Treasury Today Country Profiles in association with Citi
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July/August 2011

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Unintended consequences

Regulation puts pressure on costs

The regulatory threat extends beyond banks to their corporate clients.

There are strains appearing in the financial system that are not purely attributable to the financial crisis. The new rules and legislation being introduced by regulators and governments around the world are intended to tame the banking system and make the financial markets safer. But there are unintended consequences emerging that will have an impact on many corporates.

The new Basel rules will have the broadest impact as banks are forced to put capital against parts of their business previously enjoying much lower ratios or, in some cases, having no capital charge at all. Not because these parts of the businesses were the cause of significant losses in the crisis but because there is a perceived risk that a regulator or a politician wants covered.

Letters of credit look set to become more expensive as increased capital is allocated against this type of exposure. Capital on which a return must be earned. So, just as companies are understandably doing less open account business, the cost of the alternatives is rising. As such, the effect on international trade – if the lobbyists do not succeed – is unclear.

Other Basel rules will direct banks to fund themselves with more stable (longer term) deposits. Banks will have less interest in the short end of the market, which is where increasingly cash rich companies will still want to invest. There might be an opening here for opportunistic short-term borrowing in the capital markets by corporates. But they will find the short-term back-up lines required by the rating agencies for such facilities are also being caught by new capital guidelines. Put simply, the costs will go up.

Never mind – for investors, the money funds will surely still provide attractive short-term rates? Well, maybe. But the money funds expect to be caught by new shadow banking legislation and the fund managers may have to provide capital or some other form of support for CNAV (Constant Net Asset Value) funds. This will have to be paid for, so the returns to investors will go down.

And anyway, under new accounting rules, the ‘cash equivalents’ category is expected to disappear. Quite rightly this recognises that some assets being reported as cash equivalents were not. Quite wrongly this may catch money fund investments as well.

We will be writing more about these issues in the months to come. The game of unintended consequences has only just begun.