While Wall Street is pulling out all the stops to curb ‘Basel III Endgame’, private lenders are in pole position for implementation of the banking rules. The price at which US big banks can borrow money will be skillfully undercut by private credit funds, but critics in the banking sector denounce the lack of effective supervision of the ‘non-bank’ lenders.
CEOs on Wall Street believe regulators are overstepping their bounds by tightening the rules. Like in Europ, the Basel III Endgame, the latest stage of global financial reforms proposed by the Basel Committee on Banking Supervision, will increase borrowing costs for consumers, businesses and property owners in the US, the argument goes. The US discussions echo a similar one that has been taking place for years already in Europe, where many but not all of the Basel III requirements have already been entered into law.
The Federal Reserve said US banks’ equity will have to increase by an estimated 16 percent. A much-needed reform, said the regulator, especially following the collapse of some mid-sized US banks last year. The proposed endgame, more than 1,000 pages long, forces banks with more than 100 billion dollar under management to have higher buffers and changes to rules on risk measurements from mid-2025. Banks had until 16 January to submit adjustments to the provisional rules.
The banking sector objects and now is said to bring a gun to a knife-fight. A “damaging” plan, JPMorgan CEO Jamie Dimon bitched to Congress in Washington DC. Morgan Stanley’s now-resigned board chairman James Gorman has called the proposed rules “completely unnecessary” for an industry that is already “abundant in cash and subject to a plethora of stringent regulation”. Banks’ gripes are further amplified by lobby groups like the Bank Policy Institute, which runs an assertive campaign website to influence Congress. Since last week, the industry has been threatening to sue the regulator if the rules are not amended.
Holding billions in additional capital will make it less attractive to take risks on private credit, banks argue. Private credit still accounts for only a third of all loans to ordinary Americans. That’s grist to the mill for private credit investors.
‘Best opportunity for private credit since 2008’
Pimco sees the “best potential opportunity” for private credit markets since the 2008 financial crisis. It forecasted that some 3,600 billion dollars of commercial real estate loans in the US and Europe will mature by 2025, many of which may not be eligible for renewal. The “problem” of withdrawal by banks is exacerbated by similar declines in other lenders typically relied upon for real estate financing, such as listed mortgage REITs and CMBS issuers, which have their own challenges. As a result, Pimco expects many opportunities to arise in real estate-related credit.
Bruce Richards, CEO of Marathon Asset Management, a US asset manager with a focus on the credit market, argued that US banks have no choice but to conform to the new reality. He said the beckoning lack of real estate loans is precisely the most obvious and immediate opportunity for private credit providers, as banks reduce their exposure to this asset class.
Matthew Bass, head of private alternatives at Alliancebernstein, said he expects the new rules to force many banks to lend less and less, and shed some of the loans already on their balance sheets.
Real estate loans
“It is true that banks are reducing their commercial real estate lending, leaving more capital for other things. Banks are likely to face increasing losses on their outstanding commercial real estate loans, both in the US and in the EU. This could further erode their capital buffers, in addition to the effects of higher interest rates,” said Tomasz Piskorski, professor of real estate finance at Columbia Business School.
But, the effect of raising capital requirements on overall lending is unlikely to be as large as often claimed by banks, he says. Banks may sell their loans in different markets, migrating their loans to “non-banks”.
“In fact, I expect that in response to the increased capital requirements, banks will raise some equity, sell more loans and we will also see a growth in non-bank lending,” Piskorski told Investment Officer.
‘Non-bank’ risks
However, the banking industry itself warns against repeating mistakes - read: ignoring obvious risks - that actually proved fatal to the financial sector in 2008.
According to Sayee Srinivasan, chief economist at the American Bankers Association (ABA), “non-banks” such as private credit funds that offer many classic banking services but are not subject to the same rules have a competitive advantage. They operate without capital requirements, risk management rules and permanent regulators examining their books and records, according to the ABA. “This competitive advantage undermines the price at which banks provide credit,” warned Srinivasan.
Emphasising the need for capital requirements, Srinivasan said that “poorly capitalised private credit funds” can disrupt the market by disappearing when the economy turns. She said some of these these non-bank lenders may not be able to survive without Federal Reserve support, as seen earlier with non-bank mortgage lenders.