread, following by the construction of five representative banks, and ends with the finding of lending
spread needed to increase.
5.4.1 Lending spread
As defined in 4.2, lending spread is the difference between bank’s costs of liabilities and interest on
loans. From the World Bank (2012), Thai lending spread was last reported at 4.92% in 2010. Figure 4
shows the historical information of Thai banks lending spread for the past 20 years since 1990. It has
been fluctuated between 3 – 1.5% from 1990 until starting to rise dramatically after the serious Thai
financial crisis in 1997. After continuously reaching its peak at 4.9% in 2002, the spread begins to fall
significantly since 2004 to 2006, then, rises again, and touches its peak in 2009 and 2010. The spread is
considerably the interest rate banks put on the prime customers deducted by the one giving to the
deposits. It gives the average around 3.65%.
Figure 4: Thai lending spreads rate from 2009 - 2010 (World Bank 2012)
41
Balance Sheet Average Income Statement Average
Cash and balance at Central Bank 2.33% Interest income on Loans 3.36%
Interbank claims 9.78% Other interest income 0.56%
Loans, Leases, Mortgages 71.76% Interest expense 1.27%
Investment and securities 15.08% A: Net Interest Income 2.65%
Other assets 0.99% B: Net none interest income 1.24%
Total assets 100.00% C: Total revenue (A + B) 3.90%
Deposits 72.08% D: Total operating expenses 2.16%
Short-term debt 4.49% E: Operating profits (C-D) 1.74%
Interbank funding 4.38% F: Income Tax provision 0.45%
Long-term debt 4.68% Net Income 1.29%
Other liabilities 3.17% Return on Equity (ROE %) 13.16%
Total liabilities 90.22% Average effective tax rate (%) 26%
Total Equity 9.80%
Total Equity and libilities 100.00%
Risk-weigted assets/ Total assets (%) 69.90%
Average Bank 2009 - 2011 Balance Sheet and Income Statement (As percentage of Total assets)
5.4.2 Structure of financial statements of Thai banks
The balance sheet and income statement presented here are derived from the annual report of five
mentioned banks from 2009 -2011.
Table 10 clarifies the bank’s items, from balance sheet and income statement, which are presented in
the percentage of total assets. On the asset part, obviously, loans are the highest value of assets that is
over 70%. This is followed by 15% from investment and securities, 9% from interbank claims and 2 % the
deposit on BOT. For the lower part, the liabilities, deposit represents the significant items that is also
approximately 70%, and the other items have equally proportional values, around 4%. RWA represents
more than half of the total assets, 69.9%. On the income statement, it is shown that Interest income on
Table 10: The structure of average financial statement of Thai banks from 2009 -2011(BAY 2011A; BAY 2010A; BAY 2009A; BBL 2011A; BBL 2010A; BBL 2009A; KBANK 2011A; KBANK 2010A; KBANK 2009A; KTB 2011A; KTB 2010A; KTB 2009A; SCB
2011A; SCB 2010A; SCB 2009A)
42
Before (A) After (B) Change (C) After (D) Change (E)
Total capital / RWA 15.19% 16.19% 1.00% 16.19% 1.00%
Risk-weigted assets/ Total assets 69.90% 69.90% 0.00% 69.90% 0.00%
Shareholder’s equity 9.80% 10.50% 0.70% 10.50% 0.70%
Long-term debt 4.68% 3.98% -0.70% 3.98% -0.70%
Increase in lending spreads 0.17%
Interest income on Loans 3.36% 3.36% 0.00% 3.48% 0.12%
Other interest income 0.56% 0.56% 0.00% 0.56% 0.00%
Total interest income 3.92% 3.92% 0.00% 4.04% 0.12%
Interest expense 1.27% 1.25% -0.02% 1.25% -0.02%
Net Interest income 2.65% 2.67% 0.02% 2.79% 0.14%
Net non Interest income 1.24% 1.24% 0.00% 1.24% 0.00%
Total revenue 3.89% 3.91% 0.02% 4.03% 0.14%
Operating expenses 2.16% 2.16% 0.00% 2.16% 0.00%
Pre tax income 1.73% 1.75% 0.02% 1.87% 0.14%
Net income 1.28% 1.30% 0.01% 1.38% 0.10%
Return on Equity (ROE %) 13.16% 12.33% -0.83% 13.16% 0.00%
Calculation of rise in lending spreads for 1 percentage point increase in capital ratio assuming no change in ROE or cost of debt
No change in lending spreads Increase in lending spreads
loans is the most important income, while operating expenses are largest expense banks face. After the
net between two mentioned items is deducted by the average tax rate, 26%, net income is left at 1.29%
of total assets.
5.4.3 Estimates of higher capital level.
This section shows the impact of increasing 1 % of capital ratios in terms of lending spreads. The
equations of this calculation are presented in 4.2, from equation (5) to (19). All the variables are the
average value of items from the financial statement in 5.4.2 above. However, for the items as trading
assets and liabilities, the annual reports from the representative banks have included them as one of the
investments and short-term debts respectively. Therefore, in this calculation, they have been
categorized as shown in the annual reports, and the result of estimation is not affected.
Table 11: The result of estimation for increase 1 percent of capital ratio level for Thai banks
43
Table 11 outlines the result of calculation for 1 % increase in capital ratio. The more detail is further
illustrate in APPENDIX B. The first column (A) provides the primary value of banks’ related items, derived
from Table 10, before increasing the capital ratio. In column B, the capital ratio (Total capital/RWA) is
increased for 1 % from 15.19% to 16.19%. This change gives the increase in equity for 0.7% as well as the
equivalent value decreased in long-term debt, assuming the total assets remain the same value.
Subsequently, the interest expense is decreased by 0.02%, leading to the equivalent drop in pre tax
income. Thus, the net income ends up higher 0.01%, whereas the mentioned equity is higher 0.7%. This
implies the fall of ROE for 0.83% from 1% of higher capital ratio. To offset the fall of ROE, the lending
spread needed to be increase is shown in column D. In order to maintain the same ROE as column A,
banks need to increase the net income by 0.1% This is happened by lowering the interest expense for
0.02% and higher interest income on loans around 0.12%. So, to generate the exact value of mentioned
income, banks are required to increase lending spreads by 0.17%. This can be referred that Banks need
to increase 0.17% of lending spreads to maintain the ROE from each 1% increase in capital ratio.
44
Chapter 6: Analysis & Discussion
In this chapter, the theories from Chapter 4 and Empirical parts from Chapter 5 will be analyzed.
The analysis is conducted by comparing the regulations from Basel iii with the financial situations
of Thai banks to see the preliminary possibility to adopt the regulation in 6.1. For the impact from
higher capital level, 6.2, the discussion relies on the sensitivity of the lending spread measure.
6.1 Basel iii and Financial situation of Thai banks
According to the new level of capital adequacy in 4.1.1, it divides total capital into three levels, which is
CET1, additional Tier1 and Tier2 capital. CET1 has to be at least 4.5% of RWA. The combination of CET1
and additional Tier1 are minimal at 6% of RWA. These amounts are summed up by Tier2 Capital, and
total capital remains at least 8% of RWA. Besides, Basel iii adds conservative buffers that are stated to
be not less than 2.5%.
From the capital regulations, Basel iii requires banks to have accumulative CET1 7% of RWA. This
number comes from CET1 4.5% from minimum requirement and another 2.5% more from conservative
buffers. As shown in 4.1, Thai banks’ current CET1 is introduced at 9.01%. This means that they already
have enough CET1 Capital. For the requirement with holding 6% of CET1 and additional Tier1, Basel does
not state the minimum for the additional Tier 1, and CET1 is even safer. Thai banks holding 9.01%,
therefore, passes the requirement. Last is the total capital ratio, which Thai banks have around 15.19%.
This number is considerably very high, comparing to the stated rule at 8.5%, and 10.5% with the
additional conservative buffers (BOT 2012B). This can be reasonably said that the new capital
requirement does not directly affect the level of Thai bank’s capital. They already have very strong and
enough capitals. This is because the lesson from the 1997 financial crisis that crunches the financial
contagion to all Asian countries. This crisis motivates Thai banks to have a strict risk management and
supervision, along with the high capital level to coup with the unexpected crisis (BOT 2010). Hence, Thai
banks are not directly affected by the profitability issues coming from the new capital requirement even
they implement this rules.
45
48.03%
51.97%
Total on and off balance sheet assets exposing to credit risk on average Banks from 2009 - 2011
OTC derivatives in off-balance sheet assets Other assets
Figure 5: Total on and off balance sheet assets exposing to credit risk on average Banks from 2009 - 2011(BAY 2011A; BAY 2010B; BAY 2009B; BBL 2011B; BBL 2010B; BBL 2009B; KBANK 2011B; KBANK 2010B; KBANK 2009B; KTB 2011B; KTB 2010B; KTB
2009B; SCB 2011B; SCB 2010B; SCB 2009B)
For the new risk coverage model of the Basel iii, the attention is on the credit risk from OTC derivatives
and securitizations or CDO. Based on table 2, 3, 4, the proportion of On and Off balance sheet for the
past 3 years is averagely about 50%. This refers that the banks carry about 50% of unofficial assets,
which is likely to be not properly regulated to the credit risk. This could generate the unnoticeable risk
for the regular investors or customers who are willing to do the financial transaction with these banks.
Taking a closer look, 90% of OBS is OTC derivatives, or it can be said that 48.03% of total on and off
balance sheets as shown in figure 5
The number of OTC derivatives banks carry is very high. This means that Thai banks have a tendency to
expose a very high risk from these assets. Moreover, if the attention turns to the amount of OTC
derivatives in particular year as on figure 6, it starts growing since 2009 even slightly dropped in 2011.
This information matches with BIS (2010D) saying that OTC derivatives in Thai banking sectors continue
growing since 2004 even though the turnover is very small comparing with other countries (BIS 2010C).
This might be because Thailand is now an emerging country in the eye of investors. Thus, the credit risk
from OTC derivatives is continuously growing in Thai banks.
46
-
200,000
400,000
600,000
800,000
1,000,000
1,200,000
1,400,000
1,600,000
2009 2010 2011
The Growth of Average OTC derivatives Banks investing from 2009 - 2011
However, BIS (2010D) says that Thai banking model is not complex and have very low complex financial
products. Thus, they argue that even though Thai banks hold many of viable OTC derivatives, they are
mostly plain derivatives, and contain low credit risk, for instance, foreign exchange swaps and interest
rate swap. Their argument is supported by BBL (2011A) showing the SA risk weight showing that over
60% of weightable assets are weighted at 0%, and 15% are weighted at 20%, and only 6% is on 100% risk
weight.
Thai banks are also considered to have a conservative way to manage the credit risk. One of the
evidences found is they have weighted most of the assets that are unable to officially be weighted by
the legal ECAIs at 100% (BAY 2011A; BAY 2010B; BAY 2009B; BBL 2011B; BBL 2010B; BBL 2009B; KBANK
2011B; KBANK 2010B; KBANK 2009B; KTB 2011B; KTB 2010B; KTB 2009B; SCB 2011B; SCB 2010B; SCB
2009B). For example, the assets, from retails or corporates, are not qualified to meet the criteria of
ECAIs. This could be a small partnership with the obligation to banks. It is very likely to be weighted at
100% as the worst case scenario so that Banks always have the capital enough to buffer the default.
Another is that Thai banks always have a special provision for loss by a classification of their assets for
risk weighting to be even very stricter than BOT regulations. For instance, in Siam Commercial Banks, the
NPL that values less than 20 million baht is used, which is considered very conservative and stricter than
BOT rules (SCB 2011A) . This conservatism reason also supports why Thai banks have very high capital
level provided above.
Another instrument Basel iii emphasizes is CDOs. The data is shown in Table 5 and 6. It shows that the
number of CDOs investment in Thai banks is very small, which is only 0.08% and 0.24% of total
investment for two banks. This implies that there is a very low risk exposed from CDOs for Thai banks.
Figure 6: The growth of OTC derivatives Banks from 2009 - 2011
47
Furthermore, Basel iii gives an attention to banks which attend the financial transactions with the high
credit risk-exposed financial instructions to have more capital base. This is done by increasing the risk
weight for the particular assets. Due to the loans representing over 80% of the credit risk-exposed
assets, the focus of this regulation is on the bank’s loan. From Table 7, 70% is the loans to individual
customers. So another 30% left is the loans giving to the interbank. On the domestic items, there are
101,165 million baht giving to the BOT and financial institutions development fund. This item can be
referred as risk-free. Hence, the proportion of loans for the individual customers to other financial
institutions is 95.28% that is presented in Figure 7. This can be said that the number of interbank is very
little. Even though the entire interbank that Thai banks give loan to is a high credit risk-exposed one,
there are only 4.72 % of loans that need to be increased the risk weight. Therefore, Thai banks have a
little effect to the capital level from this regulation.
The next regulation is about the leverage ratio. According to the 5.2, the current leverage ratio of Thai
banks is 3.42%. This means that they already pass the minimum requirement from Basel iii that is 3% of
total asset. Thus, there is no effect to Thai banks from this regulation. However, Thai banks are currently
Figure 7: The percentage of Loan to individual customers and Total loan, excluding Bank of Thailand and Financial Institutions Development Fund (BAY 2011A; BAY 2010A; BAY 2009A; BBL 2011A; BBL 2010A; BBL 2009A; KBANK 2011A; KBANK 2010A; KBANK 2009A; KTB 2011A; KTB 2010A; KTB 2009A; SCB 2011A; SCB 2010A; SCB 2009A)
48
not regulated by the minimum leverage ratio (BOT 2010). This means that they can still build up the
leverage as long as the capital ratio is in a good condition, which can generate the intrinsic risk in the
long term. So, applying this regulation can be additionally beneficial to Thai banks’ structure. This is the
good way to deal with the over leverage risk with the simplicity, which means it is easy to implement
and monitor. Besides, it can considerably be quickly adopted without requiring high cost, complicated
model and the skilled supervisors. However, only leverage ratio is unable to reflect the risk from
complicated financial instrument such as, CDOs or some OBS assets due to the exclusion of risk-related
view. Hence, the leverage ratio needs to be used along with the proper capital ratio, which should not
be a problem in Thai banks because BOT already has the 8.5% of capital ratio regulations.
The last framework of Basel iii is liquidity standards. As stated in 5.3, the author is unable to access the
studying LCR and NSFR process of Thai banks due to the authorization problem. So, the analysis of
situation in Thai banks is conducted by introducing the status of liquidity. Liquidity is the ability to meet
the demanded obligation without lowering the value. Loans/Deposits for Thai banks is 95%. This means
95% of total deposits are given to loans. The number seems quite high and illiquid, but if it is compared
to other countries, such as 325% in Demark and 54% in Hong Kong, Thai ratio is in normal condition (BIS
2011C). Nevertheless, if considering Liquidity assets/Deposits that is 33%, and BOT has regulated this
ratio not less than 6%, the ratio can be viewed very high. They have 33% liquidity assets, comparing to
deposits, that can to turn to cash anytime they demand without lowering value. 21% of total assets can
be also viewed as a very high liquidity number (Fineman et al. 2011). Besides, Thai banks have the
conservative risk management strategies, mentioned in above, that ensure that Thai banks have enough
capital and assets to buffer the liquidity risk.
Another evidence can be used to support here is the level of non-performing loan (NPL)v has
continuously decreased every year since 2007, and it is also estimated to be lower in the future (BOT
2012C). These can be preliminarily said that the liquidity ability of Thai banks is in the good condition
and expected to be better.
v
Loans that are not met or closely to default to the demanded obligation.
49
6.2 The dependence of lending spread measure
From figure 11, the finding shows that if Thai banks increase 1 % of capital ratio, it will lower ROE around
0.83% of total assets. Subsequently, if the banks maintain the ROE, it will result in 0.17% of lending
spreads increased. The calculation indicates that there are two important items that is mostly sensitive
to the lending spreads. First is the amount of loans to total assets. The more size of loans, the less
lending spreads are required to increase. In calculation on Table 11, loan represents 71.76%, which
results in the net interest income (IntIncome) around 2.65%. If there is 1 % of capital level increasing,
the IntIncome has to respond by increasing around 0.14% to offset the 0.83% lower in ROE. Without
issuing more loans, lending spread needs to increase 0.17%. If the size of loans is larger as well as 1 %
increasing in capital ratio, the IntIncome will respond less, then it results in lower lending spreads
required. Second is the amount of RWA. RWA is, in the calculation, 69.9%. If this number is 100%, it
leads to the increase of equal value in equity. Finally, to offset, the lending spread will increase by
around 0.27%.
However, if the focus turns to the items that do not affect the lending spreads, the finding shows that
the items that do not change from column A to B and D have no result to lending spreads sensitivity. For
instance, if 20% of taxes are used, or the operating expense is lower to 1% of total assets at the
beginning, the lending spread still remains increased at 0.17%.
50
Chapter 7: Conclusion & Further research
This chapter contains the answers of the research questions, which are concluded from
Chapter 5. Furthermore, suggestion for the further research is provided.
7.1 The needs for Thai banks to adopt Basel iii
From three main regulations from Basel iii, there are the new capital level, leverage ratio and liquidity
standards. The finding from first pillar, 5.1, concludes that Thai banks have apparently a very high capital
level, 9% for CET1 and 15.17% for total capital ratio. These numbers already pass the requirement from
Basel iii that states that these should be at least 7% and 10.5%. For the risk coverage, focusing on credit
risk, the risky financial instrument, for instance, CDOs and OTC derivatives that Thai banks transact, is
not complicated, and has a very low level, comparing to other countries. Even more, the situation is also
dealt by the conservative risk management method that weights, for example, most of the doubtful
assets as worst case scenario. Therefore, Thai banks do not need the regulation about Capital level from
Basel iii. Another pillar is leverage ratio. The ratio of Thai banks is at 3.42%, which also passes 3%
requirement from regulation. However, adopting leverage ratio is considerably beneficial to Thai banks.
Leverage ratio is another way to reduce the intrinsic risk without requiring much cost, skilled workforce
and complicated procedure. This refers that leverage ratio should be adopted in Thai banks. The last
pillar goes to liquidity standards. The liquidity situations is considered to be in the good situation and
expected to be better. This is judged by 33% and 21% of liquidity assets to deposits and total assets,
respectively, which is very high. 33% is even much higher than 6% of regulations from BOT. Besides, the
liquidity ability is made sure by the conservative risk management idea, and the continuously lowering in
NPL every year. This can be preliminarily said the liquidity situation is in good condition as well as low
risk from both on balance sheet and OBS. So, they do not need liquidity standards for now.
51
Therefore, for the above reasons, the first research question is answered by saying there is no need for
Thai banks to adopt all main regulations from Basel iii. Only leverage ratio that Thai banks should
consider. However, they can use it as the guideline to improve their risk management model as well as
the way to control the liquidity to be better.
7.2 The impact to Thai banks from strengthening capital level in terms of lending spreads
The result shows that the higher cost in 1 %of capital ratio results in the decrease of 0.83% in ROE. Thus,
the representative banks maintain the profitability by increasing 0.17% of lending spreads. The
calculation is assumed that no change in cost of debt, sources of income and banks’ structure. The
sensitive items are found that the lending spread rate mostly depends on the size of loans and RWA to
total assets.
In practice, banks always use combination strategies to deal with the lower of ROE. The alternatives
might be the reducing the operation expense, higher the fee from noninterest income items, etc.
Nevertheless, this calculation can be used to make a preliminary assessment, and based on the idea that
banks have a high tendency to higher the lending spread when facing the lower of profitability (Roger &
Vitek 2012; King 2010).
7.3 Further research
This research provides a path way to preliminarily assess the possibility to implement Basel iii on the
banks. However, there are some aspects that are unable to calculate due to the authorization problem
to access the ongoing information especially with the LCR and NFSR. Also, some of detail regulations are
still in the developing process. Therefore, for the further research, the author should make the
assessment more reliable by dealing with the LCR and NSFR issue as well as taking more regulations into
account after more related information is released. Furthermore, it is interesting for the further
research to carry out more case studies. The scope could be extended to study banks on particular
countries that have different economic scales and various complicated financial instruments.
Subsequently, the comparison among banks can be made to find out the precise factors that need to be
52
considered for the implementation of the current Basel and next Basel afterword. The conclusion of
these factors can also be developed as the capital level-related model for banks and other financial
institutions, and they can use this model as a guideline when the new financial regulations or
assessment is needed.
53
References
Apostolic, R., Donohue, C. & Went, P. (2009). Foundations of Banking Risk: An Overview of Banking,
Banking Risks, and Risk-Based Banking Regulation. Washington: Willey
Balin, D. (2008) Basel I, Basel II, and Emerging Markets: A Nontechnical Analysis. Journal of Banking &
Finance, 24(1), 35-38.
Balin, D. (2008). Basel I, Basel II, and Emerging Markets: A Nontechnical Analysis. [online] Available
from:
https://jscholarship.library.jhu.edu/bitstream/handle/1774.2/32826/Basel%20I,%20Basel%20II,%20and
%20Emerging%20Markets%20a%20Nontechnical%20Analysis052008.pdf [2012-04-27].
BAY (2009A). Bank of Ayudhya Annual Report 2009 [online] Available from:
https://www.krungsri.com/en/investor-relation.aspx?cid=30 [2012-03-24].
BAY (2009B). Bank of Ayudhya Basel ii Pillar 3 Disclosure 2009 [online] Available from:
http://www.krungsri.com/en/investor-relation.aspx?cid=85 [2012-03-24].
BAY (2010A). Bank of Ayudhya Annual Report 2010 [online] Available from:
https://www.krungsri.com/en/investor-relation.aspx?cid=30 [2012-03-24].
BAY (2010B). Bank of Ayudhya Basel ii Pillar 3 Disclosure 2010 [online] Available from:
http://www.krungsri.com/en/investor-relation.aspx?cid=85 [2012-03-24].
BAY (2011A). Bank of Ayudhya Annual Report 2011 [online] Available from:
https://www.krungsri.com/en/investor-relation.aspx?cid=30 [2012-03-24].
BAY (2011B). Bank of Ayudhya Basel ii Pillar 3 Disclosure 2011 [online] Available from:
http://www.krungsri.com/en/investor-relation.aspx?cid=85 [2012-03-24].
BBL (2009A). Bangkok Bank Annual Report 2009 [online] Available from:
http://www.bangkokbank.com/BangkokBankThai/Documents/Site%20Documents/Annual%20Report/2
009/AR2009_En.pdf [2012-03-24].
BBL (2009B). Bangkok Bank Basel ii Pillar 3 Disclosure 2009 [online] Available from:
http://www.bangkokbank.com/BangkokBankThai/Documents/Site%20Documents/For%20Shareholder/
Basel%20II_Pillar3_Dec%2009_En_30Apr10.pdf [2012-03-24].
BBL (2010A). Bangkok Bank Annual Report 2010 [online] Available from:
http://www.bangkokbank.com/BangkokBankThai/Documents/Site%20Documents/Annual%20Report/2
010/AR2010_En.pdf [2012-03-24].
54
BBL (2010B). Bangkok Bank Basel ii Pillar 3 Disclosure 2010 [online] Available from:
http://www.bangkokbank.com/BangkokBankThai/Documents/Site%20Documents/For%20Shareholder/
BaselII_Pillar3_Dec10_En_29Apr11.pdf [2012-03-24].
BBL (2011A). Bangkok Bank Annual Report 2011 [online] Available from:
http://www.bangkokbank.com/BangkokBankThai/Documents/Site%20Documents/Annual%20Report/2
011/AR2011_En.pdf [2012-03-24].
BBL (2011B). Bangkok Bank Basel ii Pillar 3 Disclosure 2011 [online] Available from:
http://www.bangkokbank.com/BangkokBankThai/Documents/Site%20Documents/For%20Shareholder/
BaselII_Pillar3_Dec2011_En.pdf [2012-03-24].
Berk, J. and Demarzo, P. (eds.) (2009). Corporate finance: The core. London and New York: Pearson
Education
Bessis, J. (eds.) (2010). Risk Management in Banking. New York: Willey
Bhattacharya, S. & Thakor, A. (1993), Contemporary banking theory. Journal of Financial Intermedition,
3, 2–50.
Bhowmik, J. & Tewari, S. (2010). Basel Accord and the Failure of Global Trust Bank: A Case Study. The
UIP Journal of Bank management, 9(3), 37-62.
BIS (1986). The Management of Banks’ off-balance sheet. [online] Available from:
http://www.bis.org/publ/bcbs134.pdf [2012-04-16].
BIS (1998). International Convergence of capital measurement and standards. [online] Available from:
http://www.bis.org/publ/bcbsc111.pdf [2012-04-22].
BIS (1999). Capital requirements and Bank behavior: The impact of the Basel accord. [online] Available
from: http://www.bis.org/publ/bcbs_wp1.pdf [2012-04-22].
BIS (2002). Risk measurement and systemic risk. [online] Available from:
http://www.bis.org/cgfs/conf/mar02.pdf [2012-04-18].
BIS (2006A). The management of liquidity risk in financial groups. [online] Available from:
http://www.bis.org/publ/joint16.pdf [2012-04-19].
BIS (2006B). International Convergence of Capital Measurement and Capital Standards. [online]
Available from: http://www.bis.org/publ/bcbs128.pdf [2012-05-19].
BIS (2008). Principles for Sound Liquidity Risk Management and Supervision. [online] Available from:
http://www.bis.org/publ/bcbs144.pdf [2012-04-18].
BIS (2009). History of the Basel Committee and its Membership. [online] Available from:
http://www.bis.org/bcbs/history.pdf [2012-04-18].
55
BIS (2010A). Results of the comprehensive quantitative impact study. [online] Available from:
http://www.bis.org/publ/bcbs195.pdf [2012-04-28].
BIS (2010B). Systemic risk: how to deal with it?. [online] Available from:
http://www.bis.org/publ/othp08.htm [2012-04-24].
BIS (2010C). Result of 2010 Triennial Central Bank Survey of Foreign Exchange and Derivatives Market
Activity. [online] Available from: http://www.bis.org/publ/othp08.htm [2012-05-24].
BIS (2010D). The global crisis and financial intermediation in emerging market economies. [online]
Available from: http://www.bis.org/publ/bppdf/bispap54.pdf [2012-05-24].
BIS (2010E). Phase-in arrangements (shading indicates transition periods. [online] Available
http://www.bis.org/press/p100912b.pdf [2012-05-13].
BIS (2011A). Basel III: A global regulatory framework for more resilient banks and banking systems.
[online] Available from: http://www.bis.org/publ/bcbs189.pdf [2012-04-12].
BIS (2011B). Principles for the Sound Management of Operational Risk. [online] Available from:
http://www.bis.org/publ/bcbs189.pdf [2012-04-12].
BIS (2011C). Weathering the financial crisis: good policy or good luck?. [online] Available from:
http://www.bis.org/publ/work351.pdf [2012-05-8].
Blundell-Wignall, A. & Atkinson, P. (2010) Thinking beyond Basel III: Necessary Solutions for Capital and
Liquidity. OECD Journal: Financial Market Trends, 2010(1), 1-23.
Borak, D. (2012). Basel III: From Blase to Ballistic. Mergers & Acquisitions: The Dealermaker's Journal,
46(6), 12.
Bordeleau, E. & Graham, C. (2010). The impact of Liquidity on Bank Profitability. [online] Available from:
http://www.banque-
france.fr/fondation/fr/telechar/seminaires/Bordeleau_Graham_WP_Lliquidity_Profitability.pdf [2012-
05-14].
BOT (2006). Building the OTC Market for THB Interest Rate Derivatives [online] Available from:
http://www.bot.or.th/Thai/FinancialMarkets/Fin_Mkt_Development/Documents/pwc%20thai.pdf
[2012-04-2].
BOT (2012A). Average of Ratio of Thai Commercial Banks [online] Available from:
http://www2.bot.or.th/statistics/BOTWEBSTAT.aspx?reportID=427&language=ENG [2012-03-28].
BOT (2012B). นสว.
เรื่องคุณสมบตัิของตราสารทางการเงินท่ีนับเป็นเงินกองทุนและวิธกีารทยอยลดนับตราสารท่ีเป็รเงนิกองทุนตามเกณ Basel iii
[The characteristic of financial instrument and capital structure from Basel iii regulation] [online]
56
Available from: http://www2.bot.or.th/fipcs/thai/PFIPCS_summary.aspx?packId=25550045 [2012-03-
28].
BOT (2012C). NPL ratio of Banking system [online] Available from:
http://www.bot.or.th/Thai/Statistics/Graph/Pages/NPL.aspx [2012-04-3].
BOT [Bank of Thailand] (2010) แนวทางการก ากับดูแลสภาพคล่องตามหลักเกณ Basel iii [A guidance of Basel iii
framework] [online] Available from:
http://www.bot.or.th/Thai/FinancialInstitutions/Highlights/BaselIII/Pages/Basel3.aspx [2012-04-13].
Bryman, A. & Bell, E. (2007). Business research methods: Interviewing in Qualitative Research. New York:
Oxford University. pp. 472-281
Casu, B. (2005). An analysis of the relevance of off-balance sheet items in explaining productivity change
in European banking. An analysis of the relevance of off-balance sheet items in explaining productivity
change in European banking, 15(15), 1053-1061.
Chabanel,P. (2011). Implementing Basel iii: challenges, Options & Opportunities. [online] Available from:
http://www.moodysanalytics.com/~/media/Insight/Regulatory/Basel-III/Thought-Leadership/2011/11-
01-09-Implementing-Basel-III-Whitepaper.ashx [2012-05-12].
Chen, A., Nengjiu, J., Mazumda, S. & Verma, A. (2006). Correlated Default Risks and Bank Regulations.
Journal of Money, Credit & Banking, 38(2), 375-398.
Cooper D. & Emory W. (1995). Business research methods: Personal Interviewing. United States of
America: Richard D. Irwin, Inc. pp. 270-279.
Creswell, J. W. (2009). Research design: qualitative, quantitative and mixed methods approaches.
Thousand Oaks: Sage Cop.
Dalmaz, S. (2010). The Basel III Leverage Ratio Is A Raw Measure, But Could Supplement Risk-Based
Capital Metrics [online] Available from: http://www.bis.org/publ/bcbs165/splr.pdf [2012-03-27].
Docherty, P. (2008). Basel II and the Political Economy of Banking Regulation-Monetary Policy
Interaction. International Journal of Political Economy, 37(2), 82-106.
Douglas, W., Diamond, D. & Philip, D. (2012). Banking Theory, Deposit Insurance, and Bank Regulation.
Chicago Journal, 59(1), 55-68.
Drumond, I. (2009). Bank Capital Requirements, Business Cycle Fluctuations and the Basel Accords: A
Synthesis. Journal of Economic Surveys, 23(5), 798-830.
Entrop, O., Wilkens, M., & Zeisler, A. (2009). Quantifying the Interest Rate Risk of Banks: Assumptions
Do Matter. European Financial Management, 15(5), 1001-1018.
Euroweek. (2011). Banks say Basel III still threatens trade finance. Euroweek, 12(29), 17.
57
Fineman, D., Kevalee, T., Sothikul, S. (2011). Thailand Banks Sector [online] Available from:
http://data.worldbank.org/indicator/FR.INR.LNDP [2012-04-1].
Francis, W. & Osborne, M. (2012). Capital requirements and bank behavior in the UK: Are there lessons
for international capital standards?. Journal of Banking & Finance, 36(3), 803-816.
Giandomenico, R. (2011). Asset Liability Management for Banks. IUP Journal of Bank Management,
10(4), 31-46.
Gibbons, R. (2010). Risk Management in Foreign Exchange Shouldn't be a Foreign Idea. Financial
Executive, 26(3), 62-64.
Golafshani, N. (2003) Understanding Reliability and Validity in Qualitative Research. The Qualitative
report, 8(4), 597-606.
Gupta, V. & Jain, P. (2004). Liability Management in Commercial Banks in India: A Comparative Study of
Bank Groups in Liberalized-Era. Global Journal of Flexible Systems Management, 5(4), 53-66.
Haimes, Y. (2009). Liquidity Risk and Liability Management: Myths and Misconceptions. Bank Accounting
& Finance, 29(12), 1647-1654.
Hannoun, H. (2010) The Basel III Capital Framework: A Decisive Break through [online] Available from:
http://www.bis.org/speeches/sp101125a.pdf [2012-04-12].
Hempel, G. & Simonson, D. (eds.) (1999). Bank Management: Text and Cases. New York: Willey
Hull, J. (eds.) (2009). Risk Management and Financial Institutions. New York: Prentice Hall
Hulster, K. (2009) The Leverage Ratio [online] Available from:
http://www.worldbank.org/financialcrisis/pdf/levrage-ratio-web.pdf [2012-03-26].
Jablecki, J. (2009). The impact of Basel I capital requirements on bank behavior and the efficacy of
monetary policy. International Journal of Economic Sciences and Applied Research, 2(1), 16-35.
Jobst, A. (2008). What Is Securitization?. [online] Available from:
http://www.imf.org/external/pubs/ft/fandd/2008/09/pdf/basics.pdf [2012-04-16].
Jones, D. (2000). Emerging problems with the Basel Capital Accord: Regulatory capital arbitrage and
related issues. Journal of Banking & Finance, 24(1), 35-38.
KBANK (2009A). Kasikorn Bank Annual Report 2009 [online] Available from:
http://www.kasikornbank.com/EN/Investors/FinanInfoReports/FinancialReportsAnnual/en00_KBank_all
.pdf [2012-03-24].
KBANK (2009B). Kasikorn Bank Basel ii Pillar 3 Disclosure 2009 [online] Available from:
http://www.kasikornbank.com/EN/Investors/FinanInfoReports/FinancialReportsSemiAnnualNew/Risk%
20and%20Capital%20Management%20Disclosure%2031%20December%202009.pdf [2012-03-24].
58
KBANK (2010A). Kasikorn Bank Annual Report 2010 [online] Available from:
http://www.kasikornbank.com/EN/Investors/FinanInfoReports/Pages/AnnualReports.aspx?y=2010
[2012-03-24].
KBANK (2010B). Kasikorn Bank Basel ii Pillar 3 Disclosure 2010 [online] Available from:
http://www.kasikornbank.com/EN/Investors/FinanInfoReports/FinancialReportsSemiAnnualNew/Risk%
20and%20Capital%20Management%20Disclosure%2031%20December%202010.pdf [2012-03-24].
KBANK (2011B). Kasikorn Bank Basel ii Pillar 3 Disclosure 2011 [online] Available from:
http://www.kasikornbank.com/EN/Investors/FinanInfoReports/FinancialReportsSemiAnnualNew/Risk%
20and%20Capital%20Management%20Disclosure%2031%20December%202011.pdf [2012-03-24].
KBANK [Kasikorn Bank] (2011A). Kasikorn Bank Annual Report 2011 [online] Available from:
http://www.kasikornbank.com/EN/Investors/FinanInfoReports/FinancialReportsAnnual/kbank_en.pdf
[2012-03-24].
Killan, T. (2010) Basel III and Its Implications: A Closer Look [online] Available from:
http://www.sandleroneill.com/Collateral/Documents/English-
US/Basel%20III%20Implications%20FINAL.pdf [2012-04-18].
King, M. (2010). Mapping capital and liquidity requirements to bank lending spreads [online] Available
from: http://www.bis.org/publ/work324.pdf [2012-05-1].
King, P. & Tarbert, H. (2011) Basel III: An Overview. Banking & Financial Services Policy Report, 30(5), 1-
18.
Koch, T. and Mcdonald, S. (eds.) (2002). Bank Management. London: South-Western College Pub
Kothari, C.R. (2004). Research methodology: methods & techniques. [Online] (2 ed.). New Age
International : New Delhi. Available: Ebrary [2012-05-03].
KPMG (2010). Basel 3 Pressure is building. [online] Available from:
http://www.kpmg.com/BH/en/Documents/Basel%203-%20Pressure%20is%20building%E2%80%A6.pdf
[2012-05-12].
KTB (2009A). Krung Thai Bank Annual Report 2009 [online] Available from:
http://www.ktb.co.th/ktb/en/ktb-annual-report.aspx [2012-03-24].
KTB (2010A). Krung Thai Bank Annual Report 2010 [online] Available from:
http://www.ktb.co.th/ktb/en/ktb-annual-report.aspx [2012-03-24].
KTB (2010B). Krung Thai Bank Basel ii Pillar 3 Disclosure 2009 [online] Available from:
http://www.ktb.co.th/ktb/en/ktb-basel-pillar-report.aspx [2012-03-24].
KTB (2010B). Krung Thai Bank Basel ii Pillar 3 Disclosure 2010 [online] Available from:
http://www.ktb.co.th/ktb/en/ktb-basel-pillar-report.aspx [2012-03-24].
59
KTB (2011B). Krung Thai Bank Basel ii Pillar 3 Disclosure 2011 [online] Available from:
http://www.ktb.co.th/ktb/en/ktb-basel-pillar-report.aspx [2012-03-24].
KTB [Krug Thai Bank] (2011A). Krung Thai Bank Annual Report 2011 [online] Available from:
http://www.ktb.co.th/ktb/en/ktb-annual-report.aspx [2012-03-24].
Leonall, A. & Albert, B. (1969). Asset management and commercial bank portfolio behavior: Theory and
practice. Journal of finance , 24(2), 207-222.
Leonard, M. (2002). Liquidity Risk and Liability Management: Myths and Misconceptions. Bank
Accounting & Finance, 16(1), 5.
Mellor, W. , Suwannakij, S. (2012). Thailand providing best after China among Emerging countries.
[online] Available from: http://www.bloomberg.com/news/2012-02-22/thailand-proving-best-after-
china-among-global-emerging-markets.html [2012-11-10].
Misra, D. & Vishnani, S. (2012). Impact of Corporate Governance Regulation on Market Risk. The Journal
for Decision Makers, 37(2), 19-32.
Pokutta, S. & Schmaltz, C. (2011). Managing liquidity: Optimal degree of centralization. Journal of
Banking & Finance, 35(3), 627-638.
Rabiul, M. (2010). Banks, Stock Markets and Economic Growth: Evidence from Selected Developing
Countries. Decision, 37(3), 5-29.
Rayhavan, R. (2003). Risk Management In Banks. [online] Available from:
http://www.icai.org/resource_file/11490p841-851.pdf [2012-04-14].
Roger, S. & Vitek, F. (2012). The Global Macroeconomic Costs of Raising Bank Capital Adequacy
Requirements. [online] Available from: http://www.imf.org/external/pubs/ft/wp/2012/wp1244.pdf
[2012-05-14].
Rosato, J. (2011). Down the road to perdition : How the flaws of Basel II led to the collapse of Bear
stearns and Lehman Brothers . Connecticut insurance law journals, 17(2), 476-500.
Rose, P. (eds.) (2001). Commercial Bank Management. New York: McGraw-Hill/Irwin
Sachdeva, J.K. (2009). Business research methodology. [Online] (2 ed.). Himalaya Pub: Mumbai.
Available: Ebrary [2012-05-03].
Sanchez, M. (2011) Financial crises: Prevention, correction, and monetary policy. Cato journal, 31(3),
521-534.
Santos, E. (2011). Implementing Basel III in emerging economies: a process not free of pain. [online]
Available from:
http://www.bbvaresearch.com/KETD/fbin/mult/111006_Emerging_economies_economic_watch_tcm3
48-270886.pdf?ts=3182012 [2012-05-14].
60
SCB (2009A). Siam Commercial Bank Annual Report 2009 [online] Available from:
http://www.scb.co.th/en/getfile/11/annual [2012-03-24].
SCB (2009B). Siam Commercial Bank Basel ii Pillar 3 Disclosure 2009 [online] Available from:
http://www.scb.co.th/en/getfile/1/market_disclosures [2012-03-24].
SCB (2010A). Siam Commercial Bank Annual Report 2010 [online] Available from:
http://www.scb.co.th/en/getfile/12/annual [2012-03-24].
SCB (2010B). Siam Commercial Bank Basel ii Pillar 3 Disclosure 2010 [online] Available from:
http://www.scb.co.th/en/getfile/4/market_disclosures [2012-03-24].
SCB (2011B). Siam Commercial Bank Basel ii Pillar 3 Disclosure 2011 [online] Available from:
http://www.scb.co.th/en/getfile/6/market_disclosures [2012-03-24].
SCB [Siam Commercial Bank] (2011A). Siam Commercial Bank Annual Report 2011 [online] Available
from: http://www.scb.co.th/en/getfile/13/annual [2012-03-24].
Sheldon, G. (2010) Costs and Benefits of Capital Adequacy Requirements: An Empirical Analysis for
Switzerland [online] Available from:
http://wwz.unibas.ch/fileadmin/wwz/redaktion/fai/Publikationen/capital_adequacy.pdf [2012-04-18].
Sirisophonsin, S. (2009). ความเป็นศูนย์กลาง Logistic ของไทย [Thailand’s Logistic Hub]. [online] Available
from: http://www.eng.chula.ac.th/newsletter/index.php?q=node/33 [2012-11-10].
Slovik, P. & B. Cournède (2011) Macroeconomic Impact of Basel III [online] Available from:
http://www.oecd-
ilibrary.org/docserver/download/fulltext/5kghwnhkkjs8.pdf?expires=1346660743&id=id&accname=gue
st&checksum=60D61381078FB8D1C72085D74DD0840D [2012-04-30].
Smith, R. (2012). Keep Basel III Away from Small Banks. American Banker, 177(128), 8.
Songshin, H. (2009) Securitization and financial stability. The Economic Journal, 119(3), 309-322.
Walker, G. (2011). Basel III market and regulatory compromise. Journal of Banking Regulation, 12(2), 95-
99.
Watanabe, W. (2011). Prudential Regulations and Banking Behavior in Japan. Japanese Economy, 38(3),
30-70.
World Bank (2012). Interest rate spread [online] Available from:
http://data.worldbank.org/indicator/FR.INR.LNDP [2012-04-2].
Yang, C. (2012). Service, investment, and risk management performance in commercial banks. Service
Industries Journal, 32(12), 2005-2025.
61
Zaimal, Z. (2007) Case study as a research method. Journal Kemanusiaan, 9(3), 1-6.
Zimmerman, T. (2007) The Great Subprime Meltdown of 2007. The Journal of structured finance, 13(3),
7-20.
APPENDIX A: Implementation Timelines.
BIS (2010E) states the minimum level of common equity is started from 2% of total risk-weighted assets
in 2011, and continuously increased until 4.5% in 2015. The same idea also applies on the minimum level
of Teir1 Capital, which starts at 4%, and increases until 6% in 2015. The other two buffers, that are
capital conservative buffer and counter cyclical buffer, are both begun at 0.625%, and consecutively
higher until 2.5% in 2019. The leverage ratio begins using from 2013 at 3%. LCR and NSFR are currently
in the observation period until 2015 and 2018 respectively. The ratios start implementing after these
particular years.
APPENDIX B: The calculation of increasing capital level to the lending spread
Note that the calculation assumes that Risk-weighted asset/Total assets, other interest income, Net non-
Interest income and operating expense remain the same after increasing 1 % of Capital ratio. Another is
the calculation treats trading assets and liabilities as one of the investments and short-term debts
respectively and there is no effect on the result. There are two sections in this appendix. First is the
2011 2012 2013 2014 2015 2016 2017 2018As of 1st January
2019
Minimum common equity 2.0% 2.0% 3.5% 4.0% 4.5% 4.5% 4.5% 4.5% 4.5%
Minimum teir 1 capital 4.0% 4.0% 4.5% 5.5% 6.0% 6.0% 6.0% 6.0% 6.0%
Minimum total capital 8.0% 8.0% 8.0% 8.0% 8.0% 8.0% 8.0% 8.0% 8.0%
Capital conservative buffer 0.625% 1.25% 1.875% 2.50%
Counter cyclical buffer ≤ 0.625% ≤ 1.25% ≤ 1.875% ≤ 2.50%
Leverage ratio
Liquidity coverage ratio (LCR)
Net stable funding ratio (NSFR)
Supervisor monitoring Intial set as 3% during obsevation period from 1 January 2013 to 1 January 2017 The plan is to migrate to Pillar 1
treatment on 1 January 2018
Obsevation period Minimum standard applies
Obsevation period Minumum standard applies
62
result of no change in lending spread on the After column (B) and second is when increase the lending
spread, After column (D).
No change in lending spread on the After column (B)
Equity:
Et+1= E + ΔTCR (RWAt+1) (16)
ΔTCR is the capital ratio increase.
= 0.098 + 0.01(0.699) = 0.105
Long-term debt:
ΔLong-term Debt = -ΔEquity (17)
ΔEquity is the difference between Shareholder’s equity’ Before (A) and After (B) which is 0.007 = -ΔLong-
term Debt = 0.007. Therefore, Long-term debt = 0.0468 – 0.007 = 0.0398.
Interest Expense:
IntExp= rdeposit(Deposits) + rshort debt(IBFund + TradLiabs + Short-term Debt) + rlong debt (Long-term Debt) (9)
From the (9), all types of r on the equation must be firstly valued, and to get the particular r. These
equations are introduced.
rdeposit = x (10)
rshort debt = x + 0.01 (11)
rlong debt = x + 0.02 (12)
and x can be valued from the combination of (8),(9),(10),(11). Therefore,
63
X =
(13)
= 0.0124
Therefore, from (10), rdeposit = 0.0124
From (11), rshort debt = 0.0224
From (12), rlong debt = 0.0324
And the interest expense can eventually be found.
From (9), IntExp = 0.0124(0.728) + 0.0224(0.0438 + 0.0449) + 0.0324 (0.0468)
= 0.0125
Net Interest income:
Net interest income equals to the spread between total interest income and interest expense. So, Net
interest income = 0.0392 – 0.0125 = 0.0267.
Total revenue:
Total revenue equals to the accumulation of Net interest income and Net non-interest income. This
refers to 0.0267 + 0.0124 = 0.0391
Pretax income:
Pretax income is total revenue deducted by operating expense, which is 0.0391 – 0.0216 = 0.0175
Net income:
Net income is the pretax income deducted by the 26% of average effective tax rate, which is 0.0175(1-
0.26) = 0.013
Return on Equity (ROE);
64
rEquity = ROE =
(14)
= = 0.1233
Increase the lending spread on the After column (D)
There is a need to increase the lending spread in order to maintain the same ROE as in before column
(A). Thus, the remaining of ROE subsequently leads to the change in Net income, pretax income, total
revenue, net interest income, and finally interest income on loans.
Interest income on loans:
IncomeLoanst+1= IncomeLoans + (α)(Loanst+1) (18)
α = (19)
The interest income on loans can be found by the combination of these two equations. This is done by
the substitution of the (α)(Loanst+1) variable from (19) into (18). IncomeLoanst+1 is the interest income on
loans after remaining the ROE. Therefore,
IncomeLoanst+1= [((((
)-(0.0056 – 0.0125+0.0124-0.0216))-0.0336)+0.0336]
= 0.0348
Total interest income:
Total interest income is the combination of interest income on loans and other interest income, which
equals to 0.0348 + 0.0056 = 0.0404.
Net interest income:
Net interest income is the total interest income deducted by interest expense that is the same as
column (B). It equals to 0.0404 – 0.0125 = 0.0279
65
Total revenue:
Total revenue is the combination of net interest income and net non-interest income. It equals to 0.0279
+ 0.0124 = 0.0403
Pretax income:
Pretax income is total revenue deducted by operating expense, which is 0.0403 – 0.0216 = 0.0187
Net income:
Net income is the pretax income deducted by the 26% of average effective tax rate, which is 0.0187(1-
0.26) = 0.0138
Increase in lending spreads:
IncomeLoanst+1= IncomeLoans + (α)(Loanst+1) (18)
0.0348= 0.036 + (α)(0.7176)
(α) = 0.017.
Therefore, in order to maintain ROE from 1 percent increase in capital ratio, Thai banks need to higher
the lending spread by 1.07%.