Guidelines on the adoption of the risk-based capital adequacy framework by quasi-banks

CIRCULAR NO. 400 Series of 2003

The Monetary Board, in its Resolution No. 1062 dated 31 July 2003, approved the following guidelines on the adoption of the risk-based capital adequacy framework by quasi-banks taking into consideration Section 34 of The General Banking Law of 2000. The guidelines shall initially cover only capital requirements for credit risks pending issuance of supplementary guidelines to incorporate market risks. Upon effectivity, the guidelines shall replace the existing provisions of Section 4116Q and its subsections of the Manual of Regulations for Non-Bank Financial Institutions, which are hereby revised to read, as follows:

“Sec. 4116Q  Minimum Ratio. The risk-based capital ratio of a quasi-bank, expressed as a percentage of qualifying capital to risk-weighted assets, shall not be less than ten percent (10%) for both solo basis (head office plus branches) and consolidated basis (parent quasi-bank plus subsidiary financial allied undertakings, but excluding insurance companies).

The ratio shall be maintained daily.

“§  4116Q.1  Qualifying Capital. The qualifying capital shall be the sum of –

a.   Tier 1 (core) capital -

Paid-up common stock;

Paid-up perpetual and non-cumulative preferred stock;

Common stock dividends distributable;

Perpetual and non-cumulative preferred stock dividends distributable;

Surplus;

Surplus reserves;

Undivided profits; and

Minority interest in the equity of subsidiary financial allied undertakings which are less than wholly-owned: Provided, That a quasi-bank shall not use minority interests in the equity accounts of consolidated subsidiaries as avenue for introducing into its capital structure elements that might not otherwise qualify as Tier 1 capital or that would, in effect, result in an excessive reliance on preferred stock within Tier 1:

Provided, further, That the following items shall be deducted from the total of Tier 1 capital:

Common stock treasury shares;

Perpetual and non-cumulative preferred stock treasury shares;

Net unrealized losses on underwritten listed equity securities purchased (for investment houses);

Unbooked valuation reserves and other capital adjustments based on the latest report of examination as approved by the Monetary Board;

Total outstanding unsecured credit accommodations, both direct and indirect, to directors, officers, stockholders and their related interests (DOSRI);

Deferred income tax; and

Goodwill; and

b.    Tier 2 (supplementary) capital which shall be the sum of –

b.1   Upper Tier 2 capital -

Paid-up perpetual and cumulative preferred stock;

Perpetual and cumulative preferred stock dividends distributable;

Appraisal increment reserve – quasi-bank premises, as authorized by the Monetary Board;

Net unrealized gains on underwritten listed equity securities purchased: Provided, That the amount thereof that may be included in upper Tier 2 capital shall be subject to a 55% discount (for investment houses);

General loan loss provision: Provided, That the amount thereof that may be included in upper Tier 2 capital shall be limited to a maximum of 1.25% of gross risk-weighted assets, and any amount in excess thereof shall be deducted from the total risk-weighted assets in computing the denominator of the risk-based capital ratio;

With prior BSP approval, unsecured subordinated debt with a minimum original maturity of at least ten (10) years, subject to the following conditions:

It must not be secured nor covered by a guarantee of the issuer or related party;

It must be subordinated in the right of payment of principal and interest to all creditors of the quasi-bank, except those creditors expressed to rank equally with, or behind holders of the debt. Subordinated creditors must waive their right to set off any amounts they owe the quasi-bank against subordinated amounts owed to them by the quasi-bank. The issue documentation must clearly state that the debt is subordinated;

It must be fully paid-up. Only the net proceeds actually received from debt issues can be included as capital. If the debt is issued at a premium, the premium cannot be counted as part of capital;

It must not be redeemable at the initiative of the holder;

It must not contain any clause which requires acceleration of payment of principal, except in the event of insolvency;

It must not be repayable prior to maturity without the prior consent of the BSP: Provided, That repayment may be allowed in connection with call option only after a minimum of five (5) years from issue date and only if –

The quasi-bank’s capital ratio is at least equal to the required minimum capital ratio; and

The debt is simultaneously replaced with issues of new capital which is neither smaller in size nor of lower quality than the original issue;

It may allow a moderate step-up in the interest rate in conjunction with a call option, only if the step-up occurs at a minimum of ten (10) years after the issue date and if it results in an increase over the initial rate that is not more than 100 basis points, provided that only one (1) rate step up shall be allowed over the life of the instrument;

It must provide for possible conversion into common shares or preferred shares or possible deferral of payment of principal and interest if the quasi-bank’s capital ratio becomes less than the required minimum capital ratio;

It must provide for the principal and interest on the debt to absorb losses where the quasi-bank would not otherwise be solvent;

It must allow deferment of interest payment on the debt in the event of, and at the same time as, the elimination of dividends on all outstanding common or preferred stock of the issuer. It is acceptable for the deferred interest to bear interest, but the interest rate payable on deferred interest should not exceed market rates;

It must be underwritten by a third party not related to the issuer quasi-bank nor acting in reciprocity for and in behalf of the issuer quasi-bank;

It must be issued in minimum denominations of at least five hundred thousand pesos (P500,000.00) or its equivalent; and

It must clearly state on its face that it is not a deposit and is not insured by the Philippine Deposit Insurance Corporation (PDIC):

Provided, That it shall be subject to a cumulative discount factor of 20% per year during the last five (5) years to maturity (i.e., 20% if the remaining life is 4 years to less than 5 years, 40% if the remaining life is 3 years to less than 4 years, etc.): Provided, further, That where it is denominated in a foreign currency, it shall be revalued periodically (at least monthly) in Philippine peso at prevailing exchange rate using the same exchange rate used for revaluation of foreign currency-denominated assets, liabilities and forward contracts under existing regulations: Provided, furthermore, That, for purposes of reserve requirement regulation, it shall not be treated as a deposit substitute liability or other forms of borrowings;

Deposit for common stock subscription; and

Deposit for perpetual and non-cumulative preferred stock subscription:

Provided, That the following items shall be deducted from the total of upper Tier 2 capital:

Perpetual and cumulative preferred stock treasury shares;

b.2    Lower Tier 2 capital –

Paid-up limited life redeemable preferred stock: Provided, That these shall be subject to a cumulative discount factor of 20% per year during the last five (5) years to maturity (i.e., 20% if the remaining life is 4 years to less than 5 years, 40% if the remaining life is 3 years to less than 4 years, etc.);

Limited life redeemable preferred stock dividends distributable;

With prior BSP approval, unsecured subordinated debt with a minimum original maturity of at least five (5) years, subject to the following conditions:

It must not be secured nor covered by a guarantee of the issuer or related party;

It must be subordinated in the right of payment of principal and interest to all creditors of the quasi-bank, except those creditors expressed to rank equally with, or behind holders of the debt. Subordinated creditors must waive their right to set off any amounts they owe the quasi-bank against subordinated amounts owed to them by the quasi-bank. The issue documentation must clearly state that the debt is subordinated;

It must be fully paid-up. Only the net proceeds actually received from debt issues can be included as capital. If the debt is issued at a premium, the premium cannot be counted as part of capital;

It must not be redeemable at the initiative of the holder;

It must not contain any clause which requires acceleration of payment of principal, except in the event of insolvency;

It must not be repayable prior to maturity without the prior consent of the BSP: Provided, That repayment may be allowed in connection with call option only after a minimum of five (5) years from issue date and only if –

The quasi-bank’s capital ratio is at least equal to the required minimum capital ratio; and

The debt is simultaneously replaced with issues of new capital which is neither smaller in size nor of lower quality than the original issue;

It may allow a moderate step-up in the interest rate in conjunction with a call option, only if the step-up occurs at a minimum of five (5) years after the issue date and if it results in an increase over the initial rate that is not more than 100 basis points or 50% of the initial credit spread, at the option of the bank, provided that only one (1) rate step up shall be allowed over the life of the instrument;

It must be underwritten by a third party not related to the issuer quasi-bank nor acting in reciprocity for and in behalf of the issuer quasi-bank;

It must be issued in minimum denominations of at least five hundred thousand pesos (P500,000.00) or its equivalent; and

It must clearly state on its face that it is not a deposit and is not insured by the Philippine Deposit Insurance Corporation (PDIC):

Provided, further, That it shall be subject to a cumulative discount factor of 20% per year during the last five (5) years to maturity (i.e., 20% if the remaining life is 4 years to less than 5 years, 40% if the remaining life is 3 years to less than 4 years, etc.): Provided, furthermore, That where it is denominated in a foreign currency, it shall be revalued periodically (at least monthly) in Philippine peso using the same exchange rate used for revaluation of foreign currency-denominated assets, liabilities and forward contracts under existing regulations: Provided, furthermore, That, for purposes of reserve requirement regulation, it shall not be treated as equivalent to a deposit substitute liability or other forms of borrowings; and

Deposit for perpetual and cumulative preferred stock subscription;

Provided, That the following items shall be deducted from the total of Lower Tier 2 capital:

Limited life redeemable preferred stock treasury shares; and

Sinking fund for redemption of limited life redeemable preferred stock: Provided, That the amount to be deducted shall be limited to the balance of redeemable preferred stock after applying the cumulative discount factor:

Provided, further, That the total amount of lower Tier 2 capital that may be included in the Tier 2 capital shall be a maximum of 50% of total Tier 1 capital (net of deductions therefrom): Provided, furthermore, That the total amount of upper and lower Tier 2 capital that may be included in the qualifying capital shall be a maximum of 100% of total Tier 1 capital (net of deductions therefrom);

c.       Less deductions from the total of Tier 1 and Tier 2 capital, as follows:

Investments in equity of unconsolidated subsidiary banks and other subsidiary financial allied undertakings, but excluding insurance companies (for solo basis);

Investments in debt capital instruments of unconsolidated subsidiary banks (for solo basis);

Investments in equity of subsidiary insurance companies and subsidiary non-financial allied undertakings;

Reciprocal investments in equity of other banks/enterprises; and

Reciprocal investments in unsecured subordinated term debt instruments of other banks/quasi-banks in excess of the lower of (i) an aggregate ceiling of 5% of total Tier 1 capital of the quasi-bank; or (ii) 10% of the total outstanding unsecured subordinated term debt issuance of the other bank/quasi-bank:

Provided, That any asset deducted from the qualifying capital in computing the numerator of the risk-based capital ratio shall not be included in the risk-weighted assets in computing the denominator of the ratio.

“§  4116Q.2  Risk-Weighted Assets. The risk-weighted assets shall be determined by assigning risk weights to amounts of on-balance sheet assets and to credit equivalent amounts of off-balance sheet items (inclusive of derivative contracts): Provided, That the following shall be deducted from the total risk-weighted assets:

General loan loss provision (in excess of the amount permitted to be included in upper Tier 2 capital); and

Unbooked valuation reserves and other capital adjustments affecting asset accounts based on the latest report of examination as approved by the Monetary Board.

a.   For on-balance sheet assets, the risk-weighted amount shall be the product of the book value of the asset multiplied by the risk weight associated with that asset, as follows:

0% risk weight -

Cash on hand;

Claims on or portions of claims guaranteed by or collateralized by securities issued by -

Philippine national government and BSP; and

Central governments and central banks of foreign countries with the highest credit quality as defined in Subsec. 4116Q.3;

Loans to the extent covered by hold-out on, or assignment of deposit substitutes maintained with the lending quasi-bank;

Portions of loans covered by Industrial Guarantee and Loan Fund (IGLF) guarantee;

Real estate mortgage loans to the extent guaranteed by the Home Guaranty Corporation (HGC);

Loans to the extent guaranteed by the Trade and Investment Development Corporation of the Philippines (TIDCORP);

Residual value of leased equipment to the extent covered by Deposits on lease contracts (for financing companies);

Lease Contract Receivables to the extent covered by the excess of Deposits on lease contracts over residual value of leased equipment (for financing companies); and

Foreign currency notes and coins on hand acceptable as international reserves;

20% risk weight -

Checks and other cash items;

Claims on or portions of claims guaranteed by or collateralized by securities issued by non-central government public sector entities of foreign countries with the highest credit quality as defined in Subsec. 4116Q.3;

Claims on or portions of claims guaranteed by Philippine incorporated banks/quasi-banks with the highest credit quality as defined in Subsec. 4116Q.3;

Claims on or portions of claims guaranteed by foreign incorporated banks with the highest credit quality as defined in Subsec. 4116Q.3;

Claims on or portions of claims guaranteed by or collateralized by securities issued by multilateral development banks;

Loans to exporters to the extent guaranteed by Small Business Guarantee and Finance Corporation (SBGFC); and

Foreign currency checks and other cash items denominated in currencies acceptable as international reserves;

50% risk weight –

Loans for housing purpose, fully secured by first mortgage on residential property that is or will be occupied or leased out by the borrower; and

Local government unit (LGU) bonds which are covered by Deed of Assignment of Internal Revenue allotment of the LGU and guaranteed by the LGU Guarantee Corporation;

100% risk weight –

All other assets including, among others, the following:

Claims on central governments and central banks of foreign countries other than those with the highest credit quality;

Claims on Philippine local government units;

Claims on non-central government public sector entities of foreign countries other than those with the highest credit quality;

Claims on government-owned or controlled commercial corporations;

Claims on Philippine incorporated banks/quasi-banks other than those with the highest credit quality;

Claims on foreign incorporated banks other than those with the highest credit quality;

Loans to companies engaged in speculative residential building or property development;

Claims on the private sector (except those deducted from capital);

Equity investments (except those deducted from capital);

Equipment and other real estate for lease (for financing companies);

Real estate for sale/lease;

Quasi-bank premises, furniture, fixtures and equipment (net);

Appraisal increment – quasi-bank premises, furniture, fixtures and equipment (net);

Real and other properties owned or acquired (net);

Foreign currency notes and coins on hand not acceptable as international reserves;

Foreign currency checks and other cash items not denominated in foreign currencies acceptable as international reserves,

except those which are deducted from capital, as follows:

Unsecured credit accommodations, both direct and indirect, to DOSRI;

Deferred income tax;

Goodwill;

Sinking fund for redemption of limited life redeemable preferred stock;

Equity investments in unconsolidated subsidiary banks and other subsidiary financial allied undertakings, but excluding insurance companies;

Investments in debt capital instruments of unconsolidated subsidiary banks;

Equity investments in subsidiary insurance companies and subsidiary non-financial allied undertakings,

Reciprocal investments in equity of other banks/enterprises;

Reciprocal investments in unsecured subordinated term debt instruments of other banks/quasi-banks, in excess of the lower of (i) an aggregate ceiling of 5% of total Tier 1 capital of the quasi-bank; or (ii) 10% of the total outstanding unsecured subordinated term debt issuance of the other bank/quasi-bank;

b.   For off-balance sheet items, the risk-weighted amount shall be calculated using a two-step process.  First, the credit equivalent amount of an off-balance sheet item shall be determined by multiplying its notional principal amount by the appropriate credit conversion factor, as follows:

100%  credit conversion factor -

This shall apply to direct credit substitutes, e.g., general guarantees of indebtedness and acceptances (including endorsements with the character of acceptances), and shall include -

Outstanding guarantees issued

This shall also apply to sale and repurchase agreements and asset sales with recourse where the credit risk remains with the quasi-bank (to the extent not included in the balance sheet), as well as to forward asset purchases, and partly-paid shares and securities, which represent commitments with certain drawdown: Provided, That these items shall be weighted according to the type of asset and not according to the type of counterparty with whom the transaction has been entered into.

50% credit conversion factor –

This shall apply to -

Note issuance facilities and revolving underwriting facilities (for investment houses); and

Other commitments, e.g., formal standby facilities and credit lines with an original maturity of more than one (1) year. This shall include –

Underwritten accounts unsold (for investment houses).

0% credit conversion factor -

This shall apply to commitments with an original maturity of up to one (1) year.

This shall also apply to those not involving credit risk, and shall include –

Items held for safekeeping/custodianship;

Trust department accounts

Items held as collaterals; etc.

Second, the credit equivalent amount shall be treated like any on-balance sheet asset and shall be assigned the appropriate risk weight, i.e., according to the obligor, or if relevant, the qualified guarantor or the nature of collateral.

c.   For derivative contracts, the credit equivalent amount shall be the sum of the …