Why Singapore’s Bank Stocks Are Safe Right Now

Singapore’s three big banks, namely, DBS Group Holdings Ltd (SGX: D05), Oversea-Chinese Banking Corp Limited (SGX: O39), and United Overseas Bank Ltd (SGX: U11), are some of the largest listed companies in the local stock market.

They are also financial institutions where many Singaporeans deposit money in and where many companies obtain financing from.

In my view, these traits make it important for investors in Singapore to have a good grasp of how risky the three banks are.

One good way to gauge a bank’s risk is to look at the amount of equity capital it has as a percentage of its risk-weighted assets. A good example of such a measure is the Common Equity Tier 1 Capital Adequacy Ratio (CET1 CAR).

Singapore’s banking regulator, the Monetary Authority of Singapore (MAS), requires banks here to have a CET1 CAR of 6.5% or more. DBS, OCBC, and UOB’s latest financials – as of 31 December 2016 – show that they have CET1 CARs of 14.1%, 14.7%, and 13.0%, respectively.

But this is not the reason why the title of this article is Why Singapore’s Bank Stocks Are Safe Right Now. Risk-weighted ratios do not actually give the best picture of the real risks a bank is sitting on. In his book The End of Alchemy: Banking, the Global Economy and the Future of Money, Mervyn King explains:

“It is extremely difficult, if not impossible, to judge how the riskiness of different assets will change in the future. The appropriate risk weights can change abruptly and suddenly, especially in a crisis.”

King served as the governor of the Bank of England, the United Kingdom’s central bank, from 2003 to 2013. Given his experience and credentials, there’s much we can learn about the banking business from King.

What King thinks is a better way to assess a bank’s risk is the far simpler leverage ratio, which is calculated by dividing a bank’s total assets by its equity. King illustrated the usefulness of the leverage ratio over risk-weighted measures of capital adequacy in his book with the example of Northern Rock, a British bank that failed in 2007 (emphases are mine):

“At the start of [2007], Northern Rock had the highest ratio of capital to risk-weighted assets of any major bank in Britain, so much so that it was proposing to return capital to its shareholders because they had no need of it – under the regulations. At the same time, the bank’s leverage ratio was extraordinarily high at between 60 to 1 and 80 to 1.”

It’s worth noting how perilously high Northen Rock’s leverage ratios were. At 60-to-1, a dip of 1.7% in the bank’s asset values would have bankrupted it. At 80-to-1, all it would take for a death blow to be delivered is a 1.25% slide in the bank’s asset values.

In the case of Singapore’s banks, they are safe because they have very robust leverage ratios. At the end of 2016, DBS, OCBC, and UOB have leverage ratios of just 10.8, 11.1, and 10.3, respectively.

So, investors in Singapore can rest easy now knowing that Singapore’s trio of banks are currently not sitting on any large risks.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. The Motley Fool Singapore has recommended shares of United Overseas Bank. Motley Fool Singapore writer Chong Ser Jing owns shares in Oversea-Chinese Banking Corp.