The impending Basel II capital
adequacy rules will have profound impacts for corporates looking
for bank funding or trade finance, so it’s best to start preparing
for these new rules now.
The simple answer is that
using banks will become more expensive and there will be less
choice, after Basel III is introduced, particularly as regards
international services. Basel III tightens the screw on banks in
- Imposing the holding of a larger block of capital as a
percentage of risk-weighted assets (meaning all transactions
involving credit, market or operational risk, whether they are
on-balance sheet or not). The percentage rises from originally
around 4% to 10% and banks will want to earn a wider interest
margin in order to attain their return on equity (ROE)
- Increasing the risk-weighting on all transactions,
reversing the endemic and self-certified under-weighting through
the 1990s and 2000s, when OECD sovereign risk and exposure secured
on real estate (retail and commercial) enjoyed low weightings;
since proven to be flawed. On this measure again, banks will need
to hold more capital against each loan and so must earn a wider
margin in order to have the same return.
- Imposing visible costs on short-term deposits, which are
deemed “unstable” and for which the bank will have to hold a
percentage on a low- or nil-interest
bearing account at the central bank. These deposits then form a
fund for the central bank to deal with a run on any one bank, and
they reflect regulators’ unease about institutions that depend on
wholesale funding (i.e. that no lessons were learned from
Continental Bank of Illinois’ demise in 1984).
On the asset side of the
bank’s books the bank will want more money to pay for the increased
capital. On the liability side it will pay less on deposits because
the deposits cost the bank more to hold.
In other words the customer
will have to pay a higher parking fee for putting its assets and
liabilities on the bank’s balance sheet, as opposed to finding
non-bank investments and non-bank sources of funding.
Basel III: Too Much,
A study of 58 major banks in
early 2011 by Independent Credit View, a Swiss rating company,
concluded that banks may have a capital deficit of more than
US$1.5 trillion at a time when capital markets are unreceptive to new
issues, while existing shareholders are reluctant to take up new
issues that represent massive dilution.
The European Banking
Authority’s (EBA) stress test of 100 European banks required a plan
of each bank to reach the 10% target: only UniCredit proposed
raising new share capital. Nevertheless, the EBA approved all the
plans – wrongly concluding that achieving them plan would not
reduce EU money supply and cause a depression. The EBA concluded
this because the plans showed a reorganisation of balance sheets
via the sale of non-core assets.
An example would be Barclays’
disposal of 20%+ stake in BlackRock: the planned sale will indeed
reduce Barclays’ gearing but the guideline sale price is US$1bn
below book value. So Barclays might well reduce assets and
liabilities via this sale but it would directly deplete capital by
US$1bn, although at least BlackRock might attract interest from
insurance, fund management and investment organisations.
The EBA’s delusion stems from
a failure to recognise that a bank’s non-core assets are still
financial services industry assets and only of interest to another financial services industry buyer: if all 100 of the top banks are sellers, who are
the buyers? It’s a buyer’s market certainly – but in the absence of
any buyers the replenishment of capital cannot occur through sale
of non-core assets. Instead it has to be via shrinkage of business
and increased revenue on what remains.
The obvious and immediate
outcome is wider interest spreads on short-term business, meaning
firstly wider overdraft and loan margins to pay for the higher
capital allocations and then lower rates on deposits to absorb the
costs of liquidity reserves.
A key question is whether
corporate and institutional current account balances, as opposed to
time deposits, get computed into stable funding or not. If they
are, then there will be even hotter competition for this kind of
business. If they are deemed unstable, there will be a high cost to
the banks that accept the money.
Targeting and Smaller Credit Lines
The second reaction will be
for banks to shrink the target market to house clients and to
de-emphasise foreign clients where it is not top-tier, and also to
concentrate on ‘home markets’, i.e. markets where the bank can
achieve sustainable market share and profitability from that market
Then it is a reduction of the
amount of credit per customer group, de-emphasising types of
business that require large but often unutilised lines, especially
if they are uncommitted and attract no commitment fees, and cause
the bank’s notional exposure to get towards the legal lending
Impact on Banks’
The changes described above
will have a marked impact on international services and overseas
networks, few of which will qualify as sitting in home markets. An
early effect will be a reduction of the fishing right, available to
local marketing staff, to add local business that is not connected
to house clients or home markets.
That would, in turn, affect
the syndicated loans market in a location like London:
- Fewer banks with an overhang of liquidity out of their
home market, looking to invest that liquidity in loans regardless
of whether the borrower is a house client or not.
- An illiquid interbank market underlying loans that
are usually priced off the London Interbank Offered Rate
- A thinner market as traditional players ‘fold their
- Greater difficulty in achieving consensus on the right
margin for a certain loan, given the increasing diversity of banks’
capital adequacy positions and pricing models.
Without a syndicated loan
market to participate in, the rationale for a number of banks’
presences in London (for example) may dwindle. In turn, these and
other overseas operations are likely to figure in the list of
non-core assets that were shown to the EBA as ready for sale. The
policy from head office would tend towards focus and shrinkage,
inhibition of local initiatives and so on; by implication that
reduces the sale value of the asset, effectively Hobson’s
No Future for Branch
Networks as Bought-money Banks
A bought-money bank is one
without a retail deposit base. It is the kind of operation that the
rules around unstable deposits will hit hard. Foreign branches have
traditionally funded themselves with local interbank deposits in
order to meet the credit needs of subsidiaries of ‘house’ clients.
Foreign branches (other than Icesave and ING Direct) have not been
established to bring in a deposit base.
That has to change. If the
foreign branch is asset-driven and just a lending office, its net
interest income will be squeezed from both sides.
Corporates will inevitably
find that they feature in the target market of fewer banks. That
will include fewer foreign banks through their operations in the
corporate’s head office country. Foreign banks may simply have no
division focussing on what are, for them, foreign corporates, or
else that function will move from the local branch and back to head
For the corporate this could
simply mean more travel, or a great difficulty in finding banks
that will both offer local banking services and look beyond the
size of the subsidiary to the size of the parent when it comes to
size of lines and the terms and conditions.
Basel III raises the costs of
doing business with banks, and banks’ reactions will not be limited
to raising charges. They will extend to:
- Narrowing the customer target market.
- Focusing on certain lines of business.
- Offering services over a narrower geography.
Less profitable activities
will be curtailed. A customer should assume that a bank will take
them on as a customer. And banks generally will de-emphasise their
foreign operations, because they will have less scale and
sustainability, and because there will be political pressure to
focus resources on home markets.
The advice to corporates has
to go beyond clichés like “investigate non-bank alternatives” and
“optimise order-to-cash” and to have a genuine relationship
management approach towards the banks that supply the major part of
credit. Corporates are doing that already.
Could the advice include an
approach to bank and non-bank investors in the Middle East and Far
East? How likely is the corporate to fall into their investment
criteria there, if the borrower does not already tap non-bank
markets in Europe and North America?
For the corporate that relies
mainly on banking funding the advice should
- Identify retail banks with deposit bases that are willing
to offer commercial banking services to group
- Devolve relationship management with those banks back to
the subsidiary level from the group treasury level.
- Actively identify banks whose business structure is less
harmed by Basel III, and ones that have meaningful international
cooperation agreements with similar banks.
This could be perceived as
counter-cultural, representing a step back from centralisation and
a reduction in the number of bank relationships. But then the
central, wholesale market has become illiquid, so a borrower is
best advised to track back to the original source of
Europe’s opening banking regulation is finally here. After months of preparation across the continent, the Revised Payment Services Directive comes into effect on January 13.
The revised Payment Services Directive regulation, regarded as one of the most disruptive in Europe’s financial services sector, will begin to make an impact on January 13, 2018.
This year promises to further the regulatory compliance burden imposed on financial institutions. How are firms in the sector responding to the challenge?
Global trends, technology and the role of the treasurer in 2025 were hotly debated by treasurers at this year’s Treasury Leaders Summit in London. A focus on technology and automation was universal, others argued over the impact of macroeconomic and global trends on treasury.