Higher capital needs to trim future banking returns

As a result of the stricter and higher equity Tier I capital requirements demanded by the forthcoming BASEL III rules, the Sri Lankan banking sector returns to its shareholders are likely to falter, leaving the investors to contemplate if they should continue to invest in the banking sector, according to a global consultancy firm.
Sri Lankan banks’ return on equity (RoE) is anyway expected to fall due to the declining net interest margins (NIMs) in the low interest rates environment they are operating in.

“This is the most shocking. The RoE has gone down for some banks from 20 percent to 4 or 5 percent,” said Deloitte Touche Tohmatsu Limited India (Deloitte) Manager Padmaja Mishra.
Among the BASEL III adopters, western banks have been hit the hardest in their RoEs with the emerging market banks to a lesser extent (See illustration).
“That is the reason why BASEL III concerns a lot for the CEOs of the banks, because RoEs, the size of the balance sheet and the capital levels have become huge concerns,” Mishra told at a forum organised by SJMS Associates.

Sri Lanka’s banking sector RoEs during the 2Q14 ranged from 0.7 percent by Union Bank of Colombo PLC to 22.1 percent by state-owned People’s Bank.
It was only recently former Commercial Bank PLC Chairman Dinesh Weerakkody echoed the same sentiments, where banks might have to curtail dividend payouts in the future to preserve and build capital buffers.
“This negative effect on RoE and dividend payouts could reduce the investor’s preference to invest in bank equity, compared to other options available in the stock exchange,” he said.

Meanwhile, Deloitte (India) Director Dr. Lakshmi Narasimhan said investors might reconsider continuing their investments in the banking stocks if the ever increasing cost of risk management, governance and compliance fail to transform into higher RoEs.  
“Each one of these is going to result in a cost. This is an unavoidable cost but this is necessary. And we have to see how efficient we are in managing this cost vis-à-vis our competitors.

And finally does it represent value for money? And how does it impact the RoE for the investors ultimately? Ultimately it has to somehow tie back to the RoE.
If every bank is BASEL III compliant but offers only 8 percent return, why would they continue to invest in the banking sector?
If the infrastructure sector or any other sector is offering 15 percent, they will go there. Definitely there has to be some serious questions to be asked about the value for money,” Dr. Narasimhan averred.  

Dr. Narasimhan however said BASEL III is clearly an inconvenience for the banks that have now started to see a growth after the global financial crisis and is a deterrent for performance growth.
“So, in this time of growth, if you are to make additional capital to increase the growth, part of the capital will sit idle. That way, it is an inconvenience,” he said.

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