Let banks trade if they cannot lend
As bankers pack their bags and head to Tokyo for the annual IMF/World Bank meetings, the outlook for many is growing gloomier.
Senior bankers, whispering to Euromoney, confessed their worries about dire financial performance in the second half of 2012, even before the third quarter was finished. Many work for banks whose share prices have valued them at sharp discounts to book value over many quarters. Something has to give. A profound restructuring of the industry still lies ahead.
In August, Fitch surveyed one hundred fixed-income and credit portfolio managers, together responsible for $7.2 trillion of assets under management. A majority believes that fundamental credit conditions for banks are set to deteriorate, with bond investors’ pessimism plumbing the same depths evident in the third quarter of last year when the new-issue markets closed to bank borrowers. They expect banks to pass on tightening credit standards to corporate borrowers, with 80% of respondents concerned about a double-dip recession in Europe.
It’s as if the European Central Bank’s three-year long-term refinancing operation had never happened. Indeed, 82% of bond investors surveyed say the banks will need another LTRO, with most of these believing this will have to come before the existing LTRO runs off, and a third thinking it will happen this year.
In the first seven months of 2012, bank issuance of senior unsecured debt was already 28% down on the same period last year, when the market was heading for imminent closure. Euromoney’s own discussions with bond investors confirm that they are interested in buying only covered bonds from banks, with a modest allowance for senior unsecured and subordinated debt, but only from a small number of the strongest financial issuers.
The banking industry is growing more strident in calling on regulators to soften their pro-cyclical enhanced capital and liquidity requirements. Bank lobby group the Institute of International Finance cites one study that higher bank-funding costs due to enhanced capital requirements will impose an increase of between €14 billion and €24 billion in borrowing costs on companies in the euro area. And there are signs of policymakers acknowledging mistakes, for example in calls from inside the ECB for Basle regulators to allow in banks’ liquidity buffers some of the same collateral the ECB lends to them against, such as corporate loans.
But it’s equity and debt investors that have required them to de-lever. And this need not be a disaster for the economy.
If they have fewer bank bonds to buy, investors will look to lend instead to the real economy. High demand is already evident in the degree of over-subscription for public bonds from high-rated corporates. What’s more, as Euromoney’s cover story explains, real-money investors are increasingly putting their cash to work extending loans to private, unrated and below-investment-grade corporates.
Big-name asset managers are doing more of this business for insurance companies and pension funds that cannot manage such exposures in-house. Specialist credit managers are raising capital to do bank loans. The solution to the disappearance of bank credit is clear: an enhanced role for investors in direct lending.
This is where the regulators have some serious thinking to do. Such is the popular hatred of banks that it has become a little too easy to throw one more restriction after another on them. But regulators should be wary of condemning banks’ intermediary role in the capital markets at the same time as casino banking, or requiring them to reduce commitment to this.
If companies are going to fund more in the capital markets, the ability to match investors with consumers of finance becomes a valuable skill. It is here that banks might still be useful, even as their importance as loan providers diminishes.
Investors know that bank loans are illiquid credits, but they want to be able to buy and sell. The US Volcker Rule and the EU’s Mifid, by reducing market-making, will lead to market illiquidity and increase friction costs for investors. As a result, funding costs might rise for borrowers already finding that banks will not lend to them. Some companies might find capital markets cut off as well as bank loans.
This is a danger. Many investors responding to the Fitch survey say diminished liquidity in corporate bonds is already a big concern and reduces their interest in the kind of smaller sub-benchmark-size deals that SMEs will increasingly resort to. If banks are going to lend less, maybe they need some leeway on intermediating in the capital markets that replace them.