The New Rules of Capital Adequacy Basel III from the Perspective of Leasing Companies in Europe and Czech Republic

Some significant changes to the Basel III regulatory framework (called Basel IV) will come into effect during the 2022 to 2027 period. In its first part, this article shows the opinion of the European Federation of Leasing Company Associations Leaseurope on Basel IV. In its second part, this paper evaluates the situation of the largest leasing companies on the Czech market using methods of financial analysis. The results of several studies published by Leaseurope clearly show that the risk associated with the provision of liabilities through leasing is significantly lower than the risk calculated by the capital adequacy calculation for Basel rules. For this reason, the Leaseurope federation prepared concrete proposals for changes in the rules so that the regulation better corresponds to the actual risks taken. The second part of the article analyzes the situation of leasing companies in the Czech Republic in terms of capital, capital adequacy and compliance with Basel rules. It shows the state of the capital adequacy of the largest leasing companies operating on the Czech market using simplified indicators of the ratio of Equity / Balance sheet total and Equity / Receivables. As a complementary indicator, the ratio of Share capital / Balance sheet total is also used. Furthermore, a simplified stress test based on 5% and 10% decline in net receivables and coverage of this decline from equity, respectively, was performed. The results show that leasing companies operating on the Czech market would probably have no problem meeting the considered tightening of capital requirements. Several exceptions are mentioned in the text.


Introduction
The aim of this article is to evaluate the opinions and the position of leasing companies in Europe and the Czech Republic in relation to the newly prepared rules of Basel III regulatory framework (sometimes called Basel IV), which should enter into force between 2022 and 2027. The proposed new rules raise two questions: (i) whether they should be and will be approved and implemented and, if so, (ii) whether financial institutions (here leasing companies) are prepared for them. This paper also follows and expands last year's work (Svítil 2019), especially in its first part, focusing on the opinion of the European Federation of Leasing Company Associations Leaseurope on the rules of capital adequacy. This section looks for the answer to the first question (i) mentioned above.
In its second part, this article tries to answer the second question (ii) by assessing the situation of the largest leasing companies on the Czech market in terms of capital adequacy and preparedness for the intended new rules using selected methods of financial analysis.
The structure of the text is as follows: chapter 2 describes the current situation of leasing financing in Europe and Czech Republic; chapter 3 states the methodology and the sources of data used; point 4.1 shows the Leaseurope's opinion on the new regulation; point 4.2 deals with the capital adequacy of Czech leasing companies using selected indicators of financial analysis; chapter 5 provides a summary of the findings and conclusions.

Current Situation of Leasing Financing in Europe and in the Czech Republic
Leasing financing has long been a common and popular way of acquiring liabilities for businesses throughout Europe, including the Czech Republic.
As Table 1 shows, most of Europe's largest leasing companies are owned by either large banks (the fourth company in the list, a Dutch DLL belonging to the not very well-known Rabobank Group), or by a large automobile manufacturer, such as the German Alphabet, which is part of the BMW Group. Exceptions are, for example, Siemens Financial Services, (Germany), or LeasePlan, owned by a pension funds and investment funds group.  Table 2:

Methodology and Data
Information on the position of the leasing companies in relation to Basel III rules was largely drawn from the European Federation of Leasing Company Associations Leaseurope, which publishes this data on its official website (Leaseurope 2019

Leaseurope represents its members and promotes their interests in dealing with
European and international institutions, informs and provides expertise, and, last but not least, maintains pan-European statistics on leasing and related financing.
Leaseurope also works on some topics with the European federation of consumer credit providers Eurofinas -some associations (and thus some financial Furthermore, data from publicly available sources, especially annual reports of selected leasing companies and banks, as available on the on-line version of the Czech Commercial Register, was used. These datasets make it possible to achieve the objectives of this paper using methods of financial analysis, especially balance sheet ratios (assets and liabilities). For evaluation of the situation of leasing companies operating in the Czech Republic in terms of capital adequacy and preparedness for the intended new rules, two basic indicators were chosen: (i) the Equity / Balance sheet ratio and (ii) the Equity / Receivables ratio from the provided financing or from the business relations (depending on how the leasing company keeps them in its accounting). These indicators were chosen because of the availability of data and at the same time as the closest attainable approach to the capital adequacy ratio for Basel regulation. As a supplementary indicator, (iii) the ratio of Basic Capital to Balance Sheet Total can be mentioned.

Leaseurope's Opinion on the New Regulation
The document The impacts of Basel 3 on the European leasing industry -A Leaseurope research project by Deloitte describes the situation during the period when the earlier Basel II rules were in force: "Basel 2 (current CRD) requirements for leasing: -Under the standardised approach, risk-weights depend on the asset class of the counterparty and the leased asset is not recognised as mitigating risk.
-Under the IRBF approach, LGD varies between 35% and 40% depending on the national regulator.
-Under the IRBA approach, internal models allow a more accurate approach of the risk" (Fleuret N., Phaure H. for Deloitte 2012, p.6) IRBF stands for the foundation internal ratings-based approach (the abbreviations F-IRB is also used in various documents), IRBA stands for the advanced internal ratings-based approach (also mentioned as A-IRB).
-Asset sale proceeds contribute significantly to the low net losses for leasing.
 In 80% of defaults where the lease does not upgrade, the asset is sold.
 Over 20% of these contracts (i.e. defaults that do not upgrade and where the asset is sold) have a zero loss.
 At the portfolio level, asset sale proceeds account for 80.3% of total recoveries.
In contrast, there are capital requirements from 7% (Standardized Approach) to 6% (IRB-Foundation Approach) or at best 4% (IRB-Advanced Approach). Thus, in all cases, Basel requires leasing companies to hold several times more equity than would be necessary.
According to the same document, the situation for leasing financing looks similar in terms of default rates: "The average one-year default rate on the sample portfolio is 2.64%. This is very low when compared to equivalent default rates on the Retail SME portfolios of EU banks2. For instance, the sample portfolio's default rate for 2010 is 2.8% compared to the EBA's EU-wide rate of 4.5%." (Leaseurope 2013b, p. 2) Besides leasing companies themselves, the issue of capital adequacy in leasing companies was mentioned, for example, by Schmit et al. (2003) in preparing the first Basel Capital Adequacy Accord and the EU New Capital Adequacy Framework, as he stated: "Our results confirm that leasing is a low-risk activity and point to the need to review the Basel proposal in order to provide for better recognition of physical collaterals other than real estate" (Schmit et al. 2003 p. 34).
Hartmann-Wendels and Honal (2010) pointed out that in the case of leasing contracts, the actual LGD is in some cases negative, i.e. that the leasing company receives more than the amount of its contract receivable for the forfeited and sold object (e.g. car, truck, etc.). The coverage of credit risk using the subject of financing is also dealt with in more detail by Svítil (2011). Salonen (2011) expects bank owned leasing companies to be required to hold equity of ca. 10-12% of total capital according to Basel III. This is the sum of all capital items, where the uncertainty is determined, among other things, by a countercyclical buffer setting in the expected range of 0 to 2%.
According to Phaure from Deloitte (2013), capital requirements should be 10,5% from 2020 onwards, again in the form of a summary of all items. Phaure expects, in connection with this, the need for capital increases for leasing companies.

Capital Adequacy of Czech Leasing Companies
For evaluation of the situation of leasing companies operating in the Czech Republic in terms of capital adequacy (represented by the requirements for the volume of equity) based on publicly available sources (i.e. mandatory financial statements and annual reports), a simplification has to be made.

As basic indicators, (i) the Equity / Balance sheet ratio and (ii) the Equity /
Receivables ratio from the provided financing or from the business relations (depending on how the leasing company keeps them in accounting) can be used.  So these tests are much more pessimistic than Leaseurope's assumptions (see above). The results of these simplified stress tests for major leasing companies on the Czech market are shown in Appendix 4 and 5.
It follows that in the case of only a 5% loss of Equity / Balance Sheet indicator, Raiffeisen-Leasing (7,8% for 2017 numbers) falls below the threshold foreseen by Salonen (2011) and Phaur (2013) and nears the limit set by Leaseurope (2018). shows that this bank has enough equity capital not only for its own needs (CZK 23,1 billion equity compared to the CZK 10,4 billion of total regulatory capital), but also to cover the needs of its subsidiary leasing company. Therefore, the relatively weaker capital position of Raiffeisen-Leasing is not a serious issue.
Also the results of the largest leasing company in the Czech Republic, UniCredit Leasing, are not optimal (10% Stress test on Equity / Balance sheet total: 6,5% for 2017 numbers), even though they fulfill the assumptions of Leaseurope See Table 4 for details.
It should also be noted that this contribution is devoted solely to the factual fulfillment of the capital requirements imposed on the leasing company and not the associated costs. Such research could be of interest in the future, but it would probably require access to data that is not commonly published (e.g. to assess the cost of equity and equity of individual companies).

Conclusions
In its first part, this article summarizes findings from available sources, concerning the risk taken by the leasing companies on capital adequacy. These sources show that the risk associated with the provision of liabilities through leasing is significantly lower than the risk calculated by the capital adequacy calculation for Basel III rules. The same conclusion was reached by other authors, independent of Leaseurope and leasing companies in general.
For this reason, the Leaseurope has a negative view of the fact that under modified Basel III (so-called Basel IV) regulation, the same capital adequacy rules should apply to leasing companies as to banks. The Leaseurope answers the (i) first question from the Introduction of this article, whether new regulation should be adopted, by preparing some concrete proposals for changes in the rules so that the regulation better corresponds to the actual risks taken.
The second part of this work shows that large leasing companies in the Czech Republic are usually equipped with a sufficient amount of equity, both to cover capital adequacy requirements in the current situation and in the event of a significant loss of net receivables. Only a few companies could, in the event of a deeper crisis (expressed in the modelled case by a very pessimistic estimate of a 10% loss of net receivable), reach the thresholds and just one company would probably not be able to meet these requirements without additional equity