- Capital adequacy in the banking sector expected to grow persistently in the coming years. Weak economic growth, as projected by ACRA for the years ahead, will be the key reason for low growth rates of banks’ assets that are unlikely to return to pre-crisis level any time soon. Due to this as well as in view of recovering profitability of banking activities, sector’s core capital adequacy (IFRS Tier 1) will increase from the acceptable 11.5% to the moderately high 13.9%, with the minimum recommended level of 6%. Loss absorption cushion will double: advancing from RUB 3.2 trillion (approximately 50% of the total core capital of the Russian banking sector under IFRS) as of year-end 2016 to RUB 6 trillion by early 2021.
- Ability of banks to generate capital has recovered. Recovered profitability following 2016 results together with moderate dividend strategy followed by banks’ owners gave rise to a substantial growth of averaged capital generation ratio (ACGR) for both annual and five-year periods; ACRA uses ACGR as a factor for capital adequacy assessment. It returned to green and stood at the acceptable level of 84 bps versus the critical value of -17 bps a year ago..
- Capital adequacy growth to contribute to improving credit quality of Russian banks. Capital adequacy is one of the key rating factors according to ACRA methodology. The weighted average value of ACGR (directly affecting capital adequacy) may reach the adequate level of 120-130 bps for the entire banking system by year-end 2020. This, in particular, will have a positive effect on both capital adequacy factor assessment of rated banks and credit rating levels as a whole. Indicator gap between leaders and outsiders will remain, but will not be so wide.
Ability of banks to generate new capital started recovering after a three-year decline
Averaged capital generation ratio (ACGR) is calculated for each period as a ratio of financial result adjusted for gratuitous financial aid received (as recorded in P&L), one-off revenues, dividend payments, and net share buyback, to risk-weighted assets (RWA). Then, average value of this indicator is determined for the last five years. For more details, please see Methodology for Credit Rating Assignment to Banks and Bank Groups under the National Scale for the Russian Federation.
Capital adequacy level of a bank is one of the determining factors for its credit rating according to ACRA methodology. As part of capital adequacy assessment, we calculate averaged capital generation ratio (ACGR) that is the evidence of banks’ ability to increase their own capital. Due to highly volatile operational environment in the Russian banking sector, we use five years as the historic horizon for indicator calculation.
Following 2016 results, the average weighted ACGR for the largest Russian banks1 was at the acceptable 84 bps (80 bps for banks with ACRA ratings). This value exceeded both figures of the previous two years and the average figure for five years standing at 56 bps (54 bps for banks with ACRA ratings), which is the evidence of positive, albeit small, changes in the Russian banking industry.
1 Their assets amounted to 87% of the total assets in the banking system as at December 31, 2016 (excluding Bank NCC (JSC) due to specifics of its activities).
Figure 1. ACGR dynamics in 2012-2016
Although the negative trend has reversed, capital generation ability of banks is at a satisfactory level (according to ACRA methodology), which reflects a moderate ability of banks to increase their capital adequacy. At the same time, there is a substantial number of players among the largest Russian banks generating negative capital due to material operating losses, or aggressive dividend strategy of shareholders, which means that capital amount and its adequacy of loss-making banks decline without outside injections.
Figure 2. ACGR assessments for groups of banks for the period of 2012-2016
Excluding adjustments made by ACRA, average capital generation in the last five years was 97 bps (vs. 56 bps including adjustments). On average, adjustments reduced the indicator by 33%, with dividend payments and treasury shares transactions as prevailing factors (approximately 25%). ACGR, used by the Agency in it activities, is the evidence of actual capital generation (considering shareholder’s dividend strategy). Generated capital may be used to further increase active operations without losing financial stability.
Continuing recovery of banks’ profitability to support capital generation increase in the coming years
A detailed banking sector forecast is available in the research titled “Weak demand for loans stimulates risk appetite among Russian banks”.
According to ACRA’s forecast, the average weighted ACGR for the entire banking system might reach 120-130 bps by year-end 2020, which means that “Adequate” assessment of this indicator will prevail for the majority credit institutions. This expectation is based on the following assumptions:
- Lower volatility of banks’ financial results and increased income generation amid gradual recovery in economic growth rates in Russia;
- Relatively low rates of loan portfolio and overall risk-weighted assets growth (not exceeding 10% per year), with moderately high net income level;
- Moderate level of dividend payments is preserved (below 30% of net income) amid continuing regulatory pressure.
In the projected period, the largest banks will continue contributing the most to profitability and capital generation indicators (traditionally strong figures of Sberbank; very likely recovery in profitability of a number of other banks with the state as a shareholder, and large private banks (including foreign banks) with high creditworthiness level).
Although the overall expected trend is positive and consistent, reaching “Strong” capital generation level (over 200 bps) for the entire banking system is very unlikely at this time. Long-term structure limitations for income increase of banks are the key reason: lower interest rates and net interest margin, insufficiently developed commission business, and materialization of deferred credit risks in several industries.