By: Scott Hibbard
The global financial crisis of 2008 drew attention to failures by financial services institutions to adequately manage their risks. Governments and regulatory bodies around the world have responded with a spate of new laws and regulations, including the Dodd-Frank Act, the Basel III framework, expanded anti-money laundering and Know-Your-Customer requirements, as well as updates to the European Union's (EU’s) Markets in Financial Instruments Directive (MiFID) and Infrastructure Regulation (EMIR), and many others. In combination, these new guidelines will have a significant impact on how banks do business—which will necessarily impact their relationships with corporate clients. Though in the case of Basel III, there remains much ambiguity about the final form and timetable as the implementation date as it has been extended (twice) to March 31, 2018.
What are the biggest legislative and regulatory changes on the horizon for banks today?
The first is capital; all kinds of transactions will now require more capital from banks. Basel III, in particular, might have a really punitive effect on banks in terms of the capital they must hold. Prices of financial products will be affected, with the creditworthiness of the corporate customer determining the size of the impact. Banks are likely to prefer corporate customers with better ratings and products with shorter maturities.
How will the derivatives market be affected?
In derivatives trades (i.e. futures, forwards, swaps and options - hedging products designed to manage pricing risk, such as foreign currency exchange contracts, and interest rate swaps that lock all or part of a floating loan rate into a fixed loan rate), banks will be heavily impacted by the increase in counterparty (borrower) credit charges imposed by the CVA [credit valuation adjustment] capital charge. It’s new in Basel III. Banks are currently running the numbers to understand how the CVA capital charge will impact their funds transfer pricing which will obviously be felt by their corporate clients.
Other factors at work to either increase or lower prices for corporate banking clients?
Another area in which we see the new regulations affecting banking relationships is around documentation. Banks are going to have to start doing a great deal more reporting to regulatory bodies to evidence compliance. For instance, they will have to report details of derivatives contracts to regulators and will have to provide clients with more information about a range of products. This will require larger bank administrative staff for regulatory compliance (non-revenue producing) activities.
Lastly, under Basel III increased capital requirements include specific types of mandated liquidity that banks must maintain on their balance sheet. These liquidity thresholds are significantly more and higher quality “cushions” on their balance sheet to withstand market turbulence. This will definitely have an impact on pricing, but they will also have an impact on loan/product structure (i.e. preference for shorter term transactions) –possibly even reduced product offerings by some banks, because of increased capital and liquidity types the banks need to hold.
Are there any steps that corporate banking customers can take now to prepare for changes that may be coming from their banks as a result of all these new regulations?
Companies need to understand that every bank will choose to respond in a different way to deal with the incoming regulations. Some banks are proactive, others are taking a “wait and see approach”. Corporate banking clients should monitor their banks regularly, asking “What’s the current state? What is the strategy? Where are they going?” Can their bank even support the new requirements? Are they able to offer the same products?
While a lot of uncertainty remains as the new evolving regulations are phased in, and banks themselves are trying to absorb the full impacts of the new regulations on their business model, such questions can lead to a better understanding on how prepared and capable a bank is to operate effectively in the new regulatory landscape.