[OPE] The Banker: financial regulation increases cashflow problems and the price of capital

From: Jurriaan Bendien <adsl675281@telfort.nl>
Date: Sat Oct 09 2010 - 17:19:34 EDT

(The Banker magazine has an article (I post some excerpts) which explains in
detail something which I mentioned a long time ago, namely that the new
proposals for financial regulation increases the cost of capital to the
productive sector, and therefore is likely to raise final prices for output
(since the costs are transferred to the consumer) as well as impacting
negatively on job creation. The article notes specifically that larger
corporations can engage in self-financing, but that smaller firms
responsible for much of employment growth are much more dependent on bank
credit - JB)

Hitting the wrong target: how bank regulations will damage companies
By Michelle Price
The Banker, 29 September, 2010

Both the US and European regulation of derivatives, which include reforms
designed to stamp out speculation, threaten to hit the one set of
institutions - non-financial corporates and industrial companies - which use
financial instruments not for speculative purposes but to hedge cashflow
exposures caused by foreign exchange movements and volatile commodity

In some cases, the amount of cash collateral a multinational corporate would
require to centrally clear complex, long-term derivative contracts - a key
feature of both the US Dodd-Frank Act passed in July and the proposed
European Market Infrastructure Legislation - would equal if not surpass its
capitalisation, warns the European Association of Corporate Treasurers

To satisfy these requirements, many corporates would have to turn to their
bank for additional funding facilities to cover the gap and in some cases,
"they would just run out of cash," says one treasurer. Furthermore, higher
counterparty-credit risk capital charges, combined with restrictions on
proprietary trading, will reduce liquidity and increase the cost of hedging
for corporate end users.

(...)The unintended consequences of new Basel III provisions, published
in December 2009, are even more perverse.

By clamping down on off-balance-sheet finance, the new Basel III
requirements will penalise trade finance instruments, such as letters of
credit, with far reaching and damaging outcomes for global trade - the very
engine of growth needed to resuscitate moribund Western economies. Basel
III's liquidity cover ratio, meanwhile, could sharply increase the cost of
short-term corporate funding.

And the worst affected companies will be small and medium-sized enterprises
(SMEs) - just the sector that governments are looking to for expansion and
job creation. "The SMEs are really in deep trouble," says deputy managing
director at the Institute of International Finance (IIF) Hung Tran. (...)

It is widely agreed that new Basel proposals, in terms of their increased
capital requirements, will adversely affect the availability and therefore
cost of corporate finance, and the corporate community is braced for a
permanent increase in funding costs. "Capital is going to be much scarcer
and the remuneration sought for that capital will be much higher and that
will feed through to the corporates," says Martin O'Donovan, assistant
director, policy and technical, at the UK's Association of Corporate
Treasurers (ACT). (...)

Bank-intermediated trade finance underpins about 30% of world trade,
according to the ICC, meaning the proposed change in the risk weighting of
trade finance products could prove extremely damaging to exporters and
importers globally. Thierry Senechal, banking policy manager at the ICC,
adds that trade financing for emerging market transactions are likely to
suffer the most under the new Basel credit conversion factor. (...)

It is increasingly clear that the new post-crisis regulatory agenda looks
set to transfer a good chunk of risk, in particular liquidity risk, out of
the financial system and into the broader private sector. Regulators would
argue that this is only appropriate since for the past 10 years
bank-extended corporate funding has simply been under-priced. As a result,
the financial sector has borne a disproportionate amount of the risk
attached to the provision of that funding, they argue.

Certainly, European commissioners believe that derivative transactions have
been sorely under-priced, and nowhere is this more evident than in the
growth of non-collateralised OTC derivative deals whereby the bank
effectively extends the corporate client a sizeable credit line. As with all
credit lines, this must be paid for, says the European Commission. Lobbyists
argue, however, that taking on corporate credit risk is simply a standard
part of banking business and that in pushing risk into the private sector
the regulators may be sowing the seeds of the next crisis. (...)

Large multinational companies... will remain largely impervious
to the new Basel III constraints, says Hung Tran at the IIF. Such behemoths
are awash with cash, enjoy higher credit ratings than their beleaguered
lenders and are able to raise funding in the capital markets at very
competitive rates. These big beasts have little to worry about where Basel
is concerned, says Mr Tran.

"However, the sector which is very important for the global economy,
particularly in terms of generating employment - the small and medium-sized
enterprises - are really in deep trouble," says Mr Tran. "They are very much
dependent on bank lending for working capital and investment needs," he
adds. (...)

ope mailing list
Received on Sat Oct 9 17:21:16 2010

This archive was generated by hypermail 2.1.8 : Sun Oct 31 2010 - 00:00:02 EDT