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| Sherif Lotfi, Managing Director, Corporate Advisory at RBS |
The US is implementing comprehensive reform in the form of the Dodd-Frank Act. There will be winners and losers. Among the former are companies with strong credit ratings and a large wallet who will feel less pain, regardless of their location, as their access to capital will be undiminished. Estimates vary as to how dramatic the impact of regulation might be. According to the Bank for International Settlements (BIS) a wide range, from 20 basis points to 200 basis points, covers those on the increased cost of lending, while the toll on GDP growth is reckoned between 0.5 per cent and 3 per cent.
It is not surprising then to find some US politicians are putting pressure on the government to conduct a quantitative impact study to see how Basel III will affect the country’s banking sector and economy. The process has echoes of Basel II. The move to introduce that proceeded slowly and, according to the BIS, as of September last year had yet to be fully implemented in the US.
The Basel committee, which draws up the rules, cannot force Basel III on local regulators. No country is obliged to adopt them. There are questions over their implementation in the UK and Europe as well as the US. Deadlines have already come and gone and the implementation of some parts of Basel III have been delayed – often reflecting real business concerns.
Many are worried if the US fails to implement Basel III then its banks would clearly have a cost of capital very different from their European peers. In turn, this would allow its companies to benefit from lower financing costs than counterparts elsewhere in the world where the finance sector is under the Basel III yoke.
It is important, however, to look at the combined impact of regulations. Even if Basel III is not fully implemented in the US, the country’s regulators are introducing a myriad of others under the auspices of the Dodd-Frank Act, covering derivatives and proprietary trading (the Volcker Rule), consumer lending and the asset-backed market among others. These rules could be tougher than those imposed in Europe and elsewhere in the world.
In totality, the combined rules and the current economic reality are forcing banks to rethink their business models, which clients they serve, which services they provide and in which geographies they operate. Banks will try to increase their prices and fees, change their business mix towards those areas needing less capital and generating higher returns, while focusing on customers who need less capital and give the bank more business.
In many countries, companies with strong credit ratings will still enjoy liquidity in the bank markets and bond markets. Multinationals such as Caterpillar, P&G, Disney, Tesco and Vodafone will still be well served. Others, such as some smaller-to-mid-sized companies may suffer. Banks in the US and Europe have already started to be more selective in their clients and the products and services they provide.
Further, the combination of the weak economy, increased regulatory charges and concerns over impending regulations has made a number of capital markets less efficient because of lower liquidity. In the US bond markets, for example, inventories of primary dealers have fallen 75 per cent from their peak.
From a corporate perspective, it adds up to a reduced set of financial services that cost more. Although there are some factors, such as an increased investment in information technology, that can help lower costs, it is likely there will remain less flexibility in financial services.
Responses from banks will include investing in technology to provide more automation in order to drive down costs, while companies will look to emerging non-bank providers of financial services.
Whether the US implements Basel III in full or not, banking and corporate financing is set to undergo radical change.
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