Coming insurance “Solvency II” rules could end up squeezing banks and in turn, borrowers.
In trying to control excessive risk-taking in the insurance industry, regulators may be putting the squeeze on banks. European regulators will by 2013 introduce new capital rules, otherwise known as Solvency II, requiring insurers to more closely match the capital they hold with the risks on their books.
But in doing so, according to the Wall Street Journal, insurers may be less willing and able to lend to banks just as more capital and longer-term funding is needed. That could make credit harder to come by for European corporates — and more expensive.
Solvency II is a set of regulatory requirements for insurance companies operating in the European Union and scheduled to come into effect on January 1, 2013. The goal is to establish a set of European-wide capital requirements and risk management standards that will replace current solvency requirements. Like other regulations coming into play post-economic crisis, the complaints about the new rules have been loud and widespread.
The problem that Solvency II poses for European banks, according to the WSJ, is that the new capital rules may push more investment into lower-risk instruments such as government bonds, which carry zero capital requirements. This will make highly-rated and short-term securities less costly to hold than lower-rated or long-dated ones. But under Basel III, banks are being asked to “better match assets and liabilities by increasing longer-term borrowing to reduce liquidity risk and to raise more capital in equity and equity-like instruments” – the Tier 1 capital. This may mean less of an appetite for European banks’ senior debt, which many banks rely on for funding.
And as it stands, senior bank debt already is on shaky ground. Just last fall the European Union and the International Monetary Fund floated the idea of having Ireland’s senior debt holders help pay for Ireland’s bailout; that idea received more support recently when Ireland’s fianance minister warned that bondholders will have to “share the pain.” This has helped lead to a dramatic drop off in euro unsecured bank debt. To make up for the decrease in senior debt, banks might begin relying more on covered bonds, which, although also a cheap funding source, carry a heavier burden, i.e., the collateral that covers them are usually the mortgage loans the bank holds; those instruments also remain on the banks balance sheet.
The net effect is that it may force banks to shrink balance sheets and reduce the availability of credit.
The concerns surrounding credit access and pricing in Europe continues an ongoing theme. Last fall, the European Association of Corporate Treasurers conducted a survey that showed the cost of credit continuing to climb (see related story here). In the survey, 55 percent of the companies reported that pricing of “uncommitted” lines of credit increased over the last year with 38 percent reporting “committed” line increases. So far this trend has not spread to the US where credit is a bit easier to secure, but it bears watching.