Ink barely dry, EU aides fret new rules crimp investment

Tue Nov 26, 2013 8:12am EST

* Basel III, Solvency II to crimp bank funding of SMEs

* Capital rules on securitisation hit company funding

By Paul Taylor

PARIS, Nov 26 (Reuters) - With the ink barely dry on new capital rules for banks, insurers and pension funds, some European policymakers are already pressing for changes to avoid strangling investment in credit-starved small business as an unintended consequence.

At the heart of the issue is the treatment of asset-backed securities (ABS), through which banks can bundle up loans made to companies, sell the resulting package and free themselves up to do even more lending.

Forcing financial companies to set aside more capital when they buy ABS seemed like common sense after the 2008 financial crisis, yet it could hinder economic revival in euro zone states worst hit by the bloc's debt crisis, economists and market players say.

The debate comes at a time when parts of the European Union, struggling to emerge from a long recession, are suffering an investment drought, with weak banks reining in lending for smaller companies and infrastructure projects.

Even healthy small- and medium-sized enterprises (SMEs) in Spain or Italy are having to pay 4 or 5 percentage points more to borrow, when they can get credit at all, than peers in Germany or Austria.

That reflects financial fragmentation in the euro zone, not just higher credit risk.

SMEs are the backbone of those economies, providing most private sector jobs, yet most are too small to issue corporate bonds, unlike smaller firms in the United States. In Europe, banks traditionally provide about 80 percent of SME finance.

The European Central Bank (ECB) is leading the charge against the potentially perverse effects of the new Basel III bank capital adequacy rules and Solvency 2 EU insurance regulations.

ECB executive board member Yves Mersch said this month Basel III's treatment of ABS is "like calibrating the price of flood insurance on the experience of New Orleans for a city like Madrid".

High planned capital charges under Solvency II for insurers holding ABS would kill the nascent ABS market for financing small business stone dead, Mersch said in a recent speech.

The executive European Commission has also asked insurance regulators to ease Solvency II provisions on lending to SMEs.

The Basel Committee in charge of setting global banking capital standards said in September it would ease capital requirements on securitized debt within about two years to help wean banks off cheap central bank money.

But that may come too late for companies struggling now.

SUB-PRIME COMPARISON

Under the Solvency II framework, insurers would have to set aside capital equivalent to 80 percent of the value of AA-rated ABS they hold and 40 percent of products rated AAA, compared with charges for corporate bonds of just 6 and 5 percent respectively.

A 2012 survey by the Association for Financial Markets in Europe (AFME), whose members include the likes of Barclays , Santander <SAN.MC., Citi and Goldman Sachs which together hold or manage more than 5 trillion euros, found Solvency II was likely to cause a permanent drop in securitisation funding.

European Internal Market Commissioner Michel Barnier, in charge of drafting EU financial services regulation, told Reuters he shared concerns about the potential impact on SME funding and his staff are looking for a solution.

Politicians and regulators devised the tighter rules in response to the 2007 sub-prime mortgage crash in the United States, when a chain default of securitised home loans triggered the first wave of the global financial crisis.

Barnier said his first duty in the wake of the financial crisis had been to tackle an absence of rules that had led to "crazy incentives for risk taking" in the markets.

The ECB's Mersch dismissed comparisons with the sub-prime fiasco, saying data showed there was an extremely low default risk among European ABS for small business.

A senior European regulator, speaking on condition of anonymity, noted Solvency II only comes into force in 2016, and suggested some ABS rules may be changed before then.

Richard Hopkin, managing director and head of securitization at the AFME, said he expected both the Basel rules and Solvency II to be amended favourably. But another potential obstacle is what assets banks would be allowed to include in their "cash-like buffers", separate from capital.

NEGATIVE SIGNALLING

If, as current draft proposals suggest, ABS are excluded or ranked low in the pecking order, "nobody is going to want to touch them," Hopkin said. "It's negative signalling and won't do anything to encourage investors to come back."

The European Investment Bank reckons investment in fixed capital, research and development in the EU suffered an unprecedented collapse during the crisis and is now about 17 percent below its 2008 peak on average.

In the countries that needed international bailouts - Greece, Ireland, Portugal and Spain - investment has collapsed by almost 50 percent.

The chief cause was political and economic uncertainty, rather than a general lack of finance, but credit is still a serious constraint, particularly for SMEs most dependent on bank lending in the hardest-hit countries.

Given the banks' need to deleverage and raise their capital buffers to meet new EU and global regulatory requirements, EIB experts say SMEs and young innovative firms now need to tap securitisation and venture capital to expand and prosper.

An EIB report published this month said authorities should promote greater use of loan guarantees, securitisation and venture capital to diversify companies' sources of funding.

Paolo Altichieri, head of global markets at Banca Popolare de Vicenza in Italy, the only European bank to publicly place a securitisation this year, said official sector backing through guarantees or first-loss insurance could help revive the moribund market.

"Any type of protection scheme would be welcome and might be an effective catalyst to re-start the lending operations to SMEs," Altichieri said.

The ECB is pushing for unparalleled transparency on ABS through its "data warehouse" initiative, that may ultimately lead to changes in the rules and greater insurer investments.

As Barclays analysts wrote in their European Securitisation Outlook 2014: "While many of the harsh regulatory initiatives or proposals from recent years are not yet implemented, some subsectors (those that 'fund the real economy') might ultimately benefit from more lenient treatment or could even be promoted by politics, regulators and central banks".

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