Basel III is the biggest regulatory change that the banking industry has seen in decades. Add to this the Payment Services Directive II (PSD2), which when enforced will mean that banks are not the only market players offering payment solutions. Without doubt, these two regulations drastically impact the relationship between banks and their corporate clients.
The impact on bank lending
Basel III has common consequences for companies irrespective of their credit risk profile. Banks will assess loan requests by reviewing their balance profitability and the entire wallet distribution of their clients. Also, the increases in the internal capital charges for banks will be passed through to borrowers and long-term financing will be restricted since retaining loans with long maturity becomes economically unattractive. However, banks will focus on their top tier clients, leaving those with lower credit risk profiles and high dependency on bank lending with less negotiating power.
Companies will see an increase of cross-selling coming from their banks, which, for example, must set aside the same amount of capital for AAA loan commitments than for those rated BBB, while the former earn less income. Therefore, “low risk” assets need to generate higher returns. Banks will achieve this by (cross-) selling other products to their clients.
Another significant change is a decrease in the availability of debt instruments, since less profitable lending facilities are subject to more intense scrutiny. For example, banks may discontinue their participation in syndicated loans and discontinue certain credit lines if the return is unattractive. Additionally, unused committed credit lines become more expensive under Basel III. Too many committed credit lines can raise liquidity concerns for the bank, leading to a reduction in the offering of these products.
In this changed environment it is important for companies to assess their degree of dependency to bank lending. Yet financing alternatives vary depending on the sector and the issuance of corporate debt is used across many sectors. However, it is not available to all companies; only those with a stable and high credit risk profile are likely to be prepared for issuing corporate debt.
The impact on cash management
Basel III limits the aability of banks to net assets and liabilities across entities. Moreover, they will have to keep extra liquidity on the balance sheet to offset the “plus” accounts (liabilities) and hold regulatory capital for overdraft accounts (assets). Not surprisingly, this affects the ability of banks to offer products such as notional pooling. Companies with a high credit risk profile that can provide legally enforceable cross-guarantees will be much less impacted than those unable to do so. In any case, banks will price notional pooling higher, imposing thresholds with periodic cash settlements. This could to lead companies refraining from using notional pooling and we might even see more banks withdraw the service.
Under Basel III, banks are more sensitive to the nature and tenure of deposits. Non-operating deposits are a smaller source of liquidity for banks, since they can be withdrawn faster and must be backed by high-quality liquid assets – as opposed to operating deposits used for payments, payrolls and cash management. Thus, classifying cash as being operating, reserves or strategic will benefit the communication with the banks to understand the nature of deposits.
According to the 2015 Liquidity Survey published in the US by the Association for Financial Professionals (AFP), 56% of companies are keeping their cash in bank deposits. In the current low interest rate environment, these decisions are driven by interest rate differentials. In this context some banks even penalise non-operating deposits by applying negative interest rates. Other banks may discontinue interest bearing overnight accounts or price them higher. Some have even started offering new products that require a notice period of 31 days to withdraw funds. With 15% of corporate cash sitting in money market funds (MMFs) and the new Securities and Exchange Commission (SEC) regulation enforcing a floating net asset value (NAV) due to take effect in October 2016, it remains to be seen what alternatives to operating deposits will be available in the long term.
The impact on hedging
The pricing of over-the-counter (OTC) derivatives will also be impacted by an increase in the internal capital charges being passed through to clients. This is caused by the introduction of the credit valuation adjustment (CVA), which takes into account the market value of a counterparty’s credit risk deterioration. These effects will particularly affect lower-rated companies and complex hedging transactions.
Key questions and next steps
Under Basel III, the old “know your client” (KYC) dialogue between banks and corporate clients will incorporate a “know your bank” perspective. The table below provides a non-exhaustive sample of key questions and next strategic steps, to be used as a guide in identifying where treasury teams should focus their efforts as they adapt to the new regulatory environment.
We are witnessing a watershed moment in the banking industry. Corporate clients have begun to notice the impact and the effects of the new Basel III regulation are far from being over. Treasurers should already be working on a plan to adapt their department to the new economic and regulatory environment.
Many banks around the world, large and small, continue to experience major security failures. Biometric systems such as pay-by-selfie, iris scanners and vein pattern authentication can help.
The implementation date of Europe's revised Markets in Financial Instruments Directive, aka MiFID II, is fast approaching. Yet evidence suggests that awareness about the impact of Brexit on MiFID II is, at best, only patchy and there are some alarming misconceptions.
Despite all the automation and improvements that digital banking has the potential to achieve, customers and their needs still form the very core of the banking sector.
Banks might feel justified in victim blaming when fraud occurs, but it does little for customer confidence.