Dealing with the flak

Many of Asia’s banks have been vocal in their apprehension of Basel II since its publication last January, and most of the region’s central banks submitted anxious responses to the BIS’s Switzerland headquarters at the end of the first consultation period last June. As it stands, many banks could potentially endure higher capital ratios, a result of the high proportion of low-rated and unrated exposures in the loan books of Asia’s financial institutions. But Japan’s banks, teetering under the burden of an estimated ¥150 trillion ($1.12 trillion) of non-performing loans (NPLs), stand to be particularly hard hit, with proposals under the most basic standardised approach for an added risk bucket of 150% for low-rated and past-due assets likely to increase capital adequacy ratios significantly. “This is not so much a problem with the Accord,” sighs Yoshikuni. “The capital ratio ultimately depends upon the quality of loans held by individual banks.”

Yoshikuni is arguably well placed to field apprehensions from Asia’s banks and, in particular, those in Japan. As a former central banker with nearly 30 years’ experience at the Bank of Japan (BOJ), Yoshikuni is well acquainted with the Japanese banking system. Following his three-year stint as the BOJ’s chief representative in Europe before joining the BIS last July, he has also had ample experience of dealing with international banking regulations, as well as co-ordinating with other central banks. “The role of this job is liasing and communicating with the major central banks in Asia – very much a continuation of what I was doing at the Bank of Japan,” he says.

But Japan’s high proportion of bad loans is likely to prove problematic – especially with the large city banks aiming for the more sophisticated internal ratings-based (IRB) approach. The IRB approach allows financial institutions to calculate their own probability of default data for each loan, which could potentially lead to vastly inflated risk ratios for low-rated exposures, well above the 150% risk weighting ceiling specified in the standardised approach. “To deal with the new Accord, any banks, including Japanese banks, should make their balance sheet clean by disposing of bad loans and, if necessary, increase capital,” says Yoshikuni.

Japan’s banks have made progress writing off huge levels of NPLs over the past few years, but doubts remain that enough is being done. Even Japanese Prime Minister Junichiro Koizumi’s promise to clear the banking sector of NPLs has done little to boost market sentiment. However, Yoshikuni stresses that the spectre of higher capital ratios may give Asia’s banks the added incentive to clean up their loan books, and put effective credit risk systems in place. “This Basel II process can accelerate the disposal of bad loans for any banks in Asia,” he continues. “They should take into account the risk associated with each loan, and should have a good assessment ability for these loans. This is the basis of banking as we know it.”

Yoshikuni envisages that the BIS will play an educational and support role to Asian central banks around the region. Consequently, the BIS has been boosting staff in anticipation of a flurry of queries once the new Basel Accord draft paper is released within the next few months. In particular, the Swiss institution has appointed the Bundesbank’s former head of internal risk management, Stefan Hohl, as senior economist, specifically to promote Basel in Asia. Hohl will work closely with the Financial Stability Institute, a joint initiative between the BIS and the Basel Committee, and will work with the region’s banks to support the implementation of the proposals – a task likely to be taxing over the next few years, adds Yoshikuni. “Even in Hong and Singapore, we have heard many concerns about the complexity of Basel II,” he adds.

But as well as Basel, the BIS aims to strengthen ties with Asia’s central banks over a wide range of issues. “We are now hosting many seminars and meetings in the Hong Kong office, in which many central bankers and supervisors get together to exchange views, which is very important,” he states.

Stances on regulation, banking and the financial markets are discussed, with a view to strengthen co-ordination in the event of another region-wide financial crisis. But he notes that Asia’s economies have improved significantly since the dark days of 1997, and appear to have weathered the current economic downturn. While Japan continues to struggle with its structural problems, the recession has not spread to the rest of Asia, and indeed, he points to an apparent decoupling between the yen and some of the region’s currencies. “It seems Japan’s economic cycle is becoming somewhat isolated,” he remarks. “At the same time, it could be a good thing in some sense because Asia is not heavily dependent on the Japanese economy as was expected.”