Additional capital requirements for HBL, NBP and UBL to boost financial stability: Moody

Bond credit rating agency, Moody’s has said in its report that Habib Bank Ltd. (HBL), National Bank of Pakistan (NBP) and United Bank Ltd UBL will meet the additional capital requirements, despite the recent increase in private-sector lending and the short time frame for the implementation of the D-SIB buffer.

Moody’s Investor service was of the view that the D-SIBs’ enhanced requirements are credit positive because they will support overall banking system financial stability.

Earlier, the State Bank of Pakistan designated the three abovementioned banks as systemically important and requires additional capital, a credit positive. Last Thursday, the SBP designated the three commercial banks as domestic systemically important banks (D-SIBs).

The D-SIBs are required to set aside additional Common Equity Tier 1 (CET1) capital relative to risk-weighted assets by March 2019 and will also be subject to enhanced supervisory requirements. The D-SIBs’ enhanced requirements are credit positive because they will support overall banking system financial stability by strengthening the capital buffers and loss-absorption capacity of the country’s largest banks and will further develop their risk-management framework.

“The three newly designated D-SIBs are Habib Bank Ltd. (HBL, B3 stable, caa12), National Bank of Pakistan (NBP, B3 stable, caa1) and United Bank Ltd. (UBL, B3 stable, b3). The additional CET1 buffer is 2pc for HBL, and 1.5pc for both NBP and UBL,” stated the report.

The SBP determined which banks were D-SIBs on the basis of size, inter-connectedness, substitutability (i.e., whether certain bank services are critical, such as payments activity, assets under custody or underwriting activity that cannot be easily replaced by other banks) and complexity.

“All three banks are important to the country’s national payment system and any failure would have wide repercussions on the payment system and the economy. National Bank of Pakistan, the largest public-sector bank and one in which the authorities have around a 76pc stake, acts as an agent to the State Bank of Pakistan by handling treasury transactions for the government and distributing government-to-person and person-to-government payments. UBL is also active in the government-to-person payment space through its branchless banking platform. As such, the additional capital requirements for the three largest banks will enhance the overall financial stability of Pakistan’s banking system,” the report stated.

The report was of the view, that the additional capital requirements will strengthen the D-SIBs’ capital buffers, which lag those of their Moody’s-rated domestic peers, and enhance their loss-absorption capacity at a time when all three face idiosyncratic pressures. HBL is recovering from a settlement payment of $225 million made to US authorities in third-quarter 2017 as it scales down its international operations because of increased compliance risks. NBP faces a significant contingent liability related to pension disputes (equal to roughly 20pc of its March 2018 equity), which if it materializes will weigh on the bank’s capital buffers. UBL’s asset quality pressures in its international loan book (around a third of the total loan book) are ongoing and will likely lead to additional provisioning costs (1.15pc of gross loans in first-quarter 2018) as the bank builds up its coverage of overseas nonperforming loans.

“The three D-SIBs will also be subject to enhanced supervisory requirements that will strengthen their risk management frameworks. These include preparing comprehensive risk-appetite frameworks and conducting macro stress tests that will be incorporated into the banks’ internal capital adequacy assessment process, establishing effective recovery plans commensurate with the size and complexity of the bank and enhanced engagement between senior management and supervisory authorities,” it added.

All three banks met the CET1 requirements for year-end 2019 (including the D-SIB buffer) as of December 2017, and if the need arises, they can also adjust their dividend payout ratios (as HBL and NBP did in 2017) and/or optimize their balance sheets to strengthen capital ratios and increase buffers over the regulatory minimum ratios. Notwithstanding any idiosyncratic events that lead to erosion of capital buffers (e.g. NBP’s contingent liability), we expect that the three D-SIBs are well positioned to meet the additional 1.5pc-2pc D-SIB buffer.