Why high capital levels are a double-edged sword for Singapore banks

The banking sector in Singapore has shown signs of expansion, with loan growth rising to approximately 5% in 2024.

Singaporean banks are finding themselves at a crossroads, having to navigate the complexities of capital management in the wake of the Basel reforms. As financial institutions in Singapore recently reported significant increases in their capital adequacy ratios—up to 200 basis points—following the adoption of these reforms, the implications for future growth and stability are profound. 

Whilst these high capital levels bolster the banks’ resilience, they also present a challenge: how to effectively utilise this capital to foster growth and expansion.

The Basel reforms, which came into effect in July 2024, have set the stage for a gradual erosion of these capital uplifts. 

Over the next five years, Singapore banks will phase in capital output floors that will ultimately lead to a reversion of common equity Tier 1 (CET1) capital adequacy ratios to approximately 15% by 2029. 

Currently, the average CET1 ratio stands at an impressive 16.5%, nearly double the minimum requirement of 9.0% and above the long-term target of 13%-14%. 

The importance of capital management cannot be overstated. A spike in regulatory capital followed by a decline opens avenues for active capital management strategies. Stakeholders are likely to pressure banks to deploy their excess capital more effectively, which could manifest in several ways. 

One immediate avenue is the acceleration of new loan growth. By increasing risk-weighted assets through lending, banks can utilise their regulatory capital more efficiently. 

The banking sector in Singapore has shown signs of expansion, with loan growth rising to approximately 5% in 2024, a stark contrast to the -3% contraction of the previous year. Projections for 2025 and 2026 suggest that loan growth could reach between 5% and 8%, further enabling banks to manage their capital more dynamically.

However, whilst the prospect of increased lending is attractive, it is essential to recognise the inherent risks. Banks are inherently sensitive to market confidence, and maintaining robust capital buffers is crucial for ensuring financial stability. 

High capital levels not only provide assurance to stakeholders but also enhance access to low-cost funding, and a high proportion of sticky customer deposits, even across economic cycles. As such, the banks need to strike a right balance between optimising capital efficiency and maintaining sufficient financial buffers.

In response to their elevated capital levels, Singapore banks have initiated capital distribution plans aimed at paring back excess capital over the next two to three years. These plans include periodic share buybacks and special dividends, allowing banks to return capital to shareholders whilst remaining vigilant about loan growth and emerging opportunities. 

If loan growth continues to rise, banks may scale back or halt capital distributions altogether, ensuring that they have the necessary resources to support their lending activities.

Looking beyond domestic growth, Singapore banks are also eyeing opportunities for overseas expansion. With a war chest of capital at their disposal, these institutions are well-equipped to pursue strategic acquisitions that enhance their regional footprint.

Recent acquisitions, such as Oversea-Chinese Banking Corp. Ltd.’s purchase of Bank Commonwealth PT, exemplify this trend. However, it is crucial to note that such acquisitions will be approached opportunistically, with banks prioritising strategic fit and pricing over mere expansion for its own sake.

Ultimately, the goal for Singapore banks is to navigate this capital transition prudently. By the end of the five-year period, we believe that their fully phased-in CET1 capital ratio will revert to historical norms of around 15%. This transition will not only reflect effective capital management but also ensure that these banks remain competitive and resilient in an increasingly complex financial landscape.