Lukas Becker, writing on Risk.com, points out that the recent emphasis on “stress testing” banks, coupled with incoming leverage ratio requirements, are causing some banks, especially in Europe, to lower their long-term/less-liquid loan portfolios.

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As Becker notes, quoting Mark Penney, head of balance sheet management for the global markets business at HSBC in London: “We’re seeing a slight shift in infrastructure and project financing – long-term structural asset financing moves away from banks simply because you really can’t afford to have very heavy, relatively illiquid assets in relatively high proportion of your balance sheet if you’re subject to the leverage ratio.”

What does that mean in real terms? It means that companies looking for long-term financing, say of capital projects, are looking elsewhere for that type of capital.  Becker notes some experts think that “life insurers and other firms with long-dated, illiquid liabilities might be a more natural home for financing of this type than banks.”

Of course, from a risk perspective, that means that longer-term, less-liquid risk concentrations are simply moving into less-regulated, non-banking sectors. Regulators, however, notes the author, “are not about to allow risk concentrations to build up outside the banking industry.” That all sounds well and good, but if there is one thing the history of financial risk demonstrates is that regulators like to arrive late to a risk event; and if, in fact, Basel III is pushing this specific type of financial risk into less-regulated sectors, then making sure these new risk pools are understood must be a imperative for investors, risk managers, as well regulators. Moreover, if it’s true the new regulatory costs are going to follow these long-term exposures into sectors such as insurance, then one wonders what the new regulatory burdens will do the cost of borrowing in these non-banking markets. If the risk-regulatory premium is high enough, will it push borrowers to more opaque funding sources, once again taking financial risk with them?

I always note to clients that risk cannot be lowered without decreasing its source, i.e., volatility. If the risk of long-term projects is a given, risk flows will move with capital flows, and, as recent history shows, capital and credit are much more agile than international banking regulations. This is an issue to watch in the future.

Read more:

http://www.risk.net/risk-magazine/news/2337828/regulators-worry-about-bank-deleveraging

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Posted by Carlos Alvarenga

Carlos Alvarenga is the Executive Director of World 50 ThinkLabs and an Adjunct Professor at the University of Maryland's Smith School of Business.

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