Fitch Ratings notes that proposals currently being discussed to end the eurozone crisis include plans to increase banks’ capital ratios over an accelerated timeframe. If these proposals were enacted, and higher requirements were met in part or in full by shrinking assets, this could pressure banks’ ability and willingness to lend. This could accelerate the ongoing process of corporate funding disintermediation, and have implications for other asset classes.
All else being equal, increasing banks’ capital ratios should make them more creditworthy. Capital ratios can be improved by either reducing banks’ assets or increasing their capital. Increasing capital, whether from private or public funds, should be neutral, if not mildly positive, for lending. On the other hand, if banks are given the option and choose to satisfy tighter requirements by shrinking assets, this could reduce lending.
High-grade corporates, the debt of which is currently seen as a safe-haven asset, are likely to be able to work around any tightened lending conditions by satisfying their funding needs direct from the capital markets. Most investment grade companies which have managed to issue over the recent period of market stress have done so at historically low all-in costs, although access to the market has been sporadic. Further bank disintermediation would mark the continuation of a long-running trend among European corporates, as Fitch discussed in a report entitled ‘European Corporate Funding Disintermediation’.
Lower-rated corporates and small and medium-sized enterprises (SMEs) may bear the brunt of any credit rationing, as will the consumer. One source of lending to these sectors is non-bank lenders – and Fitch is already seeing intermediaries such as large corporates with banking arms enter the market. However, volumes have so far been limited.
The other alternative funding route for these groups would be via structured products. While certain parts of the structured finance market – such as deals backed by auto loans or credit cards – continue to function, much of the market is hobbled by uncertainty regarding the legal framework in which structured products will operate, their place in financial institutions’ capital structures, and investor hesitancy.
Possible negative macroeconomic implications of any measures adopted may be offset by positive effects. The recapitalisation measures at least would genuinely make banks safer to lend to. This may combine with the positive effects on sentiment which may follow a favourable view by the market on any final proposals. This could have both direct effects on consumer spending and investment, and reduce bank funding costs – potentially making certain types of lending more economical than they currently are.
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