Économie et Finance

Investigation: From subordinated bonds to banks’ financial resilience

le 4 octobre 2017

The subordinated debt (perpetual and fixed maturity) issues launched by Morocco’s three leading banks are remarkable, not by their similarities but their differences! First, not only do the sums involved amount to billions of dirhams, but they come one after another. This implies that the banks are continuing to grow, especially overseas.


If Attijariwafa bank and Banque Populaire’s bond issues, which have a fixed maturity, target all categories of institutional investor, including mutual funds, BMCE Bank of Africa’s perpetual bond issues are primarily directed at those which, given the nature of their business, such as pension funds, invest over the very long term.


When asked about their preferences when it comes to subscribing for these issues, a number of investors pointed out that, despite the returns being attractive, the level of risk assumed, alongside the banks’ shareholders, made them cautious!


Why such risk and what does it consist of? How does Bank Al-Maghrib and banking regulations protect the bank first and foremost and then those who subscribe to these subordinated bonds?


Such were the questions which framed our investigation as follows:


Basel III, causes and effects?

There was a common thread to the direct questions we asked the regulator: Why are these banks not financing their commitments and their external growth by issuing equity as recommended by the science of finance?

The answers to this question may be found in the 2013 banking reforms. The Banking Supervisory Division enlightened us on this topic by explaining the regulations that had been drawn up.

The prudential regulatory framework was in fact reformed in the wake of the global financial crisis which revealed that banks had insufficient capital to absorb their losses.

One of the lessons learnt from the crisis resulted in the Basel Committee wanting to improve both the quantity and quality of banking institutions’ capital, which was deemed both insufficient and inadequate to absorb potential losses.

The aim of capital, whether share capital or subordinated debt, is to absorb losses. Indeed, share capital must absorb the larger part, but banks can issue perpetual subordinated bonds as the second line of defence in absorbing losses to enable banking institutions to continue to operate. Fixed maturity subordinated bonds cover losses in the event of the bank’s insolvency.

Therefore, during the international financial crisis when it was realised that the large banks did not have enough capital, subordinated bonds were included in the new banking regulations in order to bolster them.

And if some banks came through this major crisis unscathed, it was indeed thanks to their adequate capital buffers. In fact, as soon as a bank anticipates that its capital adequacy ratio could dip below the regulatory requirements, it must stop making dividend distributions (partial or whole).

In December 2010, the Basel committee adopted a new prudential system, named Basel III, which was aimed at making banking systems and banking institutions more resilient.

The system recommended, first and foremost, that banks set aside high-quality capital Next, introduce a system that encourages capital conservation. And, last but not least, ensure that these standards and recommendations were adopted universally around the world.


The Central Bank’s Ariadne’s thread

In 2013, BAM incorporated the Basel capital standards within its regulatory framework while adapting them to the Moroccan banking system. Capital was structured into two categories based on specific eligibility criteria.

Tier I capital includes core capital, disclosed reserves and retained earnings. This category may also include supplementary capital largely made up of perpetual instruments.

Tier 2 capital includes instruments which have an initial maturity of at least 5 years.

The eligibility criteria for capital is based on permanence, flexibility of payments and loss absorbency.

The provisions governing supplementary capital instruments must not contain incentives for banking institutions to redeem them and must provide for the possibility of converting them into capital or for an impairment mechanism in the event that capital adequacy reaches the critical limit set by Bank Al-Maghrib.

In reality, the loss-absorption mechanism for supplementary instruments is triggered by the banking institution, as soon as the core capital ratio reaches the 6% threshold.

Insert:   Using capital ratios to spearhead regulation


BAM’s prudential approach, inspired by the Basel Committee, has transformed banking regulations.

In fact, prior to this, banks could have as much capital as debt, which was completely unrelated to business volumes.

From 2013, the new regulations imposed a capital adequacy ratio, which stipulated that the aim of capital was to cover risks.

And for each category of capital, it imposed a risk-weighted capital adequacy ratio. In practical terms, the Tier 1 capital ratio was set at 8% of a bank’s risk-weighted assets.

It stands at 1% for supplementary perpetual instruments and 3% for fixed maturity instruments. The overall capital adequacy ratio required of banks is 12%.

The 8% applicable to Tier 1 capital is split into two ratios of 5.5% and 2.5%. The 5.5% ratio represents the core capital ratio below which a bank’s capital is not permitted to fall. The 2.5% is a ‘capital cushion’ or the ‘capital conservation buffer with which banking institutions must comply.


A well-marked path taken by the Central Bank

It is widely accepted that BAM’s prudential approach, which has incorporated Basel committee standards, has transformed banking regulations.

Banking institutions must now have a Tier 1 capital ratio of at least 9% and an overall capital ratio of least 12%.

The latter, which used to be 8% until 2007, was increased in two stages. It was first increased in 2010 to 10%, against a backdrop of excessive credit expansion. It was again raised to its current limit of 12% in 2012 so as to bolster the banks’ resilience in the face of growing credit risk.

In Morocco, Basel III norms were incorporated in 2013 and have since been implemented progressively and gradually. Bank Al-Maghrib set a 5-year timeframe to fully comply with this new system, which was in line with the international requirements.

As a result, the reform implementation process, which began in 2014, will be completed in 2019. The progressive approach to implementing Basel III will ensure that it is fully effective. Thanks to these reforms, Moroccan banks are well-capitalised since the safeguards are precise, clear and stringent.

Attracting investors

However, despite all these new provisions relating to perpetual subordinated bonds, including those at the international level, banks continue to face difficulties in finding investors ready to invest in perpetual subordinated debt as they have to be aware of the conditions and consequences of investing, which entails participating in the risks assumed by the bank and contributing to absorbing losses.

Institutional investors must rely on the Central Bank having to monitor the banks closely, involving inspections and monitoring via regular reporting. It is therefore almost impossible for a bank’s capital adequacy ratio to fall to 6% overnight!

Lastly, the possible but unlikely risk of supplementary perpetual instruments of bank finance being used to cover losses is largely offset by higher rates of return. For example, the interest rate on BMCE Bank’s perpetual subordinated bonds is above 6%, offering investors a 3.8% risk premium. The only problem for institutional investors is that it is almost impossible to exit from this type of commitment…

Afifa Dassouli

Original article : https://lnt.ma/enquete-emissions-subordonnees-a-solidite-financiere-banques/