NEW CAPITAL ADEQUACY REQUIREMENTS FOR FINANCIAL HOLDING COMPANIES AND BANKS

01/01/2004

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I. Financial holding companies

On 25 November 2003, the Ministry of Finance (MOF) announced amendments to the Regula-tions Governing the Consolidated Capital Ade-quacy of Financial Holding Companies. The key points are as follows:

The old regulations provided that the qualified capital of a financial holding company should be calculated in the same way as that of banks. However, in view of the fact that investments by financial holding companies are mainly long-term in nature, to avoid financially weakening a parent company and then its subsidiaries, the MOF now requires that the maturity of funds of a financial holding com-pany should reach a certain minimum period.

The MOF has therefore revised the definition of the qualified capital of a financial holding company to: the combined total of common shares, preferred shares, subordinated debts, prepaid capital, capital reserves, retained earnings or accumulated deficit, and equity adjustments (i.e., reserves for exchange minus losses from unrealized long-term equity in-vestment plus/minus accumulated adjusted amounts), less goodwill, deferred assets, and treasury stock. Of the above, the original maturity date of preferred shares and subor-dinated debts must be seven years or more from their issuance, and during the last five years to maturity, their value is cumulatively discounted by at least 20% each year and the combined amount of such instruments in-cluded must not exceed one-third of the total qualified capital.

The old regulations defined the statutory minimum capital of a financial holding com-pany as its total risk-based capital (calculated as per the formula prescribed in the Regula-tions Governing the Capital Adequacy of Banks), multiplied by the statutory minimum capital adequacy rate for banks. However, given that the permissible short-term invest-ments are regulated by Article 39 of the Fi-nancial Holding Companies Act, the risks associated with short-term funds are already controlled. Accordingly, to avoid limiting financial holding companies' flexibility in the use of their short-term funds, in the new regulations the, MOF has redefined the statu-tory capital of a financial holding company as its total assets, less cash and cash equivalents, the book value of its short-term investments, goodwill, and deferred assets.

The old regulations provided that the qualified capital and the statutory capital of a trust en-terprise should be calculated in the same way as that for banks. However, trust enterprises may not guarantee the principal of trust prop-erty, or promise minimum interest yields. Thus their business is different in nature from the main business activities of banks, such as lending and investment, which are mainly risk assets. Therefore the MOF has adopted the same rules for trust enterprises as those for futures enterprises and venture capital in-vestment enterprises, by redefining a trust enterprise's qualified capital as its total assets less total debt; and its statutory capital must be at least 50% of its total assets.

The amendments may bar preferred shares and subordinated debts already issued by a finan-cial holding company from its qualified capi-tal. To prevent this from impacting the group capital adequacy, new provisions allow those preferred shares and subordinated debts issued before 1 July 2003 with the approval of the competent authorities, that meet the conditions for inclusion in the qualified capital of a bank, to be included in the financial holding com-pany's qualified capital; provided, that during the last five years to maturity, their value is cumulatively discounted by at least 20% each year.

II. Banks

Article 4 of the Regulations Governing the Capital Adequacy of Banks is amended to allow certain capital instruments that combine charac-teristics of both equity capital and debt to be in-cluded in a bank's Tier 1 and Tier 2 capital. The MOF made the amendments after taking into consideration the Basle Committee on Banking Supervision's guidance on banks' hybrid capital instruments and innovative capital instruments, and the current practice in major countries of allowing banks to issue hybrid financial products and include them in their capital, in order to di-versify their capital structure. The key points are as follows:

The non-cumulative perpetual preferred shares and non-cumulative subordinated debts without a matuity date that meet the follow-ing conditions are entitled to be included in Tier 1 capital:

1.the long-term subordinated debts and non-perpetual preferred shares are fully paid and non-accessible;
2.the bank or its affiliates have not provided guarantees or collateral;
3.the payment order of the holders of non-cumulative subordinated debts without a maturity date is subordinated to that of the holders of subordinated debts under Tier 2 capital and other general creditors of the bank;
4.if the bank does not have any earning in the first half of a fiscal year and does not dis-tribute any dividends to the holders of common shares, the bank should not pay the interests on subordinated debts;
5.when the bank’s capital adequacy ratio is lower than the lowest ratio stipulated by the authorities and the bank does not rectify such situation within six months, non-cumulative subordinated debts without a maturity date should be converted in whole into perpetual non-cumulative pre-ferred shares; and
6.ten (10) years after issuance, if the bank’s capital adequacy ratio reaches the lowest ratio set by the authorities after redemption approved by the authorities, such instru-ments may be redeemed prior to the ma-turity date. If they are not redeemed, the bank may raise the contracted interest rate once only, by a maximum of one percent per annum or up to 50% of the originally contracted interest rate.

The combined total of such instruments in-cluded in a bank's Tier 1 capital must not ex-ceed 15% of its total Tier 1 capital. The amount exceeding the above threshold may be carried over to its Tier 2 capital.

The cumulative perpetual preferred shares, cumulative subordinated bonds without a maturity date, and those convertible bonds that meet the following conditions may be in-cluded in Tier 2 capital:

1.the long-term subordinated debts and non-perpetual preferred shares are fully paid and non-accessible;
2. the bank or its affiliates have not provided guarantees or collateral;
3.if the bank’s capital adequacy ratio is lower than the lowest ratio set by the authorities due to payment of interests, the bank may defer the payment of interests and divi-dends and the deferred interests and divi-dends will incur no interest;
4.if the capital adequacy ratio is lower than the lowest ratio set by the authorities and its accumulated losses exceed the combination of retained earnings and capital reserves, accumulated subordinated debts without a maturity date and convertible bonds shall be converted in whole into perpetual ac-cumulated preferred shares;
5.five years after issuance, if the bank’s capital adequacy ratio reaches the lowest ratio set by the authorities after redemption approved by the authorities, such instru-ments may be redeemed earlier. If they are not redeemed, the bank may raise the con-tracted interest rate once only, by a maxi-mum of one percent per annum or up to 50% of the originally contracted interest rate;
6.convertible bonds must be subordinated bonds with a maturity date of not exceeding 10 years; and
7.convertible bonds can only be converted into common shares or perpetual preferred shares upon maturity; and before maturity, they may only be converted into common shares or perpetual preferred shares, unless the authorities approve a different mode of conversion.

The combined total of long-term subordinated debts and non-perpetual preferred shares in-cluded in Tier 2 capital shall meet the fol-lowing requirements and shall not exceed 50% of the total Tier 1 capital:

1.the long-term subordinated debts and non-perpetual preferred shares are fully paid and non-accessible;
2.the bank or its affiliates have not provided guarantees or collateral;
3.their original term to maturity is at least five years; and
4.their value is cumulatively discounted by at least 20% in each of the last five years to maturity.