Tighter regulations sought on credit

Mark Campbell, partner, Clifford Chance

David Morley, managing partner, Allen & Overy

John Tucker, head of banking, Linklaters & Alliance

The Bank of International Settlements recently produced a new set of regulatory proposals for banks that will tighten up the rules on the amount of capital they have to hold in return for lending money.

Called the Basle Accord, the rules are a tacit admission that during the recent Asian financial crisis, adequate safeguards in terms of capital holdings were not in place.

If the proposals are accepted by the European Union after the consultation period, which expires next March, there will be a less blanket approach to risk assessment. In the future, the amount of capital that banks are obliged to hold to offer protection against non-payment of a loan will alter with the credit rating of the bank or company borrowing the money.

But do the proposals go far enough and what impact will they have on the world of banking and corporate loans?

Mark Campbell, banking partner at Clifford Chance, says: "It reflects reality in the sense that banks are going to put a premium on lending to risky ventures, though banks have always charged more for credit if the company's credit rating is low. The intention is not to make the rules less or more restrictive but to try to make banks think more about where they place their money, rather than how much they lend."

Ratings agencies such as Standard & Poor's or Moody's, which assess the credit worthiness of companies, stand to do well out of the proposals, as the banks will be required to hold less capital for higher-rated companies, which will push more companies to become rated.

Also, under the current regulations, a loan agreement that is agreed for less than a year and is not used attracts a nil rating. This financial loophole will disappear and will in future attract a 20 per cent risk weighting.

"This is a slight oddity," says Allen & Overy's managing partner of the banking department, David Morley. "The fact that the proposals are to get rid of it means that in future the banks will concentrate on the actual deal rather than squeezing it into less than a year." (The 364-day agreement is currently a very popular way of getting cheaper finance).

Morley believes that the gap between the credit deal available for companies with a high rating and those with a poor rating will widen.

"The better the rating given to the company, the more cheaply it can borrow because the capital required is lower. So the proposals are likely to widen that gap between the better companies and those lower down," he says.

The proposals also include a suggestion that the categories of collateral accepted as security for a loan will be extended.

"At the moment there is a very limited and tight category of cash or near-cash assets that is accepted," explains John Tucker, head of banking at Linklaters & Alliance.

"If this is widened, the new collateral will have to be supported by strong legal opinion. Lawyers will have a very strong role in determining what will be accepted by the banks," he says.

Tucker also points out that there is a loophole in the new proposals which could be exploited by companies with a low credit rating.

In addition banks will no longer be treated as a homogenous body with a single risk weighting (currently 20 per cent) but will be subject to the same credit ratings as corporates.

"If your company has a credit rating of B-minus then the risk weighting is 150 per cent, but if it is unrated then it is just 100 per cent. That means there may be an incentive for companies to give up their rating," he says.

Although the new system will put great power into the hands of rating agencies that are private bodies, Tucker sees no problem in this. "Credit ratings are a long-standing tradition in the US – and what other method do we have for credit opinions?" he says.