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Lighter rules to lift lending

Regulation forcing up the cost of borrowing has been eased and delayed. With loan volumes low and banks’ lending capacity high, now is the time for companies to consider loan financing. Pippa Crawford, Head of Loan Capital Markets EMEA at RBS, explains.

Pippa Crawford, Head of Loan Capital Markets EMEA, RBS

New rules on bank liquidity buffers – part of the Basel III regulation to ensure banks have enough assets in reserve to withstand shocks to the economy – were expected to significantly raise the cost of borrowing. But changes announced by the Basel Committee on Banking Supervision in January mean those rules will now be phased in from 2015, rather than introduced in full that year, and at a lower level than expected.

Full compliance with the new rules will not be required until 2019, although it is widely believed that banks may still comply ahead of this date.

This eases the pressure on upward pricing and enhances the attractiveness of a loan market that is already offering good rates. With relatively low levels of demand for loans and enough bank liquidity in place, the vast majority of corporate loan deals are either fully or over-subscribed.

Businesses have been reluctant to borrow during the crisis, preferring to ‘batten down the hatches’ and focus on their existing liabilities. That means banks have capital to put to work and they will want to be as competitive as possible on terms when lending it.

Astute companies are therefore expected to access the loan market now to take full advantage of optimal pricing conditions.

They could also look to refinance existing loans, even if they don’t have to until after the changes are introduced, to take full advantage of current market conditions.

Basel III requires banks – through the so-called Liquidity Coverage Ratio (LCR) – to hold enough unencumbered, high quality assets, like UK government gilts and certain corporate bonds, to meet the amount of cash they would expect to have to lend or return over 30 days should the economy come under stress.

The main changes affect liquidity loan facilities, which tend to be unused, rather than credit loan facilities which are expected to be drawn in some shape or form when they are put in place.

These are facilities for refinancing other forms of a borrower’s debt, giving them access to bank support when alternative forms of funding are not available. The most commonly cited example of a liquidity facility is a standby facility that backs up a company’s commercial paper programme.

For these types of loan, the regulation previously assumed that companies would make complete use of – or draw down on – their committed but undrawn facilities, borrowing the money available to them to tide them over during times of stress.

This of course means that banks would need a significant liquidity buffer to provide those facilities in the first place – they have to buy and borrow this stockpile of reserve assets.

Fortunately, January’s revised rules reduced the size of this buffer because the use of such liquidity loan facilities are one of a number of actions a company could take in times of stress. The regulation now assumes non-financial corporates would only take out 30 per cent as opposed to all of it.

In terms of timing, the Basel Committee has said that the LCR will still be introduced in 2015, but it will now be phased in.

If we wind the clock forward to 2015, banks will need to have liquidity buffers for 60 per cent of the assumed 30 per cent for corporate liquidity facilities. This will rise gradually over the following years and reach 100 per cent (of the assumed 30 per cent) in 2019.

The crux of the matter is that banks initially had to have enough liquidity to cover a 100 per cent draw down on their liquidity loan facilities in 2015 but they now need to cover just 18 per cent that year (60 per cent of the 30 per cent).

It is good news for the loan market and a victory for constructive debate with regulators. The revised regulation still needs to be adopted by local regulators but all expectations are that these changes will stand.

The rules for credit facilities, such as a standard general corporate purposes revolving facility, are unchanged with an outflow assumption of 10 per cent.

Regulatory compliance will still put pressure on banks to raise the cost of borrowing – and of course the liquidity coverage ratio is just one of a myriad of regulatory changes facing banks.

The costs of this regulatory change will have to be passed on to customers eventually but building up the buffers over time, alongside the phased introduction of the regulation, means any price rises will happen incrementally.

January’s Basel III update means we are not going to see any sweeping changes straight away, and when they do kick in they will be far less severe than initially expected. With banks sitting on enough liquidity to lend, now is the time for companies to access the loan markets.

The announcement was good news for banks and businesses. It should help to give the loan market a much-needed boost and get money moving around the economy once again. 

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