Korean banks likely to control loan growth to meet higher buffers

Blame it on the Basel III requirements.

According to Fitch Ratings, Korea's banks - especially the big commercial ones - may control their loan growth and avoid large M&A transactions in order to build up sufficient capital buffers on top of the Basel III requirements.

"We do not expect their Basel III capital ratios to change significantly from their current Basel II ratios. But the banks are likely to conserve more capital to meet the higher buffers, especially for the banks that will be designated domestic systemically important banks (D-SIB)."

Here's more from Fitch:

We estimate the system-wide common equity Tier 1 (CET1) ratio to be 10.4% at end-March 2013, already comfortably above the 4.5% minimum requirement and the 2.5% capital conservation buffer being phased in from December 2013 through to 2019.

The overall impact is limited for the Korean banks because almost three-quarters of regulatory capital is already common equity. The regulator estimated the system's end-2012 total capital adequacy ratio should be boosted slightly by 22bp when Basel III is fully implemented - due to Korea's conservative treatment of some revaluation reserve items under Basel II.

But a more challenging D-SIB buffer - of up to 2.5% - will be required for some big banks, like Kookmin. There may even be a countercyclical buffer, although the Korean regulator has not proposed one yet.

We expect the large banks to hold an additional buffer over regulatory requirements, leading them to maintain a total CET1 ratio at 10% or higher, so they can pay out dividends freely even in difficult times when they report losses.

Bank holding companies (BHCs) are likely to see more significant changes as they currently calculate risk-weighted assets under Basel I. We expect the adoption of Basel II and Basel III to substantially strengthen BHCs' risk management procedures as they develop their own internal rating models over the next few years. The new requirements should also encourage bank groups to reduce leverage.

We believe most of Korea's BHCs should be able to meet the new requirements, since the system-wide average Tier 1 ratio was 10.5% at end-March 2013.

Hana Financial Group is an outlier with only a 7.9% Tier 1 ratio, and its capital has been under pressure since it embarked on its acquisition of Korea Exchange Bank. We expect BHCs to avoid significant M&A activities that would jeopardise their leverage.

Issuance of Basel III subordinated securities is likely to start in 2014 because the contribution from legacy instruments will be phased out by 10% each year.

We expect that banks may tap new securities in local currency for the first few years to take advantage of local demand, before venturing into foreign-currency issues. 

This way, they can benefit from a simpler and cheaper transaction while they adjust to the new securities. But some wholesale investors - both local and foreign - are restricted from investing in new-style instruments.

The set-up of a local primary market for Basel III securities in H213 by local authorities should support local-currency issuance.

We also believe BHCs are more likely to be the issuers of more complex contingent capital instruments, as they are unlikely to want their holdings in bank subsidiaries to be at risk of being diluted.