New regulations that require banks to hold more capital are already reducing the flow of credit to small and medium-sized enterprises (SMEs) according to law firm Allen & Overy, which adds that proposals to increase controls on non-bank lenders “raise serious questions” over whether they will be able to offset the resulting funding gap.
The firm’s report, entitled ‘The Future of Credit’, was commissioned in anticipation of The Financial Stability Board’s (FSB) paper on tougher oversight and regulation of alternative credit providers. It follows last month’s announcement by the FSB that it intends to address the threats posed by the sharp rise in so-called ‘shadow banking’.
“There is an opportunity to give alternatives a foothold but regulators are dithering about what they would like them to do,” said Etay Katz, a regulatory partner at Allen & Overy. “If I was an asset manager running an unregulated fund, I’d be scratching my head and wondering, when is there going to be a knock at the door [from regulators].”
"We are four years down the line and if you ask the man in the street, do we have a much safer system, I'm not sure you would not get a positive reaction." Katz noted. The volume of new regulation also risked producing unexpected results. “You suffocate known quantities,” he added. “And you never know what will come out of the unknown. [Regulation] is a supertanker. When we discover we’ve done too much, it’ll take five years to paddle back.”
According to the law firm’s report, the years ahead will be marked by banks focusing on “complex and large lending transactions leaving small businesses struggling to find affordable credit”. While investment funds, insurers and asset managers could potentially develop as alternative sources of corporate credit as bank lending on both sides of the Atlantic declines, this ability is hampered by measures such as the Basel III capital adequacy regime, the US Dodd-Frank Act and new EU directives on investment management, securities and derivatives trading.
Allen & Overy assessed 11 categories of lending and market finance in 13 key jurisdictions across the world. It concludes that both the new bank rules and also regulation aimed at making derivatives markets and hedge funds safer will also have the effect of making credit more expensive.
While new US legislation will, at best, have a neutral effect on lending and at worst make it more difficult, there are better opportunities for alternative sources of credit to fill the gap in regions such as Singapore, Russia and the Netherlands, the study adds.
The report also suggests that, in addition to deposit-taking and investment banks, among the worst hit investors under new regulations are European Undertakings for Collective Investment in Transferable Securities (UCITS), US bank and non-bank holding companies, and Chinese trust companies.