04 November 2013

Fitch: Basel III spurs rise in European G-SIB sovereign exposure; corporates, interbank lending drop

Since the new rules were finalised in December 2010, G-SIBs have increased their total exposure to sovereign debt by €550 billion, while reducing their exposure to corporates by €440 billion.

Fitch's analysis indicates that Basel III already appears to be influencing banks' capital management, exposure allocation, and credit strategies. The European G-SIBs have largely been reallocating credit across sectors rather than making meaningful reductions to their overall risk exposure. The shifts observed in Fitch's study reflect a migration from capital intensive to less capital intensive exposures, consistent with the incentives created by Basel III's more conservative risk-based capital ratios. At the same time, given eurozone market volatility and economic pressures, slack loan demand and elevated sovereign spreads could also have contributed to some of these shifts.

Apart from sovereign debt, residential mortgages were the only asset class that saw lending rise, as European banks increased their exposure by €275 billion, or 12 per cent, between year-end 2010 and year-end 2012. Lending to financial institutions, non-mortgage retail lending, and securitisation each declined by about €170 billion - representing a roughly 9 per cent decline in exposure to financial institutions and retail and an almost 30 per cent drop in exposure to securitisation.

Fitch notes that while Basel III is intended to strengthen banks' capital and liquidity, the new rules could create some potential unintended outcomes, particularly if they result in reduced credit availability to certain sectors or a decline in market liquidity if banks reduce their trading and counterparty activities. A broader macro-economic question is whether Basel III might be encouraging banks to lend to the public sector at the expense of private sector credit availability.

The proposed leverage ratio might neutralise some of these incentives going forward. Unlike both the risk-based capital and liquidity ratios, the leverage ratio provides no benefit to holding sovereign exposures and does not distinguish between higher-quality versus riskier corporate exposures. If the leverage ratio were to become a binding constraint within banks' capital management, the shift from corporates to sovereigns could stall and might even reverse.

Fitch's study, entitled 'Basel III: Shifting the Credit Landscape' represents the first attempt that the agency knows of to quantify the effects of banks' Basel III preparations on credit flows and lending patterns. The study is based on Pillar 3 data through year-end 2012, the latest data available for the full sample of 16 European G-SIBs. These G-SIBs represented a total of €21 trillion in assets and €13.5 trillion in credit risk exposure as of end-2012.

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