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Notice of Banco de Portugal on "Core Tier 1" capital ratio

The Portuguese banking system has shown a considerable resilience throughout the international financial crisis started in 2007. This resilience can be explained, in particular, by a negligible exposure to toxic assets, the nonexistence of a real estate bubble as well as by the institutions’ retail business model profiles. In this context, the Portuguese banking system has been able to maintain levels of solvency and profitability in line with international standards.

Meanwhile, the international crisis has put in evidence the existence of regulatory vulnerabilities in the global financial sector, which led the Basel Committee on Banking Supervision to put forward several proposals in order to strengthen the quality of banks’ own funds, which will be implemented from 2013 onwards and that will be an additional challenge for banks at the international and national levels.

In this context, considering the role played by the Portuguese banking system in the economy, the need to maintain and reinforce its ability in facing the adverse conditions that have prevailed internationally and also in order to anticipate the new international capital requirement standards of Basel III, Banco de Portugal has deemed necessary to trengthen the minimum solvency requirements on the institutions under its supervision.

As such, according with a new regulation approved by the Board of Banco de Portugal, institutions under supervision must comply, until the end of this year, with a minimum Core Tier 1 ratio of 8%, based on capital of the highest quality.

Even though this new capital requirement implies a need of recapitalization for some institutions, it should be noted that the overall Portuguese banking system has ended the year of 2010 with a Core Tier 1 ratio of 8.2%, which compares with a level of 6.5% in 2008.

Banco de Portugal is of the view that all banking groups will have the capacity to autonomously gather the capital needed to comply with this new regulation. Nevertheless, measures adopted by the Portuguese government in 2008 in order to recapitalize financial institutions and provide liquidity are still in place.

Addresses

This new ratio shall be complied with by all banking groups subjected to supervision by Banco de Portugal on a consolidated basis, whenever they include a bank or other credit institution authorized to accept deposits. Additionally, the ratio should be complied with on an individual basis by banks and other deposit-taker with headquarters in Portugal, which are not part of a financial group.

Core Tier 1 ratio

The Core Tier 1 ratio establishes a minimum level of capital which institutions should have taking into account the risks they incur in their activity. As such, this ratio is determined by the ratio between the core capital and risk-weighted exposures.

Core capital comprises the highest quality capital of the institution, in terms of both permanence and loss absorption capacity, deducted from net losses and certain elements without autonomous value (see detailed list of eligible elements in annex), in a going concern perspective.

Risk-weighted exposures represent a measure of the risks of the activity carried out by the institution, including credit risk, market risks (comprising foreign exchange risk and trading book risks) and operational risk, which are calculated according to decree-laws No. 103/2007 and no 104/2007 of 3 April, and other related regulations.

Convergence towards “Basel III”

In December 2010, the Basel Committee on Banking Supervision (BCBS) published the new "Basel III" framework, which introduces fundamental regulatory changes in the following areas: capital, liquidity and leverage ratio to be applied from 2013 onwards.  These regulatory changes will be incorporated in the European Union law through the revision of the Capital Requirements Directive (revision process known as CRD IV).

In particular, the Basel III measures aim to increase the resilience of the banking sector, through the strengthening of the quality, consistency and transparency of regulatory capital, with a view to ensuring that all the material risks taken by banks are adequately supported by a capital base of high quality, which is easily comparable between institutions.

In this sense, having in mind that the predominant form of capital should be common shares, reserves and retained earnings, the BCBS reshaped all capital components: "Tier 1 capital” (going-concern or regulatory capital capital, with ability to absorb losses on a going concern perspective), including "Common Equity Tier 1" and "Additional Going-Concern Capital"; and “Tier 2 capital” (gone-concern regulatory capital or capital available to absorb losses from a bankruptcy or liquidation perspective).

In practice, Common Equity Tier 1 is the best quality capital of the institution, in terms of permanence and ability to absorb losses. Except in the case of an eventual capitalization with public investment, throughout the acquisition by the State of shares with special right on remuneration, the Common Equity Tier 1 matches, at the beginning of the implementation of the new Basel III rules, the Core Tier 1 numerator set by the Banco de Portugal.

National legislation did not foresee, until now, a Core Tier 1 ratio. With this Notice, Banco de Portugal sets, from now on, a minimum threshold of 8% for this ratio.

For the Tier 1 ratio, Banco de Portugal recommends, since 2008 (Circular letter No. 83/2008/DSB), a minimum of not less than 8%.

In 2013, in accordance with the Basel III framework, the minimum ratios of Common Equity Tier 1, Tier 1 Capital and Total will be, respectively, 3.5% 4.5% and 8.0%, still with no deductions from Common Equity Tier 1. These ratios will gradually increase until 1 January 2015 where they reach their definitive thresholds (4.5%, 6.0% and 8.0% respectively). In addition to these minimum ratios, the Basel III framework establishes a capital buffer, applied gradually from 2016 and that will be 2.5% on January 1, 2019.

Portugal, 7 April 2011