Banks striving for capital requirement compliance

Pham Do Nhat Vinh

As many banks are preparing to apply capital adequacy requirements under Circular No.41/2016/TT-NHNN promulgated by the State Bank of Vietnam (SBV), the forthcoming trend is to implement risk management requirements, especially internal capital capacity requirements of Circular 13 (often called ICAAP). As a consultant for many financial institutions (FIs), how prepared do you see Vietnam’s banking system?

Vietnam’s banking system is going through an interesting period. Until now, around 20 banks have met Circular 41’s capital requirements and these banks may have already pre-evaluated and prepared to ensure that their capital exceeds the minimum threshold of 8 per cent of the regulator. The question is whether or not banks still ensure capital adequacy under ICAAP’s requirements when there is only one more year to go before this requirement comes into effect, and will put more pressure in terms of capital for banks. Based on KPMG’s experience and insight of the Vietnamese market and other similar markets, we assess that additional capital requirement for banks implementing ICAAP might range from 50-200 basis points, or even higher in some banks.

What is ICAAP and what motivates banks to implement it?

To put it simply, with new regulations, FIs are required to better forecast their capital needs to meet the credit growth target for the next 3-5 years. Capital forecasting is not only for financial risks which we often refer to in the banking industry as credit, market, and operations but, in addition to compliance requirements, FIs need to forecast capital for many other types of risks that they consider important a thorough process and methodology consistent with the bank's business model and operating characteristics.

Thus, the implementation of ICAAP will help banks prepare adequate capital in the medium and long term, increase safety levels, and make banks more credible in the eyes of the market and investors, thereby facilitating capital mobilisation.

In the countries that apply Basel, ICAAP will be a very useful tool to help the supervisory authority to classify high-quality and healthy banks and provide appropriate supervision and management policy for each target group.

In Vietnam, the early adoption of capital computation in accordance with Circular 41 and Circular 13 is a clear sign of banks’ pioneer, good financial health & high readiness in all business condition.

Can you share more about the implementation of ICAAP and the approach adopted by banks with whom KPMG co-operates?

Actual ICAAP implementation requires forecasting capabilities and methods to assess impacts on capital status, business indications from macro-economic factors in different scenarios (often called stress test), which are no small challenges.

Doing so requires banks to take into consideration of the unique characteristics of each country as well as their own business model. For example, when we co-operate with TPBank, we work together with the bank’s project team to develope a variety of stress test scenarios in order to forecast the Bank’s business situation and capital adequacy in the context of fluctuating macro-economic factors such as GDP, CPI, unemployment rate, exchange rate, and interest rate, among others. All is to ensure that the bank is safe at different economic prospects with necessary countermeasures ready.

Did this require a lot of calculation?

Yes, it did. However, choosing the approach, calculation model, and forecast is more important and of course dependent on the capacity and quality of data.

We all know that over-forecasting of capital will cost more capital for the bank and consequently, waste resources and reduce the competitiveness of the bank. On the contrary, under-forecasting can lead to passivity in business planning and capital allocation.

Take TPBank as an example, they did well on both data and methodology aspects.

In reality, ICAAP is not easy to implement for banks in Vietnam. What are the critical success factors for ICAAP implementation?

It is worthy of note that implementing ICAAP is very different from implementing Circular 41’s capital computation method. Circular 41 mainly provides clear calculation and quantification requirements that facilitate the implementation. For ICAAP, the regulator primarily sets the principles, and to some extent, the bank has the right to choose the way it sees fit. Therefore, only by frank interaction and communication can the bank be understood and the most appropriate approach be identified.

Therefore, with TPBank, we have adopted an approach that not only met the requirements of the State Bank of Vietnam but also the stringent standards to ensure the capacity to expand and develop in the future. The bank’s ICAAP tool is ready to integrate future results when TPBank implements IFRS 9 (international accounting standards that have a great effect on the provision of receivables) and the IRB advanced internal capital calculation method. It will be very interesting and useful for the bank to see the double impact and application of these on business planning and operation.

TPBank is one of first banks to comply with Circular 13 on the ICAAP’s internal capital requirements and has met the ICAAP’s stringent international standards. TPBank’s early adoption of the ICAAP and implementation of IFRS 9 shows its confidence and optimism in its capital plan.

The State Bank of Vietnam requires commercial banks to implement ICAAP annually and update it according to their development and business model. Therefore, the project can only be considered successful if the bank owns and operates the ICAAP tool in the coming years. We are very happy that the project has been successful to the last step when TPBank staff are ready to do this.