Debt threat defense: Singapore's new leverage ratio guidelines are credit-positive, says Moody's

It will improve disclosure requirements for the country's big three.

The Monetary Authority of Singapore recently released a consultation paper on the proposed changes to the leverage ratio disclosure requirements for banks. In a report, Moody’s Investors Service noted that this move is credit-positive for Singapore’s three biggest banks.

According to Moody’s, the new requirement will improve disclosure standards and make it more consistent among banks and it will limit banks’ exposure to assets that are perceived to be low risk, but may result in high losses.

According to Eugene Tarzimanov, Vice President, Moody's, “Banks will have to disclose the different subcomponents to calculate the leverage ratio on a quarterly basis starting in January 2015, in line with the Basel Committee’s proposed timeline. Singapore banks have to use quarter-end balance sheet values, which is a less strict approach than using the daily average within the quarter.”

Here’s more form the report:

The new framework, which will move to a minimum requirement by January 2018, will be credit positive for Singapore’s domestic banks because it will provide a backstop to the Basel III risk-based capital requirements and will limit banks’ exposure to assets that are perceived to be low risk, but may result in high losses. Additionally, disclosure standards will improve and become more consistent among banks.

The leverage ratio is calculated as Tier 1 regulatory capital divided by adjusted on- and off-balance sheet assets, with a 3% minimum recommended by the Basel Committee.

The off-balance sheet component includes, but is not limited to, potential future exposure on derivatives, standby letters of credit and cover pool assets of outstanding covered bonds, each multiplied by a predefined credit conversion factor varying between 10% and 100%.

Assets deducted from Basel III Tier 1 capital (e.g., investments in unconsolidated financial institutions) can also be deducted from the denominator.

The former approach allows banks to artificially inflate leverage ratios by reducing their balance sheets by the end of the quarter, especially by manipulating exposures in their trading book.

Before the minimum leverage ratio requirement in January 2018, the Basel Committee will test its proposed 3% limit during a parallel run period from January 2013 to January 2017 and will make final adjustments to the framework by 2017. The MAS has not announced a minimum requirement so far and we expect that it will hold off until the testing period is finalized.

If MAS were to apply the 3% requirement, we would not expect Singapore banks to be challenged in meeting the minimum requirement because of their relatively conservative risk-weighting and their relatively small capital markets businesses compared with banks in the US or Europe.