Risk Annual Summit: Bank deleveraging 'might not be cyclical'

Aircraft, shipping and project finance all set to lose out as banks seek to constrain capital consumption, panellists warn

The current round of bank deleveraging might see lending volumes sink to a permanently lower level, according to panellists at the Risk Annual Summit in London this morning – a trend driven by incoming bank capital rules, with aircraft, shipping and project finance set to suffer the most.

"The deleveraging we see might not be cyclical. In Europe, where credit intermediation is done primarily by banks rather than capital markets, that may not be desirable," warned Barbara Frohn, special adviser to the chief executive at Santander in Madrid. "I can imagine shipping finance, aircraft finance, credit facilities and bridge facilities all disappearing. You will see more loans and fewer credit facilities."

In itself, bank deleveraging will not come as a surprise to regulators, said Federico Galizia, head of risk management and monitoring at the European Investment Fund: "I do think regulators set out to shrink the banking sector – both domestic and global banks – and to disconnect banks from each other. It is a deliberate deleveraging and disconnecting push."

That push has been accelerated, in Europe at least, by a European Banking Authority (EBA) recommendation for banks to temporarily achieve a minimum 9% core Tier I capital ratio, said John Liver, a partner and regulatory specialist at Ernst & Young. The EBA made its call on December 8, and gave banks until the end of June to comply.

While broad deleveraging might be an intended consequence of regulatory reform, market participants are less impressed, said Santander's Frohn. In recent months, HSH Nordbank, Lloyds Banking Group, Royal Bank of Scotland and Société Générale have all announced plans to sell or scale back aircraft and shipping finance portfolios – and Frohn said the resulting shortage of finance was discussed at the Group of 20 (G-20) meeting in Mexico at the end of February.

The deleveraging we see might not be cyclical. In Europe, where credit intermediation is done primarily by banks rather than capital markets, that may not be desirable

"At the G-20 in Mexico, there was a clear realisation of this. The treasurer of Airbus was complaining because the company's customers can't get financing, meaning they can't sell planes – so we need to be aware of the negative consequences," she said.

Speaking to Risk after the panel discussion, Frohn said aircraft, shipping and project finance will suffer under the Basel III capital regime because they tend to be long-dated exposures – which produce higher probability of default numbers – and because many banks are unable to accurately model the risk associated with the businesses.

"They don't have a history of defaults, and the portfolios are not homogenous. Even if you had an enormous portfolio of energy projects, it would still not be homogenous because you could have one in Brazil, one in Nigeria – and supervisors will not accept the models as a result. What you end up with is a slotting approach, which is devastating," she said.

In a slotting approach, supervisors allow banks the freedom to model capital requirements up to a point, but set a minimum floor.