Europeans to feel new finance rules 'more harshly' than US: S&P

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Stricter regulatory frameworks for banks and insurers is likely to increase the cost of borrowing for European corporates more than for their US counterparts, says Standard & Poor's Ratings Services in a new report.

The Basel III and Solvency II regulations, due to come into force in stages between 2013 and 2018, are likely to result in a "repricing and even a rationing of credit for corporates globally, and change the behavior of lenders and borrowers," said Standard & Poor's.

Yet, European corporates will feel the effect "more harshly" than their US counterparts because they typically rely more heavily on banks for funding relative to capital market sources.

"Based on our simulations and certain assumptions, we calculate that the additional bank borrowing costs in the eurozone for corporates would be very large and range between €30 billion and €50 billion per year once the regulations are fully implemented by 2018," said Blaise Ganguin, Standard & Poor's chief credit officer for Europe. "In contrast, we believe the impact would be significantly smaller for those borrowing from US banks, ranging from $9 billion to $14 billion."

This represents an increase of between 10% and 20% over current interest costs for corporate borrowers in Europe and the US, depending on banks' return on equity targets of 8%-15%.

"Our calculation is based on the assumption that, because banks will have to retain higher capital levels under Basel III, and will also face higher liquidity and funding ratios, they will have to raise their profitability thresholds on lending margins."

Certain banks will have to raise "substantial amounts of capital" to be Basel III-compliant, the report said.

The Committee of European Banking Supervisors in December 2010 estimated that the largest European banks will have to raise about €260 billion externally or through increased earnings' retention.

"If they can't and current equity market conditions are less than conducive to capital-raising for banks, the stark alternative will be to deleverage to meet the new prudential standards," the report said.

This, in turn, "could lead to serious credit rationing in Europe, and hurt primarily firms with no access to the capital markets."

Standard & Poor's believes European corporates will "increasingly turn to the capital markets" as bank financing becomes pricier and the terms and conditions more restrictive as a result of the new regulations.

"Nevertheless, we believe that in the near term some of the less diversified, highly leveraged corporate entities, or those firms that simply did not want

to contend with public disclosure requirements in Europe, could find themselves scrambling for cash," said Ganguin.