S&P Global Ratings expects the RAC ratios of the top 200 rated banks globally will normalize over the next two years, following a slight increase in 2023. Despite the banking sector turmoil in the U.S. and, to a lesser extent, Europe, most of the top 200 rated banks reported good earnings in 2023. Banks mainly benefited from higher net interest margins due to contractionary monetary policies globally. The increase in interest revenues mostly offset the rise in provisions and higher funding costs, while declining--albeit still positive--credit demand slowed the increase in S&P Global Ratings' risk-weighted assets. We think major banks adopted prudent capital management strategies, given economic concerns and upcoming regulatory changes.

Our list of the top 200 rated banks globally is based on their regulatory tier 1 capital (see table 1).

Table 1

We Expect Banks' RAC Ratios Will Normalize

We forecast that the average RAC ratio will remain broadly stable (see chart 1). More specifically, we expect a median difference of 8 bps between 2025 and 2023 and forecast that 50% of the banks in our sample will increase their capital, while the other half with decrease their capital.

Chart 1

After an increase in capital levels in 2023, we predict major rated banks' capital policy will normalize. We continue to see differences among banks due to growth dynamics, varying capital management policies, and pending regulatory changes.

For most banks in our sample, our capital measure improved in 2023

The RAC ratios of 137 banks in our sample increased in 2023, with a median difference of 25 bps between 2023 and 2022. We believe the increase mainly resulted from:

• Banks' desire to maintain prudent capital buffers after the sector turmoil in 2023; and
• Higher interest rates, which largely offset normalizing credit costs and rising operating costs, and translated into broadly stable profits.

U.S.

How U.S. regulators implement the final Basel III standards will influence U.S. banks' capital management over the next two years. In our base case, we expect most banks' capital levels will remain largely unchanged.

A July 2023 proposal from regulators to implement the final components of the Basel III agreement suggested a material increase in minimum capital requirements for large banks. However, regulators have recently indicated that the original proposal requires material changes and that its effects on minimum capital requirements will likely be less pronounced than originally planned. Until regulators repropose and implement the updated capital standards, we do not believe large U.S. banks will materially change their capital levels.

Furthermore, many U.S. banks built up their capital levels over the past two years--particularly after the bank failures in the first half of 2023--meaning further significant increases are unlikely. Monetary easing could also reduce pressure to build capital since lower interest rates could reduce the high levels of unrealized losses that U.S. banks have reported on their securities.

China

We expect Chinese banks' average RAC ratio will decrease to 6.66% in 2025, from 6.83% in 2023. The Chinese banking sector has sufficient capital to withstand loan stress from the weak property market and debt-laden regions with constrained resources. Loan growth in China will likely slow as policymakers shift away from debt-fueled growth and economic conditions normalize. We forecast that decelerating loan growth will support capitalization amid pressure on profitability from lending rate cuts.

We believe the central government is committed to stability and will provide a broadly supportive funding environment that aims to avoid large-scale stress from local government financing vehicles (LGFVs). We therefore expect a selective and gradual restructuring of LGFV debt, with local governments, LGFVs, and original lenders sharing the pain of restructuring with banks to avoid a moral hazard.

New lenders will likely experience some margin pressure from restructuring LGFV debt. We estimate Chinese commercial banks' net interest margin would decrease by an average of 25 bps if all LGFV loans were to restructure simultaneously. The decline would be limited to 5 bps if wholesale restructuring occurred only in certain high-risk regions. That said, local banks in high-risk regions may have limited capacity to restructure LGFV debt. Some of these banks could fail or merge with other institutions with the government's help if they threaten regional stability.

We project credit costs will average about Chinese renminbi (RMB) 2.8 trillion--equivalent to 1.22% of average loans--over 2024-2026. Credit cost could rise to maintain provision buffers amid asset quality headwinds from economically vulnerable sectors, such as property and LGFVs.

Europe

We expect broadly stable and sound capital buffers for European banks, both in terms of regulatory capital and RAC ratios. Although bank profitability will likely decline in 2025, from highs over 2023-2024, it will remain solid and support European banks' resilience to potential financial shocks. For many banks, capital levels remain significantly in excess of regulatory requirements, paving the way for continued shareholder distributions and investments. We expect the median RAC ratio will remain at about 10.7% in 2025, which is similar to 2023 and exceeds North American banks' median RAC ratio of 9.4%.

From Jan. 1, 2025, EU banks will be subject to new capital rules that reflect the Basel III standards. We expect the related uptick in required regulatory capital will be modest. This is because EU legislators have achieved temporary deviations from the original Basel text that will delay and dilute the final capital requirement for banks. For instance, the effect of the output floor, which will be gradually phased in until 2030, will be largely muted until 2032 due to temporary preferential treatments for unrated corporates and low-risk mortgages. Additionally, the European Central Bank, which is in charge of supervising the largest eurozone banks, has indicated that its pillar 2 capital requirements would not increase in nominal terms due to the introduction of the output floor, which will also limit the overall capital impact on banks.

Finally, EU authorities have decided to postpone the implementation of rules related to market risk by one year since they want to avoid putting EU banks at a disadvantage after U.S. authorities delayed the implementation of Basel standards. In the U.K., the Prudential Regulation Authority has announced that the final Basel 3.1 rules will enter into force in January 2026 and that total capital requirements will increase by less than 1% for U.K. banks by the end of the four-year phase-in period. This modest effect mainly results from the expectation that supervisory capital add-ons aiming at capturing model risks will be reduced as the output floor is gradually phased in.

Regulatory Metrics Will Remain Only Partly Comparable Due To The Uneven Implementation Of Basel III

The Basel Committee's focus in relation to bank capital rules is on the consistent and timely implementation of previous agreements. However, we believe the uniform implementation of Basel III rules will remain difficult, even as many jurisdictions have started to implement the latest rules and the consistency of banks' regulatory metrics continues to improve in Basel III jurisdictions. The risk of an uneven application of the rules remains one of several reasons why we believe investors will have to live with the only partial comparability of regulatory metrics. Other regulatory priorities related to climate risks and digital assets are unlikely to move the dial within our two-year projection horizon.

Our RAC ratios continue to provide better comparability for bank capital globally

Variations in regulators' application of the rules nationally and in banks' internal models continue to influence regulatory capital ratios. While our RAC methodology makes some simplifying assumptions, we think it provides a more comparable view of capital and a more detailed differentiation of the risks banks are exposed to. This is particularly important in the current more volatile operating environment. Our RAC ratios remain the cornerstone of our capital analysis in our bank ratings framework (see appendix).

RAC Ratios Still Provide Strong Risk Differentiation

Regional differences in the RAC ratios of the world's top 200 rated banks persist

Unsurprisingly, banks in countries with lower economic risk, including Switzerland and the Nordics, tend to have the highest RAC ratios. This primarily results from lower credit losses, stricter underwriting standards, an absence of large economic imbalances, and strong sovereigns that can use their fiscal buffers to support the economy if necessary. Banks in Southern Europe and emerging markets, where losses tend to be higher, generally have the lowest RAC ratios.

Our RAC ratios are typically lower than the regulatory ratios

This reflects the variations in regulatory approaches nationally and differences in banks' internal models that still significantly influence regulatory ratios. However, some features of the Basel III framework will help narrow the gap since these features are already part of our capital methodology (see chart 2).

Chart 2

The cross-country gap between RAC ratios results from the extensive use of internal models

Internal models tend to produce lower risk weights than the standardized approach and those our core RAC assumptions indicate. Among others, this is the case for banks in the U.K., France, Belgium, the Netherlands, Luxembourg, and the Nordics.

Capital Strength Impact Is Neutral Or Positive For Most Banks

The capital strength impact on the stand-alone credit profiles (SACPs) of the world's top 200 rated banks ranges from minus two notches to plus two notches (see chart 3). The effect is neutral or positive for 175 of the top 200 banks. More specifically, the capital strength impact is:

• Neutral for the SACPs of 91 banks;
• A ratings strength for 84 banks; and
• A ratings weakness for 25 banks.

Chart 3

We already capture potential improvements or deteriorations in the RAC ratios in this combined assessment because we base the capital assessment on our capital projections instead of actual values.

When we assess a banks' capital and earnings, we form a forward-looking view of projected ratios, based on our view of capital management. Therefore, a temporary decrease in RAC ratios would not automatically affect ratings. That said, we could see rating pressure for banks whose solvency declines significantly beyond the thresholds set in our criteria. This could occur because of insufficient prospects of a recovery in earnings and internal capital generation or because of changes in capital management that encompass sustainably lower capital targets.

Appendix: How We Evaluate The Capital Strength Impact On Banks' SACPs

To evaluate banks' potential exposure to losses and their ability to absorb them, we take a combined view of capital and earnings, and the risk position. These are two components of our rating analysis of banks. We assess both components on a six-point scale: weak, constrained, moderate, adequate, strong, and very strong. The risk position assessment incorporates factors that we do not capture in our capital and earnings assessment, such as differences in underwriting standards and credit loss experience, the materiality of risks not addressed in the RAC ratio, and the concentration or diversification of a bank's exposures.

Related Criteria

• Banking Industry Country Risk Assessment Methodology And Assumptions, Dec. 9, 2021
• Financial Institutions Rating Methodology, Dec. 9, 2021
• General: Risk-Adjusted Capital Framework Methodology, July 20, 2017

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• Global Banks Searching For Calmer Waters, Says Midyear Outlook 2024, July 17, 2024
• Global Banks: Our Credit Loss Forecasts, July 11, 2024
• Additional Details On The Update To Our Risk-Adjusted Capital Framework Methodology, April 30, 2024
• Credit FAQ: How The U.S. Proposes To Implement Basel III Capital Rules And The Impact On U.S. Bank Capital Ratios, Jan. 11, 2024
• The Basel Capital Compromise For Banks: Better Buffers, Elusive Comparability, June 3, 2021
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