UAE banks await Basel II final approval

(SAEED DAHLAH)   

The board of directors of the UAE’s Central Bank is expected to approve a decree on the final guidelines for Basel II Accord compliance during its meeting in a few weeks’ time, according to banking sources.

The final guidelines will set the framework for all banks in the country regarding the implementation of Basel II standards for risk management, including credit, operation and capital market risks, and disclosure procedures.

The Central Bank had issued several draft guidelines for banks in the country to assess their readiness for the new standards.

It also organised a wide range of meetings and seminars with bank officials to discuss the challenges and advantages of introducing the Basel II Accord.

By the beginning of 2008, banks are expected to be compliant with at least the standardised approach for credit risk.

The UAE banks will be compliant with the internal ratings based approach for credit risk by January 1, 2011. Bank officials said that the final guidelines were ready and needed the approval of the Central Bank.

According to experts, most banks in the UAE are adopting Basel II and are in a good position to implement it.

And many banks have already done the calculations they need.

Raj Madha, researcher at EFG-Hermes, said UAE banks are well-prepared and will make sure they face no major shock in the full implementation of Basel II.

The new standards are expected to introduce essential changes in the balance sheets and capital adequacy ratio (CAR) in banks.

“It is very difficult to estimate the difference in balance sheets at the current stage but I expect there will be between 10 and 15 per cent decline in the capital adequacy ratio levels. It depends on how well the banks tested their risk management and calculations,” Madha said.

“Some banks will witness higher or lower adequacy ratios and this will depend on banks’ ability to restructure their transactions properly. If they have failed to achieve proper restructuring we will see their capital adequacy dropping sharply,” he added.

He said lowering the capital adequacy ratio by around 10 per cent is not a massive change, but some banks will face the need to raise their capital to meet the Basel standards.

“Some banks will introduce new ways to increase their capital. Recently, we saw the National Bank of Abu Dhabi talking about issuing convertible bonds to increase its capital,” he said.

Madha explained that most banks announced the distribution of bonus share dividends to increase their capital and avoid difficulties in the equities market.

“Local banks had a long time to prepare for calculating risks. Obviously, they have credit risk calculations in their balance sheets, while the big challenge will be in calculating operational risks and capital market risks. We believe most banks in the country are ready to implement the new standards,” he said.

WAREHOUSING SYSTEMS

But the cost of implementing Basel II is expected to be a big obstacle, as it is a very costly project covering the entire operations of a bank, and includes the cost of introducing new data warehousing systems.

Madha said local banks are introducing a standardised approach due to the lack of history data gathering required by Basel II.

“Collecting data of all bank operations will be costly. But we expect Basel II will play a major role in expanding banks’ risk awareness and monitoring and this will be positive for risk management,” he said.

“The biggest challenge in the banking business processes will be the introduction of ‘securitisation’. The local market is just picking up and “securitisation” will be more difficult under Basel II, while the potential leverage risks will be much more expensive.”

Jamal Saleh, Head of Risk Management at Commercial Bank of Dubai, expects that implementation of the Basel II Accord will lead to the banking sector in the UAE moving towards a more risk-based service offering and pricing.

“Bankers will have to assess the risk level of every customer, be it an individual or a company, to decide the costs incurred, including that of the Capital Charge applicable to lending products,” he said.

“One of the main positive impacts of Basel II is expanding lending for individuals and Small to Medium Enterprises (SMEs), as well as mortgages, as all draw lower capital charges, which, for qualifying exposures, equals 75 per cent of the normal 100 per cent applicable under Basel I or which applies to an average rated, or unrated, exposures under Basel II,” he added.

Saleh said Basel II may also speed up the introduction of securitisation in the local market to benefit from its role in allocating capital, which is widely practised in European markets.

Shifting to Basel standards was costly, but local markets can enjoy securitisation along with the implementation of these standards, he added.

REQUIRED MINIMUM

Basel II will probably lower the capital adequacy ratio for the banking sector, but the average CAR of local banks was well above the requirements of the UAE Central Bank and Basel II Accord, according to Saleh.

“Most local banks doubled their capital during the last three years and their ratio ranged between 10 and 20 per cent, on average, reaching 30 per cent or more in some cases, while the Central Bank set a minimum of 10 per cent versus Basel II’s eight per cent.  So, even if the implementation of Basel II standards lower banks’ adequacy, it should continue in targeted levels and comfortably above the required minimum. A few banks, however, may need to increase their capital base,” Saleh said.

“Even banks with low capital adequacy can resort to several solutions, including changing the composition of their loans and advances in their portfolio by shifting to customers who enjoy higher credit worthiness and, accordingly, lower capital charges. Raising capital may be the last option banks would have to resort to. The main challenge of Basel II is the increase in the required capital charges for credit, operational and market risks under Pillar 1, along with another applicable increase due to other risks which would be decided by the UAE Central Bank, including legal, strategic, concentration, and reputation risks,” he added.

TOO EXPENSIVE

“One of the hurdles of Basel II is reducing the period of the definition of non-performing assets [NPA] from 180 days to 90 days only.

This will increase the level of NPAs industry-wide. Capital charges for NPAs were usually higher up to 15 per cent, versus 10 per cent for other usual or unrated exposures or that of Basel I.

“Moreover, assets past due for less than 90 days but not yet classified are reportable under IFRS-7, especially that a percentage thereof may become delinquent for more than 90 days, and accordingly become NPAs in the future,” Saleh explained.

Saleh said that data systems at most banks in the region do not have the required long history.

 “Banks should collect at least five years’ of data history for different types of risks, which reaches seven years in some cases. Gathering such data will be one of the biggest problems, as well as ensuring that such data is clean and formatted in a way that meets Basel II’s calculation requirements. All of that would need a long period of time, exhaustive processing, and may prove a bit too expensive.”

He added that each bank is trying to implement Basel standards in it own way.

“Some banks assigned most of the job and accountability to their IT department, whereas others have allocated it to Financial Control or Operations. Some banks, however, set up a dedicated section for Basel II compliance, with shared overall responsibility across the entire bank, with the largest load being given to the Risk Management Department. Most or all of them, however, do require some sort of assistance from outside, be it in the form of risk consultancy or IT systems,” Saleh said.

“There has been, both regionally and internationally, a critical shortage in skilled risk managers and risk professionals who have good Basel II expertise and understanding. Such professionals have become very expensive.”

Saleh added there was a study among large global banks in the world that showed the average cost of implementing Basel standards is somewhere near US$ 50 million per bank.

Local banks, however, being much smaller in size and less complex, would average maybe around Dh10m per bank for the entire Basel II implementation, which would be much less at smaller banks and possibly more at the larger ones in the region.

Concerning disclosure procedures, Saleh said that Basel II will totally change the balance sheet.

“It requires a lot of accuracy and transparency. This will help shareholders, customers and other financial institutions dealing with the bank to get detailed data about the bank’s position.

“There are 13 tables of Basel II for disclosure that cover every financial data.”