Is Malawi heading towards a concentrated banking sector?
Prior to the launch of Basel II on January 1 2014, it was not clear whether all Malawi’s 11 banks would, by the effective date, meet the new capital adequacy requirements as prescribed by Reserve Bank of Malawi (RBM) in line with Basel II framework for Tier 1 capital of 10 percent or more of the capital requirement basis and for total capital of 15 percent or more of the capital requirement basis.
By December 31 2013, it was apparent that not all banks would meet the deadline. According to RBM’s Financial Stability Report of June 2014, only seven out of the 11 banks had complied with the capital adequacy requirements by the effective date.
Four banks failed to comply with the capital adequacy requirements by the effective date. Out of these four banks, two banks had by June 30 2014 complied with the capital adequacy requirements. The remaining two banks are yet to comply with the new regulatory regime. These two banks are currently in search of capital injection to recapitalise and meet the prescribed capital adequacy requirements.
If the remaining two banks fail to comply with the capital adequacy requirements, will this lead the banks being taken over by existing players, resulting into a concentrated banking sector? Closely related to this question, do the new higher capital adequacy requirements make it onerous for new players to enter into Malawi’s banking sector and, thus, enhancing concentrated banking sector?
–Unpacking RBM’s new regulatory regime–
Unlike the questions posed in the preceding paragraph, Basel II framework has been adopted in Malawi with the aim of enhancing capital adequacy and risk management in all the country’s banks, leading to a more stable banking sector. This has been achieved by increasing the amounts of minimum capital requirements and enhancing the criteria for assessing capital adequacy under the RBM regulatory regime.
The Basel II framework comprises three pillars. The first pillar deals with minimum capital requirements, the second pillar deals with banking supervision and the third pillar deals with market discipline.
Pursuant to Basel II implementation, RBM’s major focus has been on the first pillar of Basel I. Taking into account the technical complexity, high capacity demands and costly resource requirements involved in implementing the whole Basel II framework, the RBM’s piecemeal approach seems to be proper and prudent in the circumstances.
In terms of the second and third pillars of Basel II, suffice to say that RBM’s initiatives in regard to adoption of the second and third pillars have been more operational to ensure that banks have proper risk management mechanisms and that banks are oriented to meet their requirements as dictated by the size and complexity of business, risk philosophy, market perceptions and the expected level of capital.
For example, since banks are expected to perform rigorous, forward-looking stress testing that identifies possible events or changes in market conditions that could adversely impact the bank [second pillar of Basel II], RBM has issued out the stress testing framework guidelines in pursuance of implementing the requirements under the second pillar. These stress testing framework guidelines are aimed at: (i) allowing banks to carry out stress testing as part of risk management in assessing the potential impact of a specific event or movement in a set of financial variables; and (ii) aiding in the assessment of the susceptibility of a bank or the entire banking system to shocks.
For the rest part of this article, the focus will be on the provisions under the first pillar of Basel II. One of the most important changes introduced under Basel II is the widening of the types of risks subject to risk management under the first pillar. Unlike risk management under RBM old regulatory regime (Basel I), which assessed capital adequacy based on credit risk alone, risk management under the RBM new regulatory regime (Basel II), capital adequacy will be assessed not only based on credit risk, but also based on operational risk and market risk. Also, Tier 1 capital adequacy ratio and total capital adequacy ratio have been increased respectively from six percent and 10 percent [the RBM old regime] to 10 percent and 15 percent [the RBM new regime].
In addition to enhancing the stability of Malawi’s banking sector, it is anticipated that RBM’s new regulatory regime (Basel II) will help Malawi to benefit from, amongst others, better sovereign rating, increased foreign investment and access to international credit.
–Impact of Basel II on access to finance–
Although the benefits of implementing the provisions of Basel II under the RBM’s regulatory regime as set out in the preceding paragraphs are a very welcome move for the stability of the country’s banking sector, the new regulatory regime is likely to adversely impact on access to finance and enhance or entrench the current trend by Malawian banks of preferring to lend to government, mainly through treasury bills, to the detriment of the private sector, especially individuals and small-medium enterprises (SME). It is individuals and SMEs who are in need of access to finance as this relates to their accessibility to financial services.
Under the RBM old regulatory regime (Basel I), government enjoyed zero or to very low risk weights as compared to the higher risk weights attributable to the private sector. Under the RBM new regime (Basel II), government will continue to enjoy more favourable risk weights in assessing not only credit risk, but also operational risk and market risk. Correspondingly, risk weights attributable to the private sector will remain more stringent. For example, whereas credit to the private sector has credit risk weight of 100 percent for capital requirements purposes, government credit exposure has zero percent credit risk weight, i.e. risk-free. RBM’s new regulatory requirements will therefore reinforce the local banks’ preference to lend more to government so as to easily meet their capital adequacy requirements without raising their capital provisions. In this regard, the RBM new regulatory regime (Basel II) will adversely impact on individual and SME lending and thereby impinging on access to finance.
The risk-freeness of government borrowing is not the only incentive for the Malawi banks to have bias towards lending more to government than to the private sector. As noted in RBM’s Financial Stability Report, the other incentive with the local banks in lending to government is the attractiveness of the higher interest rates charged on government borrowing. Malawi’s economic situation has shown that where demand for government borrowing increases, there is a related increase on the rates of interest charged on government’s borrowing resulting into the local banks being attracted more the risk-free government exposure than to the private sector high risk exposure.
–Impact of RBM’s new guidelines on banks’ capital positions–
The credit risk guidelines and the market risk guidelines, which have recently issued by RBM to give guidance to banks in terms of the new regulatory regime, require all banks to use the standardised approach when measuring credit risk and market risk respectively. The standardised approach is preferred notwithstanding that the credit risk guidelines recognise that there is another method for measuring credit risk, namely Internal Ratings Based Approach. As already stated above, RBM is implementing the Basel II framework piecemeal. Similarly, the standardised approach is preferred notwithstanding that the Market Risk Guidelines recognise that there is another method for measuring market risk, namely Internal Models Based Approach. On the other hand, RBM’s operational risk guidelines require all banks use the basic indicator when measuring operational risk unless written permission has been sought from RBM to adopt the standardised approach. Under the operational risk guidelines, the basic indicator approach is easier to use than the standardised approach. The piecemeal adoption of Basel II’s risk measurement methods by RBM is an obvious indication that RBM recognises that Malawi banks are not yet ready to implement Basel II in full at the moment, particularly the more complex methods set out under the first pillar of Basel II.
Whereas the RBM’s market risk guidelines and operational risk guidelines require each bank to come up with internal systems for identifying, measuring and managing the bank’s market risk or the bank’s operational risk in accordance with their respective guidelines, credit risk guidelines require each bank to use qualified external credit rating agencies to quantify the required capital for covering credit risk.
The RBM’s Financial Stability Report, which covers the period of six months between October 1 2013 and March 31 2014, states that the capital positions for the banking system in Malawi over the review period are evidence of a sound banking sector. The Report notes that the tier 1 capital ratio of the banking industry declined slightly from 16.2 percent (Basel I) recorded in September 2013 to 14.7 percent (Basel II) recorded in March 2014. Nonetheless, the March 2014 ratio was still above the new minimum tier 1 capital ratio of 10 percent. Equally, the ratio of total capital against risk weighted assets decreased from 19 percent (Basel I) recorded in September 2013 to 18.3 percent (Basel II) recorded in March 2014. Nonetheless, the March 2014 ratio was still above the new minimum total capital ratio of 15 percent. The Report notes that the decline in the capital ratios is largely on account of the change in the capital adequacy measurement as a result of the Basel II implementation in Malawi. – ELTON JANGALE
