Top 100 Banks Capital Ratios Show Resilience to the Pandemic

S&P Global Ratings expects risk-adjusted capital (RAC) ratios for the top 100 banks to remain resilient in the next two years, with some variation across countries. Bank capital around the world held up well during COVID-19, demonstrating the effectiveness of Basel rules for capital and strengthening of bank supervision in the past 10 years. Some banks were able to recognize the bulk of the credit losses last year, lessening the need to continue raising provisions, while others will take longer to do so. As such, pressures on earnings will persist on the latter set of banks, but the impact should be gradual allowing them to recognize losses as revenues recover, supporting their capital ratios. In countries, such as Australia, banks have announced the returning of surplus capital, which has been accumulated during the pandemic, through the sale of non-core businesses.

The RAC ratios of the top 100 rated banks remained broadly stable in 2020 compared with 2019, despite the earnings deterioration due to the rise in loan-loss provisions last year. The average RAC ratio was 9.1% in 2020, equal to the one in the prior year. We believe this is mainly due to the following factors:

• Banks desire to maintain prudent capital buffers to contend with the pandemic;
• Lower dividend payouts, given restrictions put in place by regulators during the pandemic;
• The rise of government-guaranteed loans in banks' portfolios, which require less capital; and
• Credit losses will be spread over a longer time frame in some jurisdictions.

The Basel Committee is now focusing on completing what's already been agreed upon. However, we believe uniform implementation of the rules will be difficult to achieve. The decision to delay their implementation by a year to January 2023, due to the pandemic, was fully justified. But the risk of uneven application of the standards is one of several reasons why we believe investors will have to live with partial comparability of regulatory metrics (see "The Basel Capital Compromise For Banks: Better Buffers, Elusive Comparability," published June 3, 2021).

Nevertheless, the consistency of regulatory capital ratios has improved among banks in Basel III jurisdictions. Still, various levels of national discretion and differences in banks' internal models continue to influence regulatory capital ratios. As a result, our RAC ratios remain the cornerstone of our capital analysis in our bank ratings framework. In our view, our RAC ratios continue to provide a more comparable view of bank capital and stronger risk differentiation, particularly in the current operating environment.

Our list of the top 100 global rated banks is based on their regulatory Tier 1 capital. Starting in 2016, the RAC ratios reflect our revised methodology for assessing the capital adequacy of banks.

S&P's RAC Ratios Continue to Provide Strong Risk Differentiation

Regional differences in the RAC ratios among the world's top 100 rated banks persist. Banks in Switzerland, the Nordic countries, and Australia have the strongest capital ratios; while the weakest ratios among the top 100 banks remain in Brazil, China, and Spain. This is mostly due to these countries' weaker economies, resulting in higher risk weights on domestic banks' assets than those of their peers in the sample. Although Spain's economic growth had been improving until the pandemic-related shock, the country's economy was severely damaged during the 2008 financial crisis and has yet to fully recover from it.

We base the risk weights we apply to banks' exposures on our assessment of each country's economic risk, a component of our Banking Industry Country Risk Assessment (BICRA), and on the risk weights applied to sovereign exposures, which are based on the sovereign ratings. The higher the risk, the higher the risk weights, which result in weaker ratios, while all other credit fundamental remain unchanged. Consequently, changes in our view of a country's economic conditions result in changes in the domestic banks' RAC ratios.

We saw the rise in economic risk in France, Germany, and United Arab Emirates in the past 12 months, which partly explains the erosion in respective banks' 2021 forecasts.

We see significant variations in RAC ratios in some regions. Those among Japanese and North American banks were the widest.

We Expect RAC Ratios to Broadly Stabilize After Years of Buildup

Our survey indicates that the RAC ratios for 69 of the top 100 banks have remained stable or shifted less than 5 bps as of the end of 2020 compared with 2019. For 18 banks, the RAC improved by more than 5 bps, while the ratio for 13 others has weakened by more than 5 bps.

We expect RAC ratios to remain relatively stable for the next two years, because we expect lending growth to be relatively modest over the same period, while provisioning needs moderate from their peak last year, allowing profitability to gradually recover. We expect the economic recovery on the back of unprecedented government support, less need for restrictions to control the virus while the vaccination pace ramps up to help limit the residual risk inflicted by the pandemic on banks' asset quality.

Given the pandemic's harsh economic impact, NPAs could still increase in the coming months in some jurisdictions, particularly in sectors most affected by lockdowns and the changes in customer consumption patterns, but the extraordinary loan-loss provisions that banks raised in 2020 should contain future credit losses.

Nevertheless, we forecast the RAC ratios for Australia's four major banks to be lower in 2022. The lower RAC ratios reflect the Australian major banks returning excess capital to shareholders. Already three of the four major banks have announced buybacks. These buybacks reflect the sale of non-core businesses, a buildup of capital during the pandemic followed by the relaxation of pandemic-related regulatory restrictions, and greater clarity in the Australian Prudential Regulation Authority's new capital framework.

Capital Strength Impact

Similar to what we saw in our previous surveys, the capital strength impact on stand-alone credit profiles (SACPs) of the world's top 100 rated banks ranges from minus 3 notches to plus 2 notches. The capital strength impact is neutral or positive to the SACPs of 80 banks in our current review, the same trend as in our last survey.

The current distribution of the combined impact remains significantly stronger than six years ago, when only 67 banks had a neutral or positive impact, and reflects the capital buildup among the top 100 banks during that period.

Additionally, we now consider capital adequacy (capital combined with risk position) a ratings strength for 37 of the top 100 banks, up from 35 last year and 21 six years ago. Any expected improvements or deteriorations in RAC ratios are already captured in this combined assessment because we base the capital assessment on our capital projections, rather than actual values, and we have incorporated the expected improvements for the next two years.

Click here to find insights into how these trends are affecting the credit profile of banks, asset managers, clearing houses, and other non-bank financial institutions.